<PAGE>
As filed with the Securities and Exchange Commission on February 13, 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. 34 [x]
and
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [x]
AMENDMENT NO. 36 [x]
_____________________________________________
BLACKROCK FUNDS /SM/
(Formerly, Compass Capital Funds/SM/)
(Exact Name of Registrant as Specified in Charter)
<TABLE>
<S> <C> <C>
Bellevue Corporate Center Brian Kindelan, Esq. copy to:
400 Bellevue Parkway PNC Bank Corp. 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)
[ ] immediately upon filing pursuant to paragraph (b)
[ ] on August 20, 1997 pursuant to paragraph (b)
[ ] 60 days after filing pursuant to paragraph (a)(i)
[ ] on (date) pursuant to paragraph (a)(i)
[X] 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.
Registrant has previously registered an indefinite number of shares of
beneficial interest under the Securities Act of 1933, as amended, pursuant to
Rule 24f-2 under the Investment Company Act of 1940, as amended. Registrant's
24f-2 Notice for the fiscal year ended September 30, 1997 for all investment
portfolios was filed on December 9, 1997.
<PAGE>
BLACKROCK FUNDS
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
Item Number
Form N-1A, Prospectus Statement of Additional
Part A Caption Information Caption
- ------ ------- -------------------
<S> <C> <C>
1 Cover Page
2 What Are The Expenses Of The Portfolios? Expenses
3(a) Not Applicable Performance Information
3(b) Not Applicable
3(c) How Is Performance Calculated?
4(a),(b) Cover Page; What Are The Portfolios?; What Investment Policies;
Additional Investment Policies And Risks Additional Information Concerning
Apply?; What Are The Portfolios' Shares
Fundamental Investment Limitations?; How Is
The Fund Organized?
4(c) What Are The Portfolios?; What Additional Investment Policies
Investment Policies And Risks Apply?
5 Who Manages The Fund? Trustees and Officers
5A Not Applicable
6(a),(b),(c) What Are The Shareholder Features Of The Shareholder and Trustee Liability
Fund?; How Frequently Are Dividends And of
Distributions Made To Investors?; How Is The the Fund; Additional Information
Fund Organized? Concerning Shares; Miscellaneous
6(d) Not Applicable
6(e) How Can I Get More Information?
6(f) How Frequently Are Dividends And
Distributions Made To Investors?
6(g) How Are Fund Distributions Taxed? Taxes
6(h) What Pricing Options Are Available To
Investors?
7(a) How Are Shares Purchased? How are Shares Purchase And Redemption
Purchased And Redeemed? Information
7(b) How Is Net Asset Value Calculated?; What Is Purchase And Redemption
The Schedule Of Sales Charges And Information
Exemptions?
7(c) What Is The Schedule Of Sales Charges And
Exemptions?
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Item Number
Form N-1A, Prospectus Statement of Additional
Part A Caption Information Caption
- ------ ------- -------------------
<S> <C> <C>
7(d) How Are Shares Purchased?; How Are Shares
Purchased And Redeemed?
7(e) Not Applicable
7(f) Who Manages The Fund? Investment Advisory,
Administration, Distribution And
Servicing Arrangements
7(g) What Is The Schedule Of Sales Charges And
Exemptions?
8(a),(b),(c), How Are Shares Redeemed?; How Are Purchase And Redemption
(d) Shares Purchased And Redeemed? Information
9 Not Applicable
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Item Number
Form N-1A, Prospectus Statement of Additional
Part B Caption Information Caption
- ------ ------- -------------------
<S> <C> <C>
10 Cover Page
11 Table of Contents
12 Not Applicable
13(a),(b),(c) What Additional Investment Policies And Investment Policies
Risks Apply?
13(d) Not Applicable
14(a) Trustees And Officers
14(b) Not Applicable
14(c) Trustees And Officers
15(a) How Is The Fund Organized? Miscellaneous
15(b) Not Applicable
15(c) Trustees And Officers
16 Who Manages The Fund? 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) What Are The Shareholder Features Of The Additional Information
Fund?; How Frequently Are Dividends And Concerning
Distributions Made To Investors?; How Is The Shares
Fund Organized?
18(b) Not Applicable
19(a) How Are Shares Purchased?; How Are Shares Purchase And Redemption
Redeemed?; How Are Shares Purchased And Information
Redeemed?; What Are The Shareholder
Features Of The Fund?
19(b) How Is Net Asset Value Calculated? Valuation Of Portfolio Securities
19(c) Purchase And Redemption
Information
20 How Are Fund Distributions Taxed? Taxes
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Item Number
Form N-1A, Prospectus Statement of Additional
Part B Caption Information Caption
- ------ ------- -------------------
<S> <C> <C>
21(a) Who Manages The Fund? Investment Advisory,
Administration, Distribution And
Servicing Arrangements
21(b) Not Applicable
21(c) Not Applicable
22(a) Not Applicable
22(b) How Is Performance Calculated? Performance Information
23 Not Applicable
</TABLE>
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>
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 prospectuses for the Service, Investor A, Investor B, Investor C and
Institutional Shares of the Micro-Cap Equity Portfolio, 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 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 prospectus for the shares of the Multi-Sector Mortgage Securities Portfolio
III, 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 prospectus for the shares of the BlackRock Strategic Portfolio I and the
BlackRock Strategic Portfolio II, 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 statement of additional information 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, Select
<PAGE>
Equity and Micro-Cap Equity Portfolios, and 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 a definitive
copy under Rule 497 under the Securities Act of 1933, as amended (the
"Securities Act") on February 2, 1998.
The statement of additional information for the Multi-Sector Mortgage Securities
Portfolio III, 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 2, 1998.
The statement of additional information for the BlackRock Strategic Portfolio I
and the BlackRock Strategic Portfolio II, 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 2, 1998.
<PAGE>
, 1998
- --------------------------------------------------------------------------------
THE DELAWARE TAX-FREE INCOME AND KENTUCKY TAX-FREE INCOME PORTFOLIOS INVESTOR
SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASKING THE KEY
QUESTIONS
<S> <C>
What Are The Expenses Of The Portfolios?..................... 4
What Are The Portfolios?..................................... 6
What Are The Characteristics Of The Portfolios?.............. 7
What Types Of Securities Are In The Portfolios?.............. 8
What Are The Portfolios' Fundamental Investment
Limitations?................................................ 9
What Additional Investment Policies And Risks Apply?......... 10
Who Manages The Fund?........................................ 17
What Pricing Options Are Available To Investors?............. 21
What Are The Key Considerations In Selecting A Pricing
Option?..................................................... 23
How Are Shares Purchased?.................................... 24
How Are Shares Redeemed?..................................... 25
What Are The Shareholder Features Of The Fund?............... 27
What Is The Schedule Of Sales Charges And Exemptions?........ 29
How Is Net Asset Value Calculated?........................... 33
How Frequently Are Dividends And Distributions Made To
Investors?.................................................. 33
How Are Fund Distributions Taxed?............................ 34
How Is The Fund Organized?................................... 37
How Is Performance Calculated?............................... 38
How Can I Get More Information?.............................. 39
</TABLE>
This Prospectus sets forth concisely information about the Black-
Rock Delaware Tax-Free Income and Kentucky Tax-Free Income (col-
lectively, the "Portfolios") that a prospective investor needs to
know before investing. Please keep it for future reference. A
Statement of Additional Information dated , 1998 has been
filed with the Securities and Exchange Commission (the "SEC").
The Statement of Additional Information may be obtained free of
charge from BlackRock Funds /SM/ (the "Fund") by calling
(800) 441-7762. The Statement of Additional Information, as
supplemented from time to time, is incorporated by reference into
this Pro-spectus. 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.
SHARES OF THE PORTFOLIOS ARE NOT DEPOSITS OR OBLIGATIONS OF, OR
GUARANTEED OR ENDORSED BY, PNC BANK, NATIONAL ASSOCIATION OR ANY
OTHER BANK AND ARE NOT INSURED BY, GUARANTEED BY, OBLIGATIONS OF
OR OTHERWISE SUPPORTED BY THE U.S. GOVERNMENT, THE FEDERAL DE-
POSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY
OTHER GOVERNMENTAL AGENCY. INVESTMENTS IN THE PORTFOLIOS INVOLVE
INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF PRINCIPAL AMOUNT IN-
VESTED.
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 AC-
CURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE. SHARES OF THE STATE-SPECIFIC TAX-FREE PORTFOLIOS ARE INTENDED
ONLY FOR RESIDENTS OF THE RESPECTIVE STATES INDICATED.
2.
<PAGE>
- --------------------------------------------------------------------------------
THE DELAWARE TAX-FREE INCOME AND KENTUCKY TAX-FREE INCOME PORTFOLIOS OF
BLACKROCK FUNDS
- --------------------------------------------------------------------------------
The BLACKROCK FUND family consists of 35 portfolios and has
been structured to include many different investment styles so
that investors may participate across multiple disciplines in
order to seek their long-term financial goals.
Effective January 31, 1998, the Fund has changed its name from
Compass Capital Funds /SM/ to BlackRock Funds /SM/.
The Delaware Tax-Free Income and Kentucky Tax-Free Income Port-
folios of BLACKROCK FUNDS are two of fourteen investment port-
folios (the "Portfolios") that provide investors with a broad
spectrum of investment alternatives within the fixed income
sector. Eight of these Portfolios invest in taxable bonds, and
six of these Portfolios invest in tax-exempt bonds. A detailed
description of the Delaware Tax-Free Income and Kentucky Tax-
Free Income Portfolios begins on page . To obtain a prospectus
describing the Fund's other fixed income portfolios, call (800)
441-7762.
BLACKROCK PERFORMANCE LIPPER PEER GROUP
PORTFOLIO BENCHMARK
Other States Intermediate
DE TAX-FREE Lehman Local Muni Debt Funds
INCOME GO Index
KY TAX FREE Lehman Local KY Municipal Debt
INCOME GO Index
BlackRock, Inc. serves as investment adviser to the Portfolios.
BlackRock Financial Management, Inc., an affiliate of Black-
Rock, Inc., serves as sub-adviser to each of the Portfolios.
UNDERSTANDING This Prospectus has been crafted to provide detailed, accurate
THE and comprehensive information on the BlackRock Delaware Tax-
BLACKROCK Free Income and Kentucky Tax-Free Income Portfolios. We intend
DELAWARE this document to be an effective tool as you explore different
TAX-FREE directions in fixed income investing.
INCOME AND
KENTUCKY
TAX-FREE
INCOME BOND
PORTFOLIOS
CONSIDERING There can be no assurance that any mutual fund will achieve its
THE RISKS IN investment objective. Both of the Portfolios may purchase il-
BOND liquid securities; enter into repurchase and reverse repurchase
INVESTING agreements and engage in leveraging, which is a speculative
technique; lend portfolio securities to third parties; and en-
ter into futures contracts and options. Each of the Delaware
Tax-Free Income and Kentucky Tax-Free Income Portfolios is a
state-specific tax-free portfolio which concentrates in the se-
curities of issuers located in a particular state, and is non-
diversified, which means that its performance may be dependent
upon the performance of a smaller number of securities than the
other bond portfolios of the Fund, which are considered diver-
sified. See "What Additional Investment Policies And Risks Ap-
ply?"
INVESTING IN For information on how to purchase and redeem shares of the
THE Portfolios, see "How Are Shares Purchased" and "How Are Shares
BLACKROCK Redeemed?"
FUNDS
3.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ARE THE EXPENSES OF THE PORTFOLIOS?
- --------------------------------------------------------------------------------
Below is a summary of the annual operating expenses and shareholder transaction
expenses expected to be incurred by Investor Shares of the Portfolios for the
current fiscal year as a percentage of average daily net assets. The figures
shown under "Other expenses" are estimates for the current fiscal year. An ex-
ample based on the summary is also shown.
<TABLE>
<CAPTION>
DELAWARE TAX-FREE KENTUCKY TAX-FREE
INCOME PORTFOLIO INCOME PORTFOLIO
INVESTOR A INVESTOR B INVESTOR C INVESTOR A INVESTOR B INVESTOR C
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
SHAREHOLDER TRANSACTION
EXPENSES
Maximum Front-End Sales
Charge(/1/)
(as a percentage of
offering price) 4.0% None None 4.0% None None
Maximum Deferred Sales
Charge(/1/)(/2/)
(as a percentage of
offering price) None 4.5% 1.0% None 4.5% 1.0%
Sales Charge on
Reinvested Dividends None None None None None None
ANNUAL PORTFOLIO
OPERATING EXPENSES (AS
A PERCENTAGE OF AVERAGE
NET ASSETS)
Advisory fees (after fee
waiver)(/3/) .40% .40% .40% .40% .40% .40%
12b-1 fees(/3/)(/4/) .00 .75 .75 .00 .75 .75
Other operating expenses
(after fee waiver)(/3/) .77 .77 .77 .77 .77 .77
--- --- --- --- --- ---
Shareholder servicing
fee .25 .25 .25 .25 .25 .25
Shareholder processing
fee .15 .15 .15 .15 .15 .15
Other expenses (after
fee waiver) .37 .37 .37 .37 .37 .37
--- --- --- --- --- ---
Total Portfolio
operating expenses
(after fee
waivers)(/3/) 1.17% 1.92% 1.92% 1.17% 1.92% 1.92%
==== ==== ==== ==== ==== ====
</TABLE>
(1) Reduced front-end sales charges may be available. A deferred sales charge
of up to 1.00% is assessed on certain redemptions of Investor A Shares that
are purchased with no initial sales charge as part of an investment of
$1,000,000 or more. See "What Is the Schedule of Sales Charges and Exemp-
tions?"
(2) This amount applies to redemptions during the first year. The deferred
sales charge for Investor B Shares decreases for redemptions made in subse-
quent years. No deferred sales charge is charged after the sixth year on
Investor B Shares or after the first year on Investor C Shares. See "What
Is the Schedule of Sales Charges and Exemptions?"
(3) "Other expenses" includes the administration fees payable by the Portfo-
lios. Without waivers, advisory fees would be .55% and administration fees
would be .23% for each class of each Portfolio. BlackRock, Inc. and the
Portfolios' administrators are under no obligation to waive fees or reim-
burse expenses, but have informed the Fund that they expect to waive fees
and reimburse expenses during the remainder of the current fiscal year as
necessary to maintain the Portfolios' total operating expenses at the lev-
els set forth in the table. Without waivers, "Other operating expenses"
would be .83% for each of Investor A Shares, Investor B Shares and Investor
C Shares, and "Total Portfolio operating expenses" would be 1.38% for In-
vestor A Shares and 2.13% for each of the Investor B Shares and Investor C
Shares. The Portfolios do not expect to incur 12b-1 fees in excess of .005%
with respect to Investor A Shares (otherwise payable at the maximum rate of
.10%) during the current fiscal year.
(4) Investors with a long-term perspective may prefer Investor A Shares, as de-
scribed under "What Are The Key Considerations In Selecting A Pricing Op-
tion?" Long-term investors in Investor Shares may pay more than the eco-
nomic equivalent of the maximum front-end sales charges permitted by the
rules of the National Association of Securities Dealers, Inc. ("NASD").
4.
<PAGE>
- --------------------------------------------------------------------------------
EXAMPLE
An investor in Investor Shares would pay the following expenses on a $1,000 in-
vestment assuming (1) a 5% annual return, (2) redemption at the end of each
time period and (3) with respect to Investor B shares only, no redemption at
the end of each time period:
<TABLE>
<CAPTION>
ONE YEAR THREE YEARS
<S> <C> <C>
Delaware Tax-Free Income Portfolio
A Shares* $51 $76
B Shares (Redemption)** 65 98
B Shares (No Redemption) 20 60
C Shares 20 60
Kentucky Tax-Free Income Portfolio
A Shares* 51 76
B Shares (Redemption)** 65 98
B Shares (No Redemption) 20 60
C Shares 20 60
</TABLE>
* Reflects the imposition of the maximum front-end sales charge at the begin-
ning of the period.
** Reflects the deduction of the deferred sales charge.
In addition to the compensation itemized in the expense table, institutions
that sell shares of the Portfolios and/or their salespersons may receive com-
pensation for the sale and distribution of shares or for services to the Port-
folios. For information regarding such compensation, see "Who Manages The
Fund?--Distribution and Service Plan" in the Prospectus and "Investment Adviso-
ry, Administration, Distribution and Servicing Arrangements" in the Statement
of Additional Information.
The foregoing Table and Example are intended to assist investors in understand-
ing 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
brokers or other institutions directly on their customer accounts in connection
with investments in the Portfolios. For a detailed description of the expenses,
see "Who Manages the Fund?"
THE EXAMPLE SHOWN ABOVE SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE IN-
VESTMENT RETURN OR OPERATING EXPENSES. ACTUAL INVESTMENT RETURN AND OPERATING
EXPENSES MAY BE MORE OR LESS THAN THOSE SHOWN.
5.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ARE THE PORTFOLIOS?
- --------------------------------------------------------------------------------
The Delaware Tax-Free Income and Kentucky Tax-Free Income
Portfolios of BLACKROCK FUNDS are two of fourteen investment
portfolios that provide investors with a broad spectrum of
investment alternatives within the fixed income sector. Eight
of these portfolios invest solely in taxable bonds and six of
these portfolios invest in tax-exempt bonds.
In certain investment cycles and over certain holding peri-
ods, a fund that invests in any one of these styles may per-
form above or below the market. An investment program that
combines these multiple disciplines allows investors to se-
lect from among these various product options in the way that
most closely fits the individual's investment goals and sen-
timents.
<TABLE>
<CAPTION>
PORTFOLIO INVESTMENT OBJECTIVE
<S> <C>
Delaware Tax-Free Income To seek as high a level of current
income exempt from Federal income tax
and, to the extent possible, income
tax of the state of Delaware, as is
consistent with the preservation of
capital.
Kentucky Tax-Free Income To seek as high a level of current
income exempt from Federal income tax
and, to the extent possible, income
tax of the state of Kentucky, as is
consistent with the preservation of
capital.
</TABLE>
6.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ARE THE CHARACTERISTICS OF THE PORTFOLIOS?
- --------------------------------------------------------------------------------
PORTFOLIO CHARACTERISTICS:
<TABLE>
<CAPTION>
DOLLAR-
WEIGHTED
AVERAGE MIN
PERFORMANCE MATURITY CREDIT QUALITY CREDIT
PORTFOLIO BENCHMARK* (APPROXIMATE)** CONCENTRATION QUALITY
<S> <C> <C> <C> <C>
DE Tax-Free Income Lehman Local GO Index 5-10 Years Investment Grade BBB
Spectrum
KY Tax-Free Income Lehman Local GO Index 5-10 Years Investment Grade BBB
Spectrum
</TABLE>
*The Lehman Local GO Index contains local general obligation bonds.
**The Portfolios' sub-adviser will normally attempt to structure the Portfolios
to have comparable durations to the benchmarks. Duration, which measures price
sensitivity to interest rate changes, is not necessarily equal to average matu-
rity.
7.
<PAGE>
- --------------------------------------------------------------------------------
WHAT TYPES OF SECURITIES ARE IN THE PORTFOLIOS?
- --------------------------------------------------------------------------------
The following table summarizes the types of securities found in each Portfolio
according to the following designations:
Yes: The Portfolio will hold a significant concentration of these securi-
ties at all times.
Elig.: Eligible; the Portfolio may purchase these securities, but they may
or may not be a significant holding at a given time.
Temp.: Temporary; the Portfolio may purchase these securities, but under
normal market conditions is not expected to do so.
No: The Portfolio may not purchase these securities.
<TABLE>
<CAPTION>
NON FOREIGN
AGENCY/ HIGH SECURITIES/
AGENCY COMMERCIAL YIELDS CURRENCY
TREASURIES AGENCIES MBS/1/ MBS/1/ CORP. ABS/2/ SECURITIES RISK MUNICIPALS
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
DE Tax-Free Income Temp. No No No No No No No Yes
KY Tax-Free Income Temp. No No No No No No No Yes
</TABLE>
/1/MBS = mortgage-backed securities
/2/ABS = asset-backed securities
8.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ARE THE PORTFOLIOS' FUNDAMENTAL INVESTMENT LIMITATIONS?
- --------------------------------------------------------------------------------
A Portfolio's investment objective and policies may be changed by the Fund's
Board of Trustees without shareholder approval. However, shareholders will be
given at least 30 days' notice before any change to a Portfolio's investment
objective. No assurance can be provided that a Portfolio will achieve its in-
vestment objective.
Each Portfolio has also adopted certain fundamental investment limitations that
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). The
Portfolios' fundamental investment policies, which are set forth in full in the
Statement of Additional Information, are summarized below.
Neither Portfolio may:
(1) invest 25% or more of its total assets in one or more issuers conducting
their principal business activities in the same industry; and
(2) invest less than 80% of its net assets in Municipal Obligations (as defined
below), except during defensive periods or during periods of unusual market
conditions.
As a non-fundamental investment restriction, each of the Delaware Tax-Free In-
come and Kentucky Tax-Free Income Portfolios will not invest in securities (ex-
cept U.S. Government securities) that would cause, at the end of any tax quar-
ter (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 Portfo-
lio'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 any one issuer
(except U.S. Government securities).
The investment limitations stated above are applied at the time investment se-
curities are purchased.
9.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ADDITIONAL INVESTMENT POLICIES AND RISKS APPLY?
- --------------------------------------------------------------------------------
INVESTMENT QUALITY. Securities acquired by the Portfolios will be rated invest-
ment grade at the time of purchase (within the four highest rating categories
by Standard & Poor's Ratings Group ("S&P"), Moody's Investors Service, Inc.
("Moody's"), Duff & Phelps Credit Co. or Fitch Investor Services, Inc.) or, if
unrated, of comparable quality as determined by the Portfolios' sub-adviser.
Securities rated "Baa" on "BBB" are generally considered to be investment grade
although they have speculative characteristics. If a security's rating is re-
duced below the minimum rating that is permitted for a Portfolio, the Portfo-
lio's sub-adviser will consider whether the Portfolio should continue to hold
the security.
INVESTMENT CONCENTRATION. Each Portfolio will normally invest at least 80% of
the value of its total assets in debt securities. The Portfolios will invest,
during normal market conditions, at least 80% of their net assets in obliga-
tions issued by or on behalf of states, territories and possessions of the
United States, the District of Columbia and their political sub-divisions,
agencies, instrumentalities and authorities and related tax-exempt derivative
securities the interest on which is exempt from regular Federal income tax and
is not an item of tax preference for purposes of the Federal alternative mini-
mum tax ("Municipal Obligations"). In addition, each of the Portfolios intends
to invest at least 65% of its net assets in Municipal Obligations of issuers
located in the particular state indicated by its name ("State-Specific Obliga-
tions"). During temporary defensive periods each of the Portfolios may invest
without limitation in securities that are not Municipal Obligations and may
hold without limitation uninvested cash reserves.
MUNICIPAL INVESTMENTS. The two principal classifications of Municipal Obliga-
tions are "general obligation" securities and "revenue" securities. General ob-
ligation securities are secured by the issuer's pledge of its full faith,
credit and taxing power for the payment of principal and interest. Revenue se-
curities 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 fi-
nanced. 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 in-
clude "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.
Also included within the general category of Municipal Obligations are partici-
pation certificates in a lease, an installment purchase contract, or a condi-
tional sales contract ("lease obligations") entered into by a state or politi-
cal subdivision to finance the acquisition or construction of equipment, land,
or facilities. Although lease obligations are not general obligations of the
issuer for which the state or other governmental body's unlimited taxing power
is pledged, certain lease obligations are backed by a covenant to appropriate
money to make the lease obligation payments. However, under certain lease obli-
gations, the state or governmental body has no obligation to make these pay-
ments in future years unless money is appropriated on a yearly basis. Although
"non-appropriation" lease obligations are secured by the leased property, dis-
position of the
property in the event of foreclosure might prove difficult. These securities
represent a relatively new type of financing that is not yet as marketable as
more conventional securities.
Each Portfolio may invest up to 20% of its total assets in private activity
bonds the interest on which is an item of tax preference for purposes of the
Federal alternative minimum tax ("AMT Paper") when added together with any
other taxable investments held by the Portfolio. In addition, each Portfolio
may invest 25% or more of its assets in Municipal Obligations the interest on
which is paid solely from revenues of similar projects. To
10.
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the extent a Portfolio's assets are invested in Municipal Obligations payable
from the revenues of similar projects or are invested in private activity
bonds, the Portfolio will be subject to the particular risks presented by the
laws and economic conditions relating to such projects and bonds to a greater
extent than it would be if its assets were not so invested.
The Portfolios are classified as non-diversified portfolios under 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 one secu-
rity may affect the overall value of a non-diversified portfolio more than it
would a diversified portfolio.
Each Portfolio may acquire "stand-by commitments" with respect to Municipal Ob-
ligations held by it. Under a stand-by commitment, a dealer agrees to purchase,
at the Portfolio's option, specified Municipal Obligations at a specified
price. The acquisition of a stand-by commitment may increase the cost, and
thereby reduce the yield, of the Municipal Obligations to which the commitment
relates. The Portfolios may also invest in tax-exempt derivative securities re-
lating to Municipal Obligations, including tender option bonds, participations,
beneficial interests in trusts and partnership interests.
The amount of information regarding the financial condition of issuers of Mu-
nicipal Obligations may be less extensive than the information for public cor-
porations, and the secondary market for Municipal Obligations may be less liq-
uid than that for taxable obligations. Accordingly, the ability of a Portfolio
to buy and sell Municipal Obligations may, at any particular time and with re-
spect to any particular securities, be limited. In addition, Municipal Obliga-
tions purchased by the Portfolios include obligations backed by letters of
credit and other forms of credit enhancement issued by domestic and foreign
banks, as well as other financial institutions. Changes in the credit quality
of these institutions could cause loss to a Portfolio and affect its share
price.
Opinions relating to the validity of Municipal Obligations and to the exemption
of interest thereon from Federal and state income tax are rendered by counsel
to the respective issuers and sponsors of the obligations at the time of issu-
ance. The Fund and its service providers will rely on such opinions and will
not review independently the underlying proceedings relating to the issuance of
Municipal Obligations, the creation of any tax-exempt derivative securities, or
the bases for such opinions.
STRIPPED AND ZERO COUPON OBLIGATIONS. To the extent consistent with their in-
vestment objectives, 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 obliga-
tions. These participations, 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."
Stripped securities may exhibit greater price volatility than ordinary debt se-
curities because of the manner in which their principal and interest are re-
turned to investors.
Each Portfolio may invest in zero-coupon bonds, which are normally issued at a
significant discount from face value and do not provide for periodic interest
payments. Zero-coupon bonds may experience greater volatility in market value
than similar maturity debt obligations which provide for regular interest pay-
ments. Additionally, current federal tax law requires the holder of certain
zero coupon bonds to accrue income with respect to these securities prior to
the receipt of cash payments. To maintain its qualification as a regulated in-
vestment company and avoid liability for federal income and excise taxes, a
Portfolio may be required to distribute income accrued with respect to these
securities and may have to dispose of portfolio securities under disadvanta-
geous circumstances in order to generate cash to satisfy these distribution re-
quirements. See "How Are Fund Distributions Taxed?"
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 Mort-
gage Association are supported by the United States' full faith and credit;
others
11.
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such as those of the Federal National Mortgage Association 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 Fed-
eral Home Loan Mortgage Corporation are supported only by the credit of the in-
strumentality. 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.
INTEREST RATE TRANSACTIONS. The Portfolios may enter into interest rate swaps
and may purchase or sell interest rate caps and floors. The Portfolios may en-
ter into these transactions primarily to preserve a return or spread on a par-
ticular investment or portion of their holdings, as a duration management tech-
nique 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 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. 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 inter-
est on a notional principal amount from the party selling such interest rate
floor.
OPTIONS AND FUTURES CONTRACTS. To the extent consistent with its investment ob-
jective, 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 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, 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. A Portfolio will not purchase put and call options when
the aggregate premiums on outstanding options exceed 5% of its net assets at
the time of purchase, and will not write options on more than 25% of the value
of its net assets (measured at the time an option is written). Options trading
is a highly specialized activity that entails greater than ordinary investment
risks. In addition, unlisted options are not subject to the protections af-
forded purchasers of listed options issued by the Options Clearing Corporation,
which performs the obligations of its members if they default.
To the extent consistent with its investment objective, each Portfolio may also
invest in futures contracts and options on futures contracts for hedging pur-
poses or to maintain liquidity. The value of a Portfolio's contracts may equal
or exceed 100% of its total assets, although 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 for related futures options entered into for other than bona fide hedging
purposes is 5% or less of its net assets.
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 quan-
tity 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 ob-
ligated to sell or buy a futures contract if the
12.
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option is exercised. In connection with a Portfolio's position in a futures
contract or related option, the Fund will create a segregated account of 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 instru-
ments 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 re-
sulting inability to close a futures contract when desired; (c) losses caused
by unanticipated market movements, which are potentially unlimited; (d) the
sub-adviser's inability to predict correctly the direction of securities pric-
es, 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 the Statement of Additional Information.
The Fund intends to comply with the regulations of the Commodity Futures Trad-
ing Commission exempting the Portfolios from registration as a "commodity pool
operator."
GUARANTEED INVESTMENT CONTRACTS. The Portfolios may make limited investments in
guaranteed investment contracts ("GICs") issued by highly rated U.S. insurance
companies. Under these contracts, a Portfolio makes cash contributions to a de-
posit fund of the insurance company's general account. The insurance company
then credits to the Portfolio, on a monthly basis, interest which is based on
an index (such as the Salomon Brothers CD Index), but is guaranteed not to be
less than a certain minimum rate. Each Portfolio does not expect to invest more
than 5% of its net assets in GICs at any time during the current fiscal year.
SECURITIES LENDING. A Portfolio may seek additional income by lending securi-
ties 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 ir-
revocable 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 recover-
ing the loaned securities, or possibly loss of rights in the collateral if the
borrower of the securities becomes insolvent.
VARIABLE AND FLOATING RATE INSTRUMENTS. The Portfolios may purchase rated and
unrated variable and floating rate instruments. These 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 Portfolios may invest up to 10% of their total assets in leveraged inverse
floating rate debt instruments ("inverse floaters"). The interest rate of an
inverse floater resets in the opposite direction from the market rate of inter-
est to which it is indexed. An inverse floater may be considered to be
leveraged to the extent that its interest rate varies by a magnitude that ex-
ceeds the magnitude of the change in the index rate of interest. The higher de-
gree of leverage inherent in inverse floaters is associated with greater vola-
tility in their market values. Issuers of unrated variable and floating rate
instruments must satisfy the same criteria as set forth above for a Portfolio.
The absence of an active secondary market with respect to particular variable
and floating rate instruments, however, could make it difficult for a Portfolio
to dispose of a variable or floating rate instrument if the issuer defaulted on
its payment obligation or during periods when the Portfolio is not entitled to
exercise its demand rights.
REPURCHASE AGREEMENTS. Each Portfolio may agree to purchase debt securities
from financial institutions subject to the seller's agreement to repurchase
them 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.
13.
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REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWINGS. Each Portfolio is autho-
rized 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 de-
cline 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 the 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. Reverse repur-
chase agreements involve the risks that the interest income earned in the in-
vestment of the proceeds will be less than the interest expense, that the mar-
ket 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 maintain a segregated account with
the Fund's custodian containing cash, U.S. Government or other appropriate liq-
uid debt securities 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.
INVESTMENT COMPANIES. Each Portfolio may invest in securities issued by other
investment companies within the limits prescribed by the 1940 Act. As a share-
holder 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. GICs, variable and floating rate
instruments that cannot be disposed of within seven days, and repurchase agree-
ments 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 Portfolios' sub-
adviser that an adequate trading market exists for the securities. This invest-
ment practice could have the effect of increasing the level of illiquidity in a
Portfolio during any period that qualified institutional buyers become uninter-
ested in purchasing these restricted securities.
WHEN-ISSUED PURCHASES AND FORWARD COMMITMENTS. Each Portfolio may purchase se-
curities on a "when-issued" basis and may purchase or sell securities on a
"forward commitment" basis. These transactions involve a commitment by a Port-
folio to purchase or sell particular securities with payment and delivery tak-
ing 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 are not
expected to exceed 25% of the value of its total assets absent unusual market
conditions.
SHORT SALES. The Portfolios may only make short sales of securities "against-
the-box." 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 de-
cline. 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 portfolio flexibility. In a short sale "against-the-box," at the time
of sale, the Portfolio owns or has the immediate and unconditional right to ac-
quire the identical security at no additional cost. When selling short
"against-the-box," a Portfolio forgoes an opportunity for capital appreciation
in the security.
14.
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PORTFOLIO TURNOVER RATES. Under normal market conditions, it is expected that
the annual portfolio turnover rate for each of the Portfolios will not exceed
150%. A Portfolio's annual portfolio turnover rate will not be a factor pre-
venting a sale or purchase when the sub-adviser believes investment considera-
tions warrant such sale or purchase. Portfolio turnover may vary greatly from
year to year as well as within a particular year. High portfolio turnover rates
(i.e., 100% or more) will generally result in higher transaction costs to a
Portfolio and may result in the realization of short-term capital gains that
are taxable to shareholders as ordinary income.
INTEREST RATE AND EXTENSION RISK. The value of fixed income securities in the
Portfolios can be expected to vary inversely with changes in prevailing inter-
est rates. Fixed income securities with longer maturities, which tend to pro-
duce higher yields, are subject to 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 within the limits stated above under "What Are the Differences Among the
Portfolios?" based upon its sub-adviser's assessment of economic and market
conditions. Although the Portfolios' sub-adviser will normally attempt to
structure each Portfolio to have a comparable duration to its benchmark as
stated for that section, there can be no assurance that it will be able to do
so at all times.
STATE-SPECIFIC TAX-FREE PORTFOLIOS--ADDITIONAL RISK CONSIDERATIONS. The concen-
tration of investments by the Portfolios in State-Specific Obligations raises
special investment considerations. In particular, changes in the economic con-
dition and governmental policies of a state and its political subdivisions
could adversely affect the value of a Portfolio's shares. Certain matters re-
lating to the states in which the Portfolios invest are described below. For
further information, see "Special Considerations Regarding State-Specific Obli-
gations" in the Statement of Additional Information.
Delaware. Delaware's economy has expanded throughout most sectors during the
1990's and has diversified beyond its historical emphasis in chemical and auto-
mobile manufacturing to include strong banking and service sectors. Delaware
completed fiscal year 1997 with a cumulative cash balance of $392.8 million, of
which $116.2 million was unencumbered. The State's general obligation debt out-
standing as of December 31, 1997 was $626.7 million. Approximately 80% of this
debt is scheduled to mature within ten years and approximately 90% of this debt
is scheduled to mature within 15 years. While the State has constitutionally-
imposed limits on tax and license fee increases and the imposition of new taxes
or fees (requiring approval by a three-fifths vote of each house of the General
Assembly), there are no constitutionally-imposed limits on debt incurrence.
However, Delaware has instituted several measures designed to manage and reduce
its indebtedness, including legislative debt limits, "pay-as-you-go" financing
for capital projects, bond refundings and cash debt defeasance and
deauthorizations.
Kentucky. Kentucky is a leader among the states in the production of coal and
tobacco. The Coal Severance Tax is a significant revenue producer for the Com-
monwealth and its political subdivisions, and any substantial decrease in the
amount of coal or other minerals produced could result in revenue shortfalls.
Additionally, any federal legislation or litigation adversely affecting the to-
bacco and/or cigarette industries would have a negative impact on Kentucky's
economy. There is significant diversification in Kentucky's manufacturing sec-
tor, which includes, among other things, tobacco processing plants, distiller-
ies and durable goods production. No single segment of the Commonwealth's econ-
omy consists of as much as one-fourth of the overall state domestic product.
The Commonwealth continues to experience a high unemployment rate in non-urban-
ized areas. Although revenue obligations of the Commonwealth or its political
subdivisions may be payable from a specific project, there can be no assurances
that economic difficulties and the resulting impact on state and local govern-
ment finances will not adversely affect the market value of Kentucky State-Spe-
cific Obligations or the ability of the respective entities to pay debt serv-
ice.
15.
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Because of constitutional limitations, the Commonwealth cannot enter into a fi-
nancial obligation of more than two years' duration, and no other municipal is-
suer within the Commonwealth can enter into a financial obligation of more than
one year's duration. As a consequence, the payment and security arrangements
applicable to Kentucky State-Specific Obligations differ significantly from
those generally applicable to municipal revenue obligations in other states.
16.
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WHO MANAGES THE FUND?
- --------------------------------------------------------------------------------
BOARD OF The business and affairs of the Fund are managed under the di-
TRUSTEES rection of its Board of Trustees. The following persons cur-
rently serve on the Board:
William O. Albertini--Executive Vice President and Chief Finan-
cial 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, The Wharton School, University
of Pennsylvania.
David R. Wilmerding, Jr.--Chairman, Gee, Wilmerding & Associ-
ates, Inc.
ADVISER AND The Adviser to BlackRock Funds is BlackRock, Inc. Each of the
SUB-ADVISER Portfolios within the BlackRock Funds family is managed by
a specialized portfolio manager who is a member of BlackRock,
Inc.'s fixed income portfolio management affiliate, BlackRock
Financial Management, Inc. ("BlackRock"). BlackRock has its
primary offices at 345 Park Avenue, New York, New York 10154.
The Portfolios and their portfolio managers are as follows:
<TABLE>
<CAPTION>
BLACKROCK FUNDS
PORTFOLIO PORTFOLIO MANAGER
--------------- -----------------
<C> <S>
Delaware Tax-Free Income Kevin Klingert; Portfolio manager at
BlackRock since 1991; prior to joining
BlackRock, Assistant Vice President,
Merrill Lynch, Pierce, Fenner & Smith;
Portfolio manager since commencement of
Portfolio operations and Portfolio manager
of predecessor fund since 1995.
Kentucky Tax-Free Income Kevin Klingert (see above).
</TABLE>
BlackRock, Inc. (formerly PNC Asset Management Group, Inc.) was
organized in 1994 to perform advisory services for investment
companies, and has its principal offices at 1600 Market Street,
29th Floor, Philadelphia, Pennsylvania 19103. BlackRock, Inc.
is an indirect wholly-owned subsidiary of PNC Bank Corp., a
multi-bank holding company.
As adviser, BlackRock, Inc. is responsible for the overall in-
vestment management of the Portfolios. As sub-adviser, Black-
Rock Financial Management is responsible for the day-to-day
management of the Portfolios, and generally makes all purchase
and sale investment decisions for the Portfolios. BlackRock Fi-
nancial Management also provides research and credit analysis.
17.
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THE AFFILIATE SUB-ADVISERS OF BLACKROCK, INC. ARE:
. BlackRock Financial Management, Inc.: Domestic and non-
dollar fixed income.
. PNC Equity Advisors: Growth equity.
. Provident Capital Management: Value equity.
. CastleInternational Asset Management: International
equity.
. PNC Institutional Management Corporation: Money market.
For their investment advisory and sub-advisory services,
BlackRock, Inc. and the Portfolios' sub-adviser are entitled
to fees, computed daily on a Portfolio-by-Portfolio basis
and payable monthly, at the maximum annual rates set forth
below. As stated under "What Are The Expenses Of The Portfo-
lios?", BlackRock, Inc. and the sub-adviser intend to waive
a portion of their fees during the current fiscal year. All
sub-advisory fees are paid by BlackRock, Inc., and do not
represent an extra charge to the Portfolios.
MAXIMUM ANNUAL CONTRACTUAL FEE RATE (BEFORE WAIVERS)
<TABLE>
<CAPTION>
AVERAGE DAILY NET INVESTMENT SUB-ADVISORY
ASSETS ADVISORY FEE FEE
----------------- ------------ ------------
<S> <C> <C>
first $1 billion .550% .400%
$1 billion--$2 billion .500 .350
$2 billion--$3 billion .475 .325
greater than $3 billion .450 .300
</TABLE>
The Portfolios' sub-adviser strives to achieve best execu-
tion on all transactions. Infrequently, brokerage transac-
tions for the Portfolios may be directed through registered
broker/dealers who have entered into dealer agreements with
the Fund's distributor, subject to the requirements of best
execution.
ADMINISTRATORS BlackRock, Inc., PFPC Inc. ("PFPC") and BlackRock Distribu-
tors, Inc. ("BDI") (the "Administrators") serve as the
Fund's co-administrators. BlackRock, Inc. and PFPC are indi-
rect wholly-owned subsidiaries of PNC Bank Corp. BDI is a
wholly-owned subsidiary of Provident Distributors, Inc.
("PDI"). A majority of the outstanding stock of PDI is owned
by its officers.
The Administrators generally assist the Fund in all aspects
of its administration and operation, including matters re-
lating to the maintenance of financial records and fund ac-
counting. As compensation for these services, BlackRock,
Inc. is entitled to receive a fee, computed daily and pay-
able monthly, at an annual rate of .03% of each Portfolio's
average daily net assets. PFPC and BDI are entitled to re-
ceive a combined administration fee, computed daily and pay-
able monthly, at the aggregate annual rate of (i) .085% of
the first $500 million of each Portfolio's average daily net
assets, .075% of the next $500 million of each Portfolio's
average daily net assets and .065% of the average daily net
assets of each Portfolio in excess of $1 billion and (ii)
.115% of the first $500 million of the average daily net as-
sets allocated to each class of Investor Shares of each
Portfolio, .105% of the next $500 million of such average
daily net assets and .095% of the average daily net assets
allocated to each class of Investor Shares of each Portfolio
in excess of $1 billion. From time to time the Administra-
tors may waive some or all of their administration fees from
a Portfolio.
For information about the operating expenses the Portfolios
expect to incur in the current fiscal year, see "What Are
the Expenses of the Portfolios?"
18.
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TRANSFER PNC Bank, whose principal offices are located at 1600 Market
AGENT, Street, Philadelphia, Pennsylvania 19103, serves as the Portfo-
DIVIDEND lios' custodian and PFPC, whose principal offices are located
DISBURSING at 400 Bellevue Parkway, Wilmington, Delaware 19809, serves as
AGENT AND their transfer agent and dividend disbursing agent.
CUSTODIAN
DISTRIBUTION Under the Fund's Distribution and Service Plan (the "Plan"),
AND SERVICE Investor Shares of the Portfolios bear the expense of payments
PLAN ("distribution fees") made to BDI, as the Fund's distributor
(the "Distributor"), or affiliates of PNC Bank, for distribu-
tion and sales support services. The distribution fees may be
used to compensate the Distributor for distribution services
and to compensate the Distributor and PNC Bank affiliates for
sales support services provided in connection with the offering
and sale of Investor Shares. The distribution fees may also be
used to reimburse the Distributor and PNC Bank affiliates for
related expenses, including payments to brokers, dealers, fi-
nancial institutions and industry professionals ("Service Orga-
nizations") for sales support services and related expenses.
Distribution fees payable under the Plan will not exceed .10%
(annualized) of the average daily net asset value of each
Portfolio's outstanding Investor A Shares and .75% (annualized)
of the average daily net asset value of each Portfolio's out-
standing Investor B and Investor C Shares. Payments under the
Plan are not tied directly to out-of-pocket expenses and there-
fore may be used by the recipients as they choose (for example,
to defray their overhead expenses). The Plan also permits the
Distributor, the Administrators and other companies that re-
ceive fees from the Fund to make payments relating to distribu-
tion and sales support activities out of their past profits or
other sources available to them. For further information, see
"Investment Advisory, Administration, Distribution and Servic-
ing Arrangements" in the Statement of Additional Information.
Under the Plan, the Fund intends to enter into service arrange-
ments with Service Organizations (including PNC Bank and its
affiliates) with respect to each class of Investor Shares pur-
suant to which Service Organizations will render certain sup-
port services to their customers who are the beneficial owners
of Investor Shares. In consideration for a shareholder servic-
ing fee of up to .25% (annualized) of the average daily net as-
set value of Investor Shares owned by their customers, Service
Organizations may provide one or more of the following servic-
es: responding to customer inquiries relating to the services
performed by the Service Organization and to customer inquiries
concerning their investments in Investor Shares; assisting cus-
tomers in designating and changing dividend options, account
designations and addresses; and providing other similar share-
holder liaison services. In consideration for a separate share-
holder processing fee of up to .15% (annualized) of the average
daily net asset value of Investor Shares owned by their custom-
ers, Service Organizations may provide one or more of these ad-
ditional services to such customers: processing purchase and
redemption requests from customers and placing orders with the
Fund's transfer agent or the Distributor; processing dividend
payments from the Fund on behalf of customers; providing sub-
accounting with respect to Investor Shares beneficially owned
by customers or the information necessary for sub-accounting;
and providing other similar services.
Service Organizations may charge their clients additional fees
for account services. Customers who are beneficial owners of
Investor Shares should read this Prospectus in light of the
terms and fees governing their accounts with Service Organiza-
tions.
19.
<PAGE>
- --------------------------------------------------------------------------------
The Glass-Steagall Act and other applicable laws, among other
things, prohibit banks from engaging in the business of un-
derwriting securities. It is intended that the services pro-
vided by Service Organizations under their service agreements
will not be prohibited under these laws. Under state securi-
ties laws, banks and financial institutions that receive pay-
ments from the Fund may be required to register as dealers.
EXPENSES Expenses are deducted from the total income of each Portfolio
before dividends and distributions are paid. Expenses in-
clude, but are not limited to, fees paid to BlackRock, Inc.
and the Administrators, transfer agency and custodian fees,
trustee fees, taxes, interest, professional fees, shareholder
servicing and processing fees, distribution fees, fees and
expenses in registering and qualifying the Portfolios and
their shares for distribution under Federal and state securi-
ties laws, expenses of preparing prospectuses and statements
of additional information and of printing and distributing
prospectuses and statements of additional information to ex-
isting shareholders, expenses relating to shareholder re-
ports, shareholder meetings and proxy solicitations, insur-
ance premiums, the expense of independent pricing services,
and other expenses which are not expressly assumed by Black-
Rock, Inc. or the Fund's service providers under their agree-
ments with the Fund. Any general expenses of the Fund that do
not belong to a particular investment portfolio will be allo-
cated among all investment portfolios by or under the direc-
tion of the Board of Trustees in a manner the Board deter-
mines to be fair and equitable.
20.
<PAGE>
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WHAT PRICING OPTIONS ARE AVAILABLE TO INVESTORS?
- --------------------------------------------------------------------------------
The Delaware Tax-Free Income and Kentucky Tax-Free Income Port-
folios of BlackRock Funds offer different pricing options to
investors in the form of different share classes. These options
are described below:
A SHARES (FRONT-END LOAD)
One time, front-end sales charge at time of purchase
No charges or fees at any time for redeeming shares
Lower ongoing expenses
Free exchanges with other A Shares in the BlackRock Funds fam-
ily
A Shares may make sense for investors with a long-term invest-
ment horizon who prefer to pay a one-time front-end sales
charge and have reduced ongoing fees.
B SHARES (BACK-END LOAD)
No front-end sales charge at time of purchase
Contingent deferred sales charge (CDSC) if shares are re-
deemed, declining over 6 years from a high of 4.50%
Free exchanges with other B Shares in the BlackRock Funds fam-
ily
Automatically convert to A Shares seven years from purchase
B Shares may make sense for investors who prefer to pay for
professional investment advice on an ongoing basis (asset-based
sales charge) rather than with a traditional, one-time front-
end sales charge.
C SHARES (LEVEL LOAD)
No front-end sales charge at time of purchase
Contingent deferred sales charge (CDSC) of 1.00% if shares are
redeemed within 12 months of purchase
Free exchanges with other C Shares in the BlackRock Funds fam-
ily
C Shares may make sense for shorter term (relative to both A
and B Shares) investors who prefer to pay for professional in-
vestment advice on an ongoing basis (asset-based sales charge)
rather than with a traditional, one-time front-end sales
charge. Such investors may plan to make substantial redemptions
within 6 years of purchase.
21.
<PAGE>
- --------------------------------------------------------------------------------
THE PRICING OPTIONS FOR EACH PORTFOLIO ARE DESCRIBED IN THE TABLE BELOW:
<TABLE>
<CAPTION>
A SHARES B SHARES C SHARES
<S> <C> <C> <C>
Maximum Front-End Sales
Charge 4.00% 0.00% 0.00%
12b-1 Fee 0.00%* 0.75% 0.75%
CDSC (Redemption Charge) 0.00% 4.50%-0.00% 1.00%
(Depends on when (If redeemed within
shares are redeemed) 12 months of purchase)
</TABLE>
*The Portfolios do not expect to incur 12b-1 fees in excess of .005% with re-
spect to Investor A Shares during the current fiscal year.
Investors wishing to purchase shares of the Portfolios may do so either by
mailing the investment application attached to this Prospectus along with a
check or by wiring money as specified below under "How Are Shares Purchased?"
22.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ARE THE KEY CONSIDERATIONS IN SELECTING A PRICING OPTION?
- --------------------------------------------------------------------------------
In deciding which class of Investor Shares to purchase, investors should con-
sider the following:
INTENDED HOLDING PERIOD. Over time, the cumulative distribution fees on a Port-
folio's Investor B Shares and Investor C Shares will exceed the expense of the
maximum initial sales charge on Investor A Shares. For example, if net asset
value remains constant, the Investor B Shares' and Investor C Shares' aggregate
distribution fees would be equal to the Investor A Shares' initial maximum
sales charge from four to seven years after purchase (depending on the Portfo-
lio). Thereafter, Investor B Shares and Investor C Shares would bear higher ag-
gregate expenses. Investor B and Investor C shareholders, however, enjoy the
benefit of permitting all their dollars to work from the time the investments
are made. Any positive investment return on the additional invested amount
would partially or wholly offset the higher annual expenses borne by Investor B
Shares and Investor C Shares.
Because the Portfolios' future returns cannot be predicted, however, there can
be no assurance that such a positive return will be achieved.
At the end of seven years after the date of purchase, Investor B Shares will
convert automatically to Investor A Shares, based on the relative net asset
values of shares of each class. Investor B Shares acquired through reinvestment
of dividends or distributions are also converted at the earlier of these
dates--seven years after the reinvestment date or the date of conversion of the
most recently purchased Investor B Shares that were not acquired through rein-
vestment. Investor C Shares have no conversion feature.
Unless a sales charge waiver applies, Investor B shareholders pay a contingent
deferred sales charge if they redeem during the first six years after purchase,
and Investor C shareholders pay a contingent deferred sales charge if they re-
deem during the first twelve months after purchase. Investors expecting to re-
deem during these periods should consider the cost of the applicable contingent
deferred sales charge in addition to the aggregate annual Investor B or In-
vestor C distribution fees, as compared with the cost of the applicable initial
sales charges applicable to the Investor A Shares.
REDUCED SALES CHARGES. Because of reductions in the front-end sales charge for
purchases of Investor A Shares aggregating $25,000 or more, it may be advanta-
geous for investors purchasing large quantities of Investor Shares to purchase
Investor A Shares. In any event, the Fund will not accept any purchase order
for $1,000,000 or more of Investor B Shares or Investor C Shares.
WAIVER OF SALES CHARGES. The entire initial sales charge on Investor A Shares
of a Portfolio may be waived for certain eligible purchasers allowing their en-
tire purchase price to be immediately invested in a Portfolio. The contingent
deferred sales charge may be waived upon redemption of certain Investor B
Shares and Investor C Shares.
23.
<PAGE>
- --------------------------------------------------------------------------------
HOW ARE SHARES PURCHASED?
- --------------------------------------------------------------------------------
GENERAL. Initial and subsequent purchase orders may be placed through securi-
ties brokers, dealers or financial institutions ("brokers"), or the transfer
agent. Generally, individual investors will purchase Investor Shares through a
broker who will then transmit the purchase order directly to the transfer
agent.
The minimum investment for the initial purchase of shares is $500; there is a
$50 minimum for subsequent investments. Purchases through the Automatic Invest-
ment Plan described below are subject to a lower initial purchase minimum. In
addition, the minimum initial investment for employees of the Fund, the Fund's
investment adviser, sub-adviser, Distributor or transfer agent or employees of
their affiliates is $100, unless payment is made through a payroll deduction
program in which case the minimum investment is $25.
When placing purchase orders, investors should specify whether the order is for
Investor A, Investor B or Investor C Shares of a Portfolio. All share purchase
orders that fail to specify a class will automatically be invested in Investor
A Shares.
PURCHASES THROUGH BROKERS. Shares of the Portfolios may be purchased through
brokers which have entered into dealer agreements with the Distributor. Pur-
chase orders received by a broker and transmitted to the transfer agent before
the close of regular trading on the New York Stock Exchange (currently 4:00
p.m. Eastern time) on a Business Day will be effected at the net asset value
determined that day, plus any applicable sales charge. Payment for an order may
be made by the broker in Federal funds or other funds immediately available to
the Portfolios' custodian no later than 4:00 p.m. (Eastern time) on the third
Business Day following receipt of the purchase order.
It is the responsibility of brokers to transmit purchase orders and payment on
a timely basis. If payment is not received within the period described above,
the order will be canceled, notice thereof will be given, and the broker and
its customers will be responsible for any loss to the Fund or its shareholders.
Orders of less than $500 may be mailed by a broker to the transfer agent.
PURCHASES THROUGH THE TRANSFER AGENT. Investors may also purchase Investor
Shares by completing and signing the Account Application Form and mailing it to
the transfer agent, together with a check in at least the minimum initial pur-
chase amount payable to BlackRock Funds. The Fund does not accept third party
checks for initial or subsequent investments. An Account Application Form may
be obtained by calling (800) 441-7762. The name of the Portfolio with respect
to which shares are purchased must also appear on the check or Federal Reserve
Draft. Investors may also wire Federal funds in connection with the purchase of
shares. The wire instructions must include the name of the Portfolio, specify
the class of Investor Shares, and include the name of the account registration
and the shareholder account number. Before wiring any funds, an investor must
call PFPC at (800) 441-7762 in order to confirm the wire instructions. Purchase
orders which are received by PFPC, together with payment, before the close of
regular trading hours on the New York Stock Exchange (currently 4:00 p.m. East-
ern time) on any Business Day (as defined below) are priced at the applicable
net asset value next determined on that day, plus any applicable sales charge.
OTHER PURCHASE INFORMATION. Shares of each Portfolio are sold on a continuous
basis by BDI as the Distributor. BDI maintains its principal offices at Four
Falls Corporate Center, 6th Floor, West Conshohocken, PA 19428-2961. Purchases
may be effected on weekdays on which both the New York Stock Exchange and the
Federal Reserve Bank of Philadelphia are open for business (a "Business Day").
Payment for orders which are not received or accepted will be returned after
prompt inquiry. The issuance of shares is recorded on the books of the Fund. No
certificates will be issued for shares. Payments for shares of a Portfolio may,
in the discretion of the Fund's investment adviser, be made in the form of se-
curities that are permissible investments for that Portfolio. The Fund reserves
the right to reject any purchase order, to modify or waive the minimum initial
or subsequent investment requirement and to suspend and resume the sale of any
share class of a Portfolio at any time.
24.
<PAGE>
- --------------------------------------------------------------------------------
HOW ARE SHARES REDEEMED?
- --------------------------------------------------------------------------------
REDEMPTION. Shareholders may redeem their shares for cash at any time. A writ-
ten redemption request in proper form must be sent directly to BlackRock Funds
c/o PFPC, P.O. Box 8907, Wilmington, Delaware 19899-8907. Except for the con-
tingent deferred sales charge, if applicable, there is no charge for a redemp-
tion. Shareholders may also place redemption requests through a broker or other
institution, which may charge a fee for this service.
WHEN REDEEMING INVESTOR SHARES IN THE PORTFOLIOS, SHAREHOLDERS SHOULD INDICATE
WHETHER THEY ARE REDEEMING INVESTOR A SHARES, INVESTOR B SHARES OR INVESTOR C
SHARES. If a redeeming shareholder owns both Investor A Shares and Investor B
or Investor C Shares in the same Portfolio, the Investor A Shares will be re-
deemed first unless the shareholder indicates otherwise. If a redeeming share-
holder owns both Investor B Shares and Investor C Shares in the same Portfolio,
the redemption order will be processed to minimize the amount of the contingent
deferred sales charge that will be charged unless the shareholder indicates
otherwise.
Except as noted below, a request for redemption must be signed by all persons
in whose names the shares are registered. Signatures must conform exactly to
the account registration. If the proceeds of the redemption would exceed
$25,000, or if the proceeds are not to be paid to the record owner at the rec-
ord address, or if the shareholder is a corporation, partnership, trust or fi-
duciary, signature(s) must be guaranteed by any eligible guarantor institution.
Eligible guarantor institutions generally include banks, broker/dealers, credit
unions, national securities exchanges, registered securities associations,
clearing agencies and savings associations.
Generally, a properly signed written request with any required signature guar-
antee is all that is required for a redemption. In some cases, however, other
documents may be necessary. Shareholders holding Investor A Share certificates
must send their certificates with the redemption request. Additional documen-
tary evidence of authority is required by PFPC in the event redemption is re-
quested by a corporation, partnership, trust, fiduciary, executor or adminis-
trator.
EXPEDITED REDEMPTIONS. If a shareholder has given authorization for expedited
redemption, shares can be redeemed by telephone and the proceeds sent by check
to the shareholder or by Federal wire transfer to a single previously desig-
nated bank account. Once authorization is on file, PFPC will honor requests by
any person by telephone at (800) 441-7762 or other means. The minimum amount
that may be sent by check is $500, while the minimum amount that may be wired
is $10,000. The Fund reserves the right to change these minimums or to termi-
nate these redemption privileges. If the proceeds of a redemption would exceed
$25,000, the redemption request must be in writing and will be subject to the
signature guarantee requirement described above. This privilege may not be used
to redeem Investor A Shares in certificated form. 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 Fund is not responsible for the efficiency of the Federal wire system or
the shareholder's firm or bank. The Fund does not currently charge for wire
transfers. The shareholder is responsible for any charges imposed by the share-
holder's bank. To change the name of the single designated bank account to re-
ceive wire redemption proceeds, it is necessary to send a written request (with
a guaranteed signature as described above) to BlackRock Funds c/o PFPC, P.O.
Box 8907, Wilmington, Delaware 19899-8907.
The Fund reserves the right to refuse a telephone redemption if it believes it
advisable to do so. The Fund, the Administrators and the Distributor will em-
ploy reasonable procedures to confirm that instructions communicated by tele-
phone are genuine. The Fund, the Administrators and the Distributor will not be
liable for any loss, liability, cost or expense for acting upon telephone in-
structions reasonably believed to be genuine in accordance with such proce-
dures.
25.
<PAGE>
- -------------------------------------------------------------------------------
ACCOUNTS WITH LOW BALANCES. The Fund reserves the right to redeem a sharehold-
er's account in any Portfolio at any time the net asset value of the account
in such Portfolio falls below the required minimum initial investment as the
result of a redemption or an exchange request. A shareholder will be notified
in writing that the value of the shareholder's account in a Portfolio is less
than the required amount and will be allowed 30 days to make additional in-
vestments before the redemption is processed.
PAYMENT OF REDEMPTION PROCEEDS. The redemption price for shares is their net
asset value per share next determined after the request for redemption is re-
ceived in proper form by BlackRock Funds c/o PFPC, P.O. Box 8907, Wilmington,
Delaware 19899-8907. Proceeds from the redemption of shares will be reduced by
the amount of any applicable contingent deferred sales charge. Unless another
payment option is used as described above, payment for redeemed shares is nor-
mally made by check mailed within seven days after acceptance by PFPC of the
request and any other necessary documents in proper order. Payment may, howev-
er, be postponed or the right of redemption suspended as provided by the rules
of the SEC. If the shares to be redeemed have been recently purchased by
check, the Fund's transfer agent may delay the payment of redemption proceeds,
which may be a period of up to 15 days after the purchase date, pending a de-
termination that the check has cleared.
The Fund may also suspend the right of redemption or postpone the date of pay-
ment 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 Fund's responsi-
bilities under the 1940 Act. See "Purchase and Redemption Information" in the
Statement of Additional Information for examples of when such redemption might
be appropriate.
26.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ARE THE SHAREHOLDER FEATURES OF THE FUND?
- --------------------------------------------------------------------------------
BlackRock Funds offers shareholders many special features which enable an in-
vestor to have greater investment flexibility as well as greater access to in-
formation about the Fund throughout the investment period.
Additional information on each of these features is available from PFPC by
calling (800) 441-7762.
EXCHANGE PRIVILEGE. Investor A, Investor B and Investor C Shares of each Port-
folio may be exchanged for shares of the same class of other portfolios of the
Fund which offer that class of shares, based on their respective net asset val-
ues. Exchanges of Investor A Shares may be subject to the difference between
the sales charge previously paid on the exchanged shares and the higher sales
charge (if any) payable with respect to the shares acquired in the exchange.
Investor A Shares of money market portfolios of the Fund that were (1) acquired
through the use of the exchange privilege and (2) can be traced back to a pur-
chase of shares in one or more investment portfolios of the Fund for which a
sales charge was paid, can be exchanged for Investor A Shares of a portfolio
subject to differential sales charges as applicable.
The exchange of Investor B and Investor C Shares will not be subject to a CDSC,
which will continue to be measured from the date of the original purchase and
will not be affected by exchanges.
A shareholder wishing to make an exchange may do so by sending a written re-
quest to PFPC at the address given above. Shareholders are automatically pro-
vided with telephone exchange privileges when opening an account, unless they
indicate on the Application that they do not wish to use this privilege. Share-
holders holding share certificates are not eligible to exchange Investor A
Shares by phone because share certificates must accompany all exchange re-
quests. To add this feature to an existing account that previously did not pro-
vide for this option, a Telephone Exchange Authorization Form must be filed
with PFPC. This form is available from PFPC. Once this election has been made,
the shareholder may simply contact PFPC by telephone at (800) 441-7762 to re-
quest the exchange. During periods of substantial economic or market change,
telephone exchanges may be difficult to complete and shareholders may have to
submit exchange requests to PFPC in writing.
If the exchanging shareholder does not currently own shares of the investment
portfolio whose shares are being acquired, a new account will be established
with the same registration, dividend and capital gain options and broker of
record as the account from which shares are exchanged, unless otherwise speci-
fied in writing by the shareholder with all signatures guaranteed by an eligi-
ble guarantor institution as defined above. In order to participate in the Au-
tomatic Investment Program or establish a Systematic Withdrawal Plan for the
new account, however, an exchanging shareholder must file a specific written
request.
Any share exchange must satisfy the requirements relating to the minimum ini-
tial investment requirement, and must be legally available for sale in the
state of the investor's residence. For Federal income tax purposes, a share ex-
change is a taxable event and, accordingly, a capital gain or loss may be real-
ized. Before making an exchange request, shareholders should consult a tax or
other financial adviser and should consider the investment objective, policies
and restrictions of the investment portfolio into which the shareholder is mak-
ing an exchange, as set forth in the applicable Prospectus. Brokers may charge
a fee for handling exchanges.
The Fund reserves the right to modify or terminate the exchange privilege at
any time. Notice will be given to shareholders of any material modification or
termination except where notice is not required.
27.
<PAGE>
- -------------------------------------------------------------------------------
The Fund reserves the right to reject any telephone exchange request. Tele-
phone exchanges may be subject to limitations as to amount or frequency, and
to other restrictions that may be established from time to time to ensure that
exchanges do not operate to the disadvantage of any portfolio or its share-
holders. The Fund, the Administrators and the Distributor will employ reason-
able procedures to confirm that instructions communicated by telephone are
genuine. The Fund, the Administrators and the Distributor will not be liable
for any loss, liability, cost or expense for acting upon telephone instruc-
tions reasonably believed to be genuine in accordance with such procedures.
Exchange orders may also be sent by mail to the shareholder's broker or to
PFPC at P.O. Box 8907, Wilmington, Delaware 19899-8907.
AUTOMATIC INVESTMENT PLAN ("AIP"). An investor in shares of any Portfolio may
arrange for periodic investments in that Portfolio through automatic deduc-
tions from a checking or savings account by completing the AIP Application
Form which may be obtained from PFPC. The minimum pre-authorized investment
amount is $50.
RETIREMENT PLANS. Portfolio shares may be purchased in conjunction with indi-
vidual retirement accounts ("IRAs") and rollover IRAs where PNC Bank or any of
its affiliates acts as custodian. For further information as to applications
and annual fees, contact the Distributor. To determine whether the benefits of
an IRA are available and/or appropriate, a shareholder should consult with a
tax adviser.
SYSTEMATIC WITHDRAWAL PLAN ("SWP"). The Fund offers a Systematic Withdrawal
Plan which may be used by investors who wish to receive regular distributions
from their accounts. Upon commencement of the SWP, the account must have a
current value of $10,000 or more in a Portfolio. Shareholders may elect to re-
ceive automatic cash payments of $50 or more either monthly, every other
month, quarterly, three times a year, semi-annually, or annually. Automatic
withdrawals are normally processed on the 25th day of the applicable month or,
if such day is not a Business Day, on the next Business Day and are paid
promptly thereafter. An investor may utilize the SWP by completing the SWP Ap-
plication Form which may be obtained from PFPC.
Shareholders should realize that if withdrawals exceed income dividends their
invested principal in the account will be depleted. To participate in the SWP,
shareholders must have their dividends automatically reinvested and may not
hold share certificates. Shareholders may change or cancel the SWP at any
time, upon written notice to PFPC. Purchases of additional Investor A Shares
of the Fund concurrently with withdrawals may be disadvantageous to investors
because of the sales charges involved and, therefore, are discouraged. No con-
tingent deferred sales charge will be assessed on redemptions of Investor B or
Investor C Shares made through the SWP that do not exceed 12% of an account's
net asset value on an annualized basis. For example, monthly, quarterly and
semi-annual SWP redemptions of Investor B or Investor C Shares will not be
subject to the CDSC if they do not exceed 1%, 3% and 6%, respectively, of an
account's net asset value on the redemption date. SWP redemptions of Investor
B or Investor C Shares in excess of this limit are still subject to the appli-
cable CDSC.
28.
<PAGE>
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WHAT IS THE SCHEDULE OF SALES CHARGES AND EXEMPTIONS?
- --------------------------------------------------------------------------------
INVESTOR A Investor A Shares are subject to a front-end sales charge de-
SHARES termined in accordance with the following schedule:
<TABLE>
<CAPTION>
REALLOWANCE OR
SALES CHARGE AS SALES CHARGE AS PLACEMENT FEES
AMOUNT OF TRANSACTION % OF % OF TO DEALERS (AS % OF
AT OFFERING PRICE OFFERING PRICE* NET ASSET VALUE* OFFERING PRICE)**
<S> <C> <C> <C>
Less than $25,000 4.00% 4.17% 3.50%
$25,000 but less than
$50,000 3.75 3.90 3.25
$50,000 but less than
$100,000 3.50 3.63 3.00
$100,000 but less than
$250,000 3.00 3.09 2.50
$250,000 but less than
$500,000 2.00 2.04 1.50
$500,000 but less than
$1,000,000 1.00 1.01 0.75
$1-2 million 0.00 0.00 0.75
$2-3 million 0.00 0.00 0.72
$3-5 million 0.00 0.00 0.63
$5-10 million 0.00 0.00 0.44
$10-15 million 0.00 0.00 0.38
$15-20 million 0.00 0.00 0.35
$20-40 million 0.00 0.00 0.30
</TABLE>
*There is no initial sales charge on purchase of $1,000,000 or more of Investor
A Shares; however, a contingent deferred sales charge of 1.00% will be imposed
on the lesser of the offering price or the net asset value of the shares on the
redemption date for shares redeemed within 18 months after purchase.
**The Distributor may pay placement fees to dealers as shown on purchases of
Investor A Shares of $1,000,000 or more.
During special promotions, the entire sales charge may be reallowed to dealers.
Dealers who receive 90% or more of the sales charge may be deemed to be "under-
writers" under the 1933 Act. The amount of the sales charge not reallowed to
dealers may be paid to broker-dealer affiliates of PNC Bank Corp. who provide
sales support services. The Distributor, BlackRock, Inc. and/or their affili-
ates may also pay additional compensation, out of their assets and not as an
additional charge to the Portfolios, to dealers in connection with the sale and
distribution of shares (such as additional payments based on new sales), and
may, subject to applicable NASD regulations, contribute to various non-cash and
cash incentive arrangements to promote the sale of shares, as well as sponsor
various educational programs, sales contests and promotions in which partici-
pants 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.
SALES CHARGE WAIVERS--INVESTOR A SHARES. The following persons associated with
the Fund, the Distributor, the Fund's investment adviser, sub-adviser or trans-
fer agent and their affiliates may buy Investor A Shares without paying a sales
charge to the extent permitted by these firms: (a) officers, directors and
partners (and their spouses and minor children); (b) employees and retirees
(and their spouses and minor children); (c) registered representatives of bro-
kers who have entered into selling agreements with the Distributor; (d) spouses
or children of such persons; and (e) any trust, pension, profit-sharing or
other benefit plan for any of the persons set forth in (a) through (c). The
following persons may also buy Investor A Shares without paying a sales charge:
(a) persons investing through an authorized payroll deduction plan; (b) persons
investing through an authorized investment plan for organizations which operate
under Section 501(c)(3) of the Internal Revenue Code; (c) registered investment
advisers, trust companies and bank trust
29.
<PAGE>
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departments exercising discretionary investment authority with respect to
amounts to be invested in a Portfolio, provided that the aggregate amount in-
vested pursuant to this exemption in Investor A Shares that would otherwise be
subject to front- end sales charges equals at least $250,000; and (d) persons
participating in a "wrap account" or similar program under which they pay ad-
visory fees to a broker-dealer or other financial institution. INVESTORS WHO
QUALIFY FOR ANY OF THESE EXEMPTIONS FROM THE SALES CHARGE MUST PURCHASE IN-
VESTOR A SHARES.
QUALIFIED PLANS. In general, the sales charge (as a percentage of offering
price) payable by qualified employee benefit plans ("Qualified Plans") having
at least 20 employees eligible to participate in purchases of Investor A
Shares of the Portfolios aggregating less than $500,000 will be 1.00%. No
sales charge will apply to purchases by such Qualified Plans of Investor A
Shares aggregating $500,000 and above. The sales charge payable by Qualified
Plans having less than 20 employees eligible to participate in purchases of
Investor A Shares of the Portfolios aggregating less than $500,000 will be
2.50%. The above schedule will apply to purchases by such Qualified Plans of
Investor A Shares aggregating $500,000 and above.
The Fund has established different waiver arrangements with respect to the
sales charge on Investor A Shares of the Portfolios for purchases through cer-
tain Qualified Plans participating in programs whose sponsors or administra-
tors have entered into arrangements with the Fund. For further information,
see "Purchase and Redemption Information" in the Statement of Additional
Information.
QUANTITY DISCOUNTS. As shown above, larger purchases may reduce the sales
charge price. Upon notice to the investor's broker or the transfer agent, pur-
chases of Investor A Shares made at any one time by the following persons may
be considered when calculating the sales charge: (a) an individual, his or her
spouse, and their children under the age of 21; (b) a trustee or fiduciary of
a single trust estate or single fiduciary account; or (c) any organized group
which has been in existence for more than six months, if it is not organized
for the purpose of buying redeemable securities of a registered investment
company, and if the purchase is made through a central administrator, or
through a single dealer, or by other means which result in economy of sales
effort or expense. An organized group does not include a group of individuals
whose sole organizational connection is participation as credit card holders
of a company, policyholders of an insurance company, customers of either a
bank or broker/dealer or clients of an investment adviser. Purchases made by
an organized group may include, for example, a trustee or other fiduciary pur-
chasing for a single fiduciary account or other employee benefit plan pur-
chases made through a payroll deduction plan.
REDUCED SALES CHARGES--INVESTOR A SHARES
RIGHT OF ACCUMULATION. Under the Right of Accumulation, the current value of
an investor's existing Investor A Shares in any of the Portfolios that are
subject to a front-end sales charge or the total amount of an investor's ini-
tial investment in such shares, less redemptions (whichever is greater) may be
combined with the amount of the investor's current purchase in determining the
applicable sales charge. IN ORDER TO RECEIVE THE CUMULATIVE QUANTITY REDUC-
TION, PREVIOUS PURCHASES OF INVESTOR A SHARES MUST BE CALLED TO THE ATTENTION
OF PFPC BY THE INVESTOR AT THE TIME OF THE CURRENT PURCHASE.
REINVESTMENT PRIVILEGE. Upon redemption of Investor A Shares of a Portfolio
(or Investor A Shares of another non-money market portfolio of the Fund), a
shareholder has a one-time right, to be exercised within 60 days, to reinvest
the redemption proceeds without any sales charges. PFPC must be notified of
the reinvestment in writing by the purchaser, or by his or her broker, at the
time the purchase is made in order to eliminate a sales charge. An investor
should consult a tax adviser concerning the tax consequences of use of the re-
investment privilege.
LETTER OF INTENT. An investor may qualify for a reduced sales charge immedi-
ately by signing a Letter of Intent stating the investor's intention to invest
during the next 13 months a specified amount in Investor A Shares which, if
made at one time, would qualify for a reduced sales charge. The Letter of In-
tent may be signed at any time within 90 days after the first investment to be
included in the Letter of Intent. The initial investment must meet the minimum
initial investment requirement and represent at least 5% of the total intended
investment. THE INVESTOR MUST INSTRUCT PFPC UPON MAKING SUBSEQUENT PURCHASES
THAT SUCH PURCHASES ARE SUBJECT TO A LETTER OF INTENT. All dividends and capi-
tal gains of a Portfolio that are invested in additional Investor A Shares of
the same Portfolio are applied to the Letter of Intent.
30.
<PAGE>
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During the term of a Letter of Intent, the Fund's transfer agent will hold In-
vestor A Shares representing 5% of the indicated amount in escrow for payment
of a higher sales load if the full amount indicated in the Letter of Intent is
not purchased. The escrowed Investor A Shares will be released when the full
amount indicated has been purchased. Any redemptions made during the 13-month
period will be subtracted from the amount of purchases in determining whether
the Letter of Intent has been completed.
If the full amount indicated is not purchased within the 13-month period, the
investor will be required to pay an amount equal to the difference between the
sales charge actually paid and the sales charge the investor would have had to
pay on his or her aggregate purchases if the total of such purchases had been
made at a single time. If remittance is not received within 20 days of the ex-
piration of the 13-month period, PFPC, as attorney-in-fact, pursuant to the
terms of the Letter of Intent, will redeem an appropriate number of Investor A
Shares held in escrow to realize the difference.
PURCHASES OF INVESTOR B SHARES. Investor B Shares are subject to a deferred
sales charge at the rates set forth in the chart below if they are redeemed
within six years of purchase. The deferred sales charge on Investor B Shares is
based on the lesser of the offering price or the net asset value of the In-
vestor B Shares on the redemption date. Dealers will generally receive commis-
sions equal to 4.00% of the Investor B Shares sold by them plus ongoing fees
under the Fund's Distribution and Service Plan and described under "Who Manages
The Fund?" Dealers may not receive a commission in connection with sales of In-
vestor B Shares to certain retirement plans sponsored by the Fund, BlackRock,
Inc. or its affiliates, but may receive fees under the Distribution and Service
Plan. These commissions and payments may be different than the reallowances,
placement fees and commissions paid to dealers in connection with sales of In-
vestor A Shares and Investor C Shares. See "What Is The Schedule Of Sales
Charges And Exemptions--Investor A Shares" for information on additional sales
incentives which the Distributor, BlackRock, Inc. and/or their affiliates may
provide to dealers in connection with the sale of shares.
The amount of any contingent deferred sales charge an investor must pay on In-
vestor B Shares depends on the number of years that elapse between the purchase
date and the date the Investor B Shares are redeemed as set forth in the fol-
lowing chart:
<TABLE>
<CAPTION>
CONTINGENT DEFERRED
SALES CHARGE (AS A
NUMBER OF YEARS PERCENTAGE OF DOLLAR AMOUNT
ELAPSED SINCE PURCHASE SUBJECT TO THE CHARGE)
<S> <C>
Less than one 4.50%
More than one, but less than two 4.00
More than two, but less than three 3.50
More than three, but less than four 3.00
More than four, but less than five 2.00
More than five, but less than six 1.00
More than six, but less than seven 0.00
</TABLE>
PURCHASES OF INVESTOR C SHARES. Investor C Shares are subject to a deferred
sales charge of 1.00% based on the lesser of the offering price or the net as-
set value of the Investor C Shares on the redemption date if redeemed within
twelve months after purchase. Dealers will generally receive commissions equal
to 1.00% of the Investor C Shares sold by them plus ongoing fees under the
Fund's Distribution and Service Plan as described above under "Who Manages the
Fund?" Dealers may not receive a commission in connection with sales of In-
vestor C Shares to certain retirement plans sponsored by the Fund, BlackRock,
Inc. or its affiliates, but may receive fees under the Distribution and Service
Plan. These commissions and payments may be different than the reallowances,
placement fees and commissions paid to dealers in connection with sales of In-
vestor A Shares and Investor B Shares. See "What Is The Schedule Of Sales
Charges And Exemptions--Investor A Shares" for information on additional sales
incentives which the Distributor, BlackRock, Inc. and/or their affiliates may
provide to dealers in connection with the sale of shares.
31.
<PAGE>
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EXEMPTIONS FROM THE CONTINGENT DEFERRED SALES CHARGE. The contingent deferred
sales charge on Investor B Shares and Investor C Shares is not charged in con-
nection with: (1) exchanges described in "What Are the Shareholder Features of
the Fund?--Exchange Privilege"; (2) redemptions made in connection with minimum
required distributions from IRA, 403(b)(7) and Qualified Plan accounts due to
the shareholder reaching age 70 1/2; (3) redemptions made with respect to cer-
tain retirement plans sponsored by the Fund, BlackRock, Inc. or its affiliates;
(4) redemptions in connection with a shareholder's death or disability (as de-
fined in the Internal Revenue Code) subsequent to the purchase of Investor B or
Investor C Shares; (5) involuntary redemptions of Investor B or Investor C
Shares in accounts with low balances as described in "How Are Shares Re-
deemed?"; and (6) redemptions made pursuant to the Systematic Withdrawal Plan,
subject to the limitations set forth above under "What Are the Shareholder Fea-
tures of the Fund?--Systematic Withdrawal Plan." In addition, no contingent de-
ferred sales charge is charged on Investor B or Investor C Shares acquired
through the reinvestment of dividends or distributions. The Fund also waives
the contingent deferred sales charge on redemptions of Investor B Shares of the
Portfolios purchased through certain Qualified Plans participating in programs
whose sponsors or administrators have entered into arrangements with the Fund.
For further information, see "Purchase and Redemption Information" in the
Statement of Additional Information.
When an investor redeems Investor B or Investor C Shares, the redemption order
is processed to minimize the amount of the contingent deferred sales charge
that will be charged. Investor B and Investor C Shares are redeemed first from
those shares that are not subject to the deferred sales load (i.e., shares that
were acquired through reinvestment of dividends or distributions) and after
that from the shares that have been held the longest.
32.
<PAGE>
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HOW IS NET ASSET VALUE CALCULATED?
- --------------------------------------------------------------------------------
Net asset value is calculated separately for each class of Investor Shares of
each Portfolio as of the close of regular trading hours on the NYSE (currently
4:00 p.m. Eastern Time) on each Business Day by dividing the value of all secu-
rities and other assets owned by a Portfolio that are allocated to a particular
class of shares, less the liabilities charged to that class, by the number of
shares of the class that are outstanding.
Most securities held by a Portfolio are priced based on their market value as
determined by reported sales prices, or the mean between bid and asked prices,
that are provided by securities dealers or pricing services. Portfolio securi-
ties which are primarily traded on foreign securities exchanges are normally
valued at the preceding closing values of such securities on their respective
exchanges. Securities for which market quotations are not readily available are
valued at fair market value as determined in good faith by or under the direc-
tion 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 a Portfolio's sub-adviser under the supervision of the Board of
Trustees determines such method does not represent fair value.
HOW FREQUENTLY ARE DIVIDENDS AND DISTRIBUTIONS MADE TO INVESTORS?
- --------------------------------------------------------------------------------
Each Portfolio will distribute substantially all of its net investment income
and net realized capital gains, if any, to shareholders. All distributions are
reinvested at net asset value in the form of additional full and fractional
shares of the same class of shares of the relevant Portfolio unless a share-
holder 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. Each Portfolio declares a dividend each day on "set-
tled" shares (i.e., shares for which the particular Portfolio has received pay-
ment in Federal funds) on the first Business Day after a purchase order is
placed with the Fund. Payments by check are normally converted to Federal funds
within two Business Days of receipt. Over the course of a year, substantially
all of the Portfolio's net investment income will be declared as dividends. The
amount of the daily dividend for each Portfolio will be based on periodic pro-
jections of its net investment income. All dividends are paid within ten days
after the end of each month. Net realized capital gains (including net short-
term capital gains), if any, will be distributed by each Portfolio at least an-
nually.
33.
<PAGE>
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HOW ARE FUND DISTRIBUTIONS TAXED?
- --------------------------------------------------------------------------------
Each Portfolio intends to qualify as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). If
a Portfolio qualifies, 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 distributions (except distributions
that are "exempt interest dividends" or are treated as a return of capital),
whether the distributions are paid in cash or reinvested in additional shares.
Distributions paid out of a Portfolio's "net capital gain" (the excess of 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 shares. All other distributions, to the extent taxable, are
taxed to shareholders as ordinary income.
Each Portfolio intends to pay substantially all of its dividends as "exempt in-
terest dividends." However, taxpayers are required to report the receipt of
"exempt interest dividends" on their Federal income tax returns, and in two
circumstances such amounts, while exempt from regular Federal income tax, are
taxable to persons subject to alternative minimum tax. First, "exempt interest
dividends" derived from certain private activity bonds issued after August 7,
1986 generally will constitute an item of tax preference for corporate and non-
corporate taxpayers in determining alternative minimum tax liability. Second,
"exempt interest dividends" must be taken into account by corporate taxpayers
in determining certain adjustments for alternative minimum tax purposes. In ad-
dition, investors should be aware of the possibility of state and local alter-
native minimum or minimum income tax liability on interest from private activ-
ity bonds. Shareholders who are recipients of Social Security Act or Railroad
Retirement Act benefits should note that "exempt interest dividends" will be
taken into account in determining the taxability of their benefit payments.
Each Portfolio will determine annually the percentages of its net investment
income which are exempt from the regular Federal income tax, which constitute
an item of tax preference for Federal alternative minimum tax purposes, and
which are fully taxable. These percentages will apply uniformly to all distri-
butions declared from net investment income during that year and may differ
significantly from the actual percentages for any particular day.
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 speci-
fied date in those months will be deemed to have been received by the share-
holders on December 31 of such year, if the dividends are paid during the fol-
lowing January.
An investor considering buying shares on or just before a dividend record date
should be aware that the amount of the forthcoming dividend payment, although
in effect a return of capital, will be taxable.
A taxable gain or loss may be realized by a shareholder upon the redemption,
transfer or exchange of shares depending upon their tax basis and their price
at the time of redemption, transfer or exchange. Generally, shareholders may
include sales charges paid on the purchase of shares in their tax basis for the
purposes of determining gain or loss on a redemption, transfer or exchange of
such shares. However, if a shareholder exchanges the shares for shares of an-
other Portfolio within 90 days of purchase and is able to reduce the sales
charges applicable to the new shares (by virtue of the Fund's exchange privi-
lege), the amount equal to such reduction may not be included in the tax basis
of the shareholder's exchanged shares for the purpose of determining gain or
loss but may be included (subject to the same limitation) in the tax basis of
the new shares.
Any loss upon the sale or exchange of shares held for six months or less will
be disallowed for Federal income tax purposes to the extent of any exempt in-
terest dividends received by the shareholder. For the Delaware Tax-Free Income
Portfolio, any loss upon the sale or exchange of shares held for six months or
less will also be disallowed for Delaware income tax purposes to the extent of
any exempt interest dividends received by the shareholder[, without regard to
whether all or any portion of such exempt interest dividends may have been sub-
ject to Delaware income tax.
34.
<PAGE>
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A Portfolio may make investments that produce income that is not matched by a
corresponding cash distribution to the Portfolio, such as investments in pay-
in-kind bonds or in obligations such as zero coupon securities having original
issue discount (i.e., an amount equal to the excess of the stated redemption
price of the security at maturity over its issue price), or market discount
(i.e., an amount equal to the excess of the stated redemption price of the se-
curity over the basis of such bond immediately after it was acquired) if the
Portfolio elects to accrue market discount on a current basis. In addition, in-
come may continue to accrue for federal income tax purposes with respect to a
non-performing investment. Any such income would be treated as income earned by
a Portfolio and therefore would be subject to the distribution requirements of
the Code. Because such income may not be matched by a corresponding cash dis-
tribution to a Portfolio, such Portfolio may be required to borrow money or
dispose of other securities to be able to make distributions to its investors.
In addition, if an election is not made to currently accrue market discount
with respect to a market discount bond, all or a portion of any deduction or
any interest expenses incurred to purchase or hold such bond may be deferred
until such bond is sold or otherwise disposed.
This is not an exhaustive discussion of applicable tax consequences, and in-
vestors may wish to contact their tax advisers concerning investments in the
Portfolios. Except as discussed below, 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 addi-
tion, shareholders who are non-resident alien individuals, foreign trusts or
estates, foreign corporations or foreign partnerships may be subject to differ-
ent Federal income tax treatment. Future legislative or administrative changes
or court decisions may materially affect the tax consequences of investing in a
Portfolio. For additional information concerning the tax treatment of dividends
and distributions by the states listed below, including certain restrictions
applicable to such treatment, see "Taxes" in the Statement of Additional Infor-
mation.
DELAWARE TAX CONSIDERATIONS. Individuals, estates and trusts that are subject
to Delaware personal income tax will be subject to such tax on distributions
from the Delaware Tax-Free Income Portfolio (other than distributions qualify-
ing as "exempt interest dividends" under the Code which are subject to such tax
as discussed below and distributions attributable to interest paid on certain
U.S. government obligations) to the same extent as such distributions are in-
cludible in the gross income of such shareholders for Federal income tax pur-
poses. Unlike the Code, however, Delaware tax law does not provide for differ-
ent tax rates for distributions paid out of "net capital gain" and other dis-
tributions.
Individuals, estates and trusts that are subject to Delaware personal income
tax will not be subject to such tax on distributions that qualify as "exempt
interest dividends" under the Code to the extent that such distributions are
attributable to interest on Delaware State-Specific Obligations and provided
that the Delaware Tax-Free Income Portfolio sends shareholders a written state-
ment of the dollar amount or percentage of the exempt interest dividends that
are attributable to interest on Delaware State-Specific Obligations. Similarly,
if the Delaware Tax-Free Income Portfolio qualifies as a regulated investment
company under the Code, individuals, estates and trusts that are subject to
Delaware personal income tax will not be subject to such tax on distributions
that are attributable to interest paid on certain U.S. government obligations,
provided that the Delaware Tax-Free Income Portfolio sends shareholders a writ-
ten statement of the dollar amount or percentage of such distributions that are
attributable to interest paid on such U.S. government obligations. The Fund
will send written notices to shareholders annually regarding the Delaware tax
status of distributions made by the Delaware Tax-Free Income Portfolio.
For corporations and other entities that are subject to Delaware corporate in-
come tax, distributions will be excluded from the Delaware taxable income of
such shareholders to the same extent as such distributions are excluded from
the Federal taxable income of such shareholders.
35.
<PAGE>
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KENTUCKY TAX CONSIDERATIONS. Exempt interest dividends paid by the Kentucky
Tax-Free Income Portfolio that are attributable to Kentucky State-Specific Ob-
ligations will be excludible from a shareholder's gross income for Kentucky in-
come tax purposes. Further, distributions attributable to interest on certain
U.S. government obligations will similarly be excluded from gross income for
Kentucky income tax purposes. All other distributions by the Kentucky Tax-Free
Income Portfolio will be included in a shareholder's gross income for Kentucky
income tax purposes. Kentucky taxes distributions of net capital gain at the
same rates as ordinary income. Under the laws of Kentucky relating to ad valo-
rem taxation of property, the shareholders rather than the Kentucky Tax-Free
Income Portfolio are considered the owners of the Portfolio's assets. Each
shareholder will be deemed to be the owner of a pro-rata portion of the Ken-
tucky Tax-Free Income Portfolio's assets. According to the Kentucky Revenue
Cabinet, the portion of the Portfolio's assets that consists of Kentucky State-
Specific Obligations will be exempt from intangible property taxes, but the
portion that consists of cash on hand, cash in out-of-state banks, futures, op-
tions and other nonexempt assets will be subject to intangible property taxes.
36.
<PAGE>
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HOW IS THE FUND ORGANIZED?
- --------------------------------------------------------------------------------
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. 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 thirty-eight investment portfolios. Each of the Portfolios
described herein, offers five separate classes of shares--Institutional Shares,
Service Shares, Investor A Shares, Investor B Shares and Investor C Shares.
This prospectus relates only to Investor A Shares, Investor B Shares and
Investor C Shares of the Portfolios described herein.
Shares of each class bear their pro rata portion of all operating expenses paid
by a Portfolio, except transfer agency fees, certain administrative/servicing
fees and amounts payable under the Fund's Distribution and Service Plan. In ad-
dition, each class of Investor Shares is sold with different sales charges. Be-
cause of these "class expenses" and sales charges, the performance of the Port-
folios' Institutional Shares is expected to be higher than the performance of
the Portfolio's Service Shares, and the performance of each of the Institu-
tional Shares and Service Shares of a Portfolio is expected to be higher than
the performance of the Portfolio's three classes of Investor Shares. The per-
formance of each class of Investor Shares may be different. The Fund offers
various services and privileges in connection with its Investor Shares that are
not generally offered in connection with its Institutional and Service Shares,
including an automatic investment plan and an automatic withdrawal plan. For
further information regarding the Fund's Institutional or Service Share clas-
ses, contact PFPC at (800) 441-7764.
Each share of a Portfolio has a par value of $.001, represents an interest in
that Portfolio and is entitled to the dividends and distributions earned on
that Portfolio's assets that 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 February 4, 1998, PNC Bank held of record approximately 78% of the Fund's
outstanding shares, as trustee on behalf of individual and institutional in-
vestors, 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.
37.
<PAGE>
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HOW IS PERFORMANCE CALCULATED?
- --------------------------------------------------------------------------------
Performance information for each class of Investor 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 Investor Shares of a Portfolio over the measuring pe-
riod. 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 a class of
shares are reinvested in shares of the same class, and also reflect the maximum
sales load charged by the Portfolio with respect to a class of shares. When,
however, a Portfolio compares the total return of a share class to that of
other funds or relevant indices, total return may also be computed without re-
flecting the sales load.
The yield of a class of shares is computed by dividing the Portfolio's net in-
come per share allocated to that class during a 30-day (or one month) period by
the maximum offering price per share on the last day of the period and
annualizing the result on a semi-annual basis. Each Portfolio's "tax-equivalent
yield" may also be quoted, which shows the level of taxable yield needed to
produce an after-tax equivalent to a Portfolio's tax-free yield. This is done
by increasing the Portfolio's yield (calculated above) by the amount necessary
to reflect the payment of Federal and/or state income tax at a stated tax rate.
The performance of a class of a Portfolio's Investor Shares may be compared to
the performance of other mutual funds with similar investment objectives and to
relevant indices, as well as to ratings or rankings prepared by independent
services or other financial or industry publications that monitor the perfor-
mance of mutual funds. For example, the performance of a class of a Portfolio's
Investor Shares 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 Lehman GNMA Index, the T-Bill Index,
the "stocks, bonds and inflation index" published annually by Ibbotson Associ-
ates and the Lehman Government Corporate Bond Index, as well as the benchmarks
attached to this Prospectus. Performance information may also include evalua-
tions of the Portfolios and their share classes published by nationally recog-
nized ranking services, and information as reported in 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 return of a class of shares of a particular Portfolio, a Portfolio may
provide other information demonstrating hypothetical investment returns. This
information may include, but is not limited to, illustrating the compounding
effects of dividends in a dividend reinvestment plan or the impact of tax-de-
ferred investing.
Performance quotations for shares of a Portfolio 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 Investor Shares, when redeemed, may be worth
more or less than their original cost. Since performance will fluctuate, per-
formance data for Investor Shares of a 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. Performance is generally a function of
the kind and quality of the instruments held in a portfolio, portfolio maturi-
ty, operating expenses and market conditions. Any fees charged by brokers or
other institutions directly to their customer accounts in connection with in-
vestments in Investor Shares will not be included in the Portfolio performance
calculations.
38.
<PAGE>
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HOW CAN I GET MORE INFORMATION?
- --------------------------------------------------------------------------------
Below is a brief description of how investors can easily access information
about the BlackRock Funds.
<TABLE>
<CAPTION>
FUND INFORMATION HOURS AVAILABLE PHONE INFORMATION
<S> <C> <C>
INTERNAL 9 AM to 6 PM, E.S.T. toll-free 888-8BLACKROCK
WHOLESALERS/BROKER-DEALER Monday through Friday toll-free 888-825-2257
SUPPORT:
PORTFOLIO MANAGERS 24 Hours, 7 days a week toll-free 800-FUTURE4
COMMENTARY: toll-free 800-388-8734
(Audio recording updated
periodically)
SHAREHOLDER SERVICES
TELEPHONE ACCESS: 24 Hours, 7 days a week toll-free 800-441-7762
ACCOUNT SERVICE 8:30 to 5 PM, E.S.T. toll-free 800-441-7762
REPRESENTATIVES: Monday through Friday
Available to discuss
account balance
information, mutual fund
prospectus, literature and
discuss programs and
services available.
PURCHASES AND REDEMPTIONS: 8:30 to 5 PM, E.S.T. toll-free 800-441-7762
Monday through Friday
WORLD WIDE WEB:
Access general fund 24 Hours, 7 days a week http://www.blackrock.com
information and specific
fund performance. Request
mutual fund prospectuses
and literature. Forward
mutual fund inquiries.
E-MAIL:
Request prospectuses and 24 Hours, 7 days a week [email protected]
literature. Forward mutual
fund inquiries.
WRITTEN CORRESPONDENCE: POST OFFICE BOX ADDRESS STREET ADDRESS
BlackRock Funds BlackRock Funds
c/o PFPC Inc. c/o PFPC Inc.
P.O. Box 8907 400 Bellevue Parkway
Wilmington, DE 19899-8907 Wilmington, DE 19809
</TABLE>
39.
<PAGE>
BLACKROCK FUNDS
THE BLACKROCK FUNDS
BlackRock Funds is a leading mutual fund company currently managing in excess
of $14 billion in 35 portfolios designed to fit a broad range of investment
goals. Each portfolio is managed by recognized experts in equity, fixed income,
international, and tax-free investing who adhere to a pure investment style/SM/.
STOCK PORTFOLIOS
- --------------------------------------------------------------------------------
Large Cap Growth Equity Select Equity
Large Cap Value Equity Micro-Cap Equity
Mid-Cap Growth Equity International Equity
Mid-Cap Value Equity International Emerging Markets
Small Cap Growth Equity International Small Cap Equity
Small Cap Value Equity Index Equity
STOCK & BOND PORTFOLIO
- --------------------------------------------------------------------------------
Balanced
BOND PORTFOLIOS
- --------------------------------------------------------------------------------
Low Duration Bond Government Income
Intermediate Government Bond Managed Income
Intermediate Bond International Bond
Core Bond GNMA
TAX-FREE BOND PORTFOLIOS
- --------------------------------------------------------------------------------
Tax-Free Income New Jersey Tax-Free Income
Delaware Tax-Free Income Ohio Tax-Free Income
Kentucky Tax-Free Income Pennsylvania Tax-Free Income
MONEY MARKET PORTFOLIOS
- --------------------------------------------------------------------------------
Money Market North Carolina Municipal Money Market
U.S. Treasury Money Market Ohio Municipal Money Market
Municipal Money Market Pennsylvania Municipal Money Market
New Jersey Municipal Money Market Virginia Municipal Money Market
<PAGE>
, 1998
- --------------------------------------------------------------------------------
THE DELAWARE TAX-FREE INCOME AND KENTUCKY TAX-FREE INCOME PORTFOLIOS SERVICE
SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASKING THE KEY
QUESTIONS
PAGE
<S> <C>
What Are The Expenses Of The Portfolios?..................... 4
What Are The Portfolios?..................................... 6
What Are The Characteristics Of The Portfolios?.............. 7
What Types Of Securities Are In The Portfolios?.............. 7
What Are The Portfolios' Fundamental Investment
Limitations?................................................ 8
What Additional Investment Policies And Risks Apply?......... 9
Who Manages The Fund?........................................ 16
How Are Shares Purchased And Redeemed?....................... 20
What Special Purchase And Redemption Procedures May Apply?... 22
How Is Net Asset Value Calculated?........................... 24
How Frequently Are Dividends And Distributions Made To
Investors?.................................................. 24
How Are Fund Distributions Taxed?............................ 25
How Is The Fund Organized?................................... 28
How Is Performance Calculated?............................... 29
How Can I Get More Information?.............................. 30
</TABLE>
This Prospectus sets forth concisely information about the Black-
Rock Delaware Tax-Free Income Portfolio and the Kentucky Tax-Free
Income Portfolio (collectively, the "Portfolios") that a prospec-
tive investor needs to know before investing. Please keep it for
future reference. A Statement of Additional Information dated
, 1998 has been filed with the Securities and Exchange Com-
mission (the "SEC"). The Statement of Additional Information may
be obtained free of charge from BlackRock Funds/SM/ (the "Fund")
by calling (800) 441-7764. The Statement of Additional
Information, as supplemented from time to time, is incorporated by
reference into 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 infor-
mation regarding the Fund that has been filed with the SEC.
SHARES OF THE PORTFOLIOS ARE NOT DEPOSITS OR OBLIGATIONS OF, OR
GUARANTEED OR ENDORSED BY, PNC BANK, NATIONAL ASSOCIATION OR ANY
OTHER BANK AND ARE NOT INSURED BY, GUARANTEED BY, OBLIGATIONS OF
OR OTHERWISE SUPPORTED BY THE U.S. GOVERNMENT, THE FEDERAL DE-
POSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY
OTHER GOVERNMENTAL AGENCY. INVESTMENTS IN THE PORTFOLIOS INVOLVE
INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF PRINCIPAL AMOUNT IN-
VESTED.
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 AC-
CURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE. SHARES OF THE STATE-SPECIFIC TAX-FREE PORTFOLIOS ARE INTENDED
ONLY FOR RESIDENTS OF THE RESPECTIVE STATES INDICATED.
2.
<PAGE>
- --------------------------------------------------------------------------------
THE DELAWARE TAX-FREE INCOME AND KENTUCKY TAX-FREE INCOME PORTFOLIOS OF
BLACKROCK FUNDS
- --------------------------------------------------------------------------------
The BLACKROCK FUND family consists of 35 portfolios and has
been structured to include many different investment styles so
that investors may participate across multiple disciplines in
order to seek their long-term financial goals.
Effective January 31, 1998, the Fund has changed its name from
Compass Capital Funds /SM/ to BlackRock Funds/SM/.
The Delaware Tax-Free Income and Kentucky Tax-Free Income Port-
folios of BLACKROCK FUNDS are two of fourteen investment port-
folios that provide investors with a broad spectrum of invest-
ment alternatives within the fixed income sector. Eight of
these portfolios invest in taxable bonds, and six of these
portfolios invest in tax-exempt bonds. A detailed description
of the Delaware Tax-Free Income and Kentucky Tax-Free Income
Portfolios begins on page . To obtain a prospectus describ-
ing the Fund's other fixed income portfolios, call (800) 441-
7762.
BLACKROCK PORTFOLIO PERFORMANCE LIPPER PEER GROUP
BENCHMARK
DE TAX-FREE Lehman Local Go Other States
INCOME Index Intermediate Municipal
Debt Funds
KY TAX-FREE Lehman Local Go KY Municipal Debt
INCOME Index
BlackRock, Inc. serves as investment adviser to the Portfolios.
BlackRock Financial Management, Inc., an affiliate of Black-
Rock, Inc., serves as sub-adviser to each of the Portfolios.
UNDERSTANDING This Prospectus has been crafted to provide detailed, accurate
THE and comprehensive information on the BlackRock Delaware Tax-
BLACKROCK Free Income and Kentucky Tax-Free Income Portfolios. We intend
DELAWARE this document to be an effective tool as you explore different
TAX-FREE directions in fixed income investing.
INCOME AND
KENTUCKY
TAX-FREE
INCOME
PORTFOLIOS
CONSIDERING There can be no assurance that any mutual fund will achieve its
THE RISKS IN investment objective. Both of the Portfolios may purchase il-
BOND liquid securities; enter into repurchase and reverse repurchase
INVESTING agreements and engage in leveraging, which is a speculative
technique; lend portfolio securities to third parties; and en-
ter into futures contracts and options. Each of the Delaware
Tax-Free Income and Kentucky Tax-Free Income Portfolios is a
state-specific tax-free portfolio which concentrates in the se-
curities of issuers located in a particular state, and is non-
diversified, which means that its performance may be dependent
upon the performance of a smaller number of securities than the
other bond portfolios of the Fund, which are considered diver-
sified. See "What Additional Investment Policies And Risks Ap-
ply?"
INVESTING IN
THE
BLACKROCK
FUNDS
For information on how to purchase and redeem shares of the
Portfolios, see "How Are Shares Purchased And Redeemed?" and
"What Special Purchase And Redemption Procedures May Apply?"
3.
<PAGE>
- -------------------------------------------------------------------------------
WHAT ARE THE EXPENSES OF THE PORTFOLIOS?
- -------------------------------------------------------------------------------
Below is a summary of the annual operating expenses expected to be incurred by
Service Shares of the Portfolios after fee waivers for the current fiscal year
as a percentage of average daily net assets. The figures shown under "Other
expenses" are estimated for the current fiscal year. An example based on the
summary is also shown.
<TABLE>
<CAPTION>
DELAWARE KENTUCKY
TAX--FREE TAX--FREE
INCOME INCOME
PORTFOLIO PORTFOLIO
<S> <C> <C> <C> <C>
ANNUAL PORTFOLIO OPERATING
EXPENSES
(AS A PERCENTAGE OF AVERAGE NET
ASSETS)
Advisory fees (after fee
waivers)(/1/) .40% .40%
Other operating expenses .60 .60
----- -----
Administration fees (after fee
waivers)(/1/) .17 .17
Shareholder servicing fees .30 .30
Other expenses .13 .13
--- ---
Total Portfolio operating
expenses
(after fee waivers)(/1/) 1.00% 1.00%
===== =====
</TABLE>
(1) Without waivers, advisory fees would be .55% and administration fees would
be .23% for each Portfolio. BlackRock, Inc. and the Portfolios' adminis-
trators are under no obligation to waive fees or reimburse expenses, but
have informed the Fund that they expect to waive fees and reimburse ex-
penses during the remainder of the current fiscal year as necessary to
maintain the Portfolios' total operating expenses at the levels set forth
in the table. Without waivers, "Other operating expenses" would be .66%
and "Total Portfolio operating expenses" would be 1.21% for each Portfo-
lio.
4.
<PAGE>
- --------------------------------------------------------------------------------
EXAMPLE
An investor in Service Shares would pay the following expenses on a $1,000 in-
vestment assuming (1) a 5% annual return, and (2) redemption at the end of each
time period:
<TABLE>
<CAPTION>
ONE YEAR THREE YEARS
<S> <C> <C>
Delaware Tax-Free Income Portfolio $10 $32
Kentucky Tax-Free Income Portfolio 10 32
</TABLE>
In addition to the compensation itemized in the expense table, institutions
that sell shares of the Portfolios and/or their salespersons may receive com-
pensation for the sale and distribution of shares or for services to the Port-
folios. For information regarding such compensation, see "Who Manages The
Fund?--Shareholder Servicing" in the Prospectus and "Investment Advisory, Ad-
ministration, Distribution and Servicing Arrangements" in the Statement of Ad-
ditional Information.
The foregoing Table and Example are intended to assist investors in understand-
ing 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
brokers or other institutions directly on their customer accounts in connection
with investments in the Portfolios. For a detailed description of the expenses,
see "Who Manages The Fund?"
THE EXAMPLE SHOWN ABOVE SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE IN-
VESTMENT RETURN OR OPERATING EXPENSES. ACTUAL INVESTMENT RETURN AND OPERATING
EXPENSES MAY BE MORE OR LESS THAN THOSE SHOWN.
5.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ARE THE PORTFOLIOS?
- --------------------------------------------------------------------------------
The Delaware Tax-Free Income and Kentucky Tax-Free Income
Portfolios of BLACKROCK FUNDS are two of fourteen investment
portfolios that provide investors with a broad spectrum of
investment alternatives within the fixed income sector. Eight
of these portfolios invest solely in taxable bonds and six of
these portfolios invest in tax-exempt bonds.
In certain investment cycles and over certain holding peri-
ods, a fund that invests in any one of these styles may per-
form above or below the market. An investment program that
combines these multiple disciplines allows investors to se-
lect from among these various product options in the way that
most closely fits the investor's goals and sentiments.
<TABLE>
<CAPTION>
PORTFOLIO INVESTMENT OBJECTIVE
<S> <C>
Delaware Tax-Free Income To seek as high a level of
current income exempt from
Federal income tax and, to the
extent possible, income tax of
the state of Delaware, as is
consistent with the preservation
of capital.
Kentucky Tax-Free Income To seek as high a level of
current income exempt from
Federal income tax and, to the
extent possible, income tax of
the state of Kentucky, as is
consistent with the preservation
of capital.
</TABLE>
6.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ARE THE CHARACTERISTICS OF THE PORTFOLIOS?
- --------------------------------------------------------------------------------
PORTFOLIO CHARACTERISTICS:
<TABLE>
<CAPTION>
DOLLAR-WEIGHTED MIN
PERFORMANCE AVERAGE MATURITY CREDIT QUALITY CREDIT
PORTFOLIO BENCHMARK* (APPROXIMATE)** CONCENTRATION QUALITY
<S> <C> <C> <C> <C>
DE Tax-Free Income Lehman Local GO Index 5-10 Years Investment Grade BBB
Spectrum
KY Tax-Free Income Lehman Local GO Index 5-10 Years Investment Grade BBB
Spectrum
</TABLE>
* The Lehman Local GO Index contains local general obligation bonds.
** The Portfolios' sub-adviser will normally attempt to structure the Portfo-
lios to have comparable durations to the benchmarks. Duration, which mea-
sures price sensitivity to interest rate changes, is not necessarily equal
to average maturity.
WHAT TYPES OF SECURITIES ARE IN THE PORTFOLIOS?
- --------------------------------------------------------------------------------
The following table summarizes the types of securities found in each Portfolio
according to the following designations:
Yes:The Portfolio will hold a significant concentration of these securities
at all times.
Elig.: Eligible; the Portfolio may purchase these securities, but they may or
may not be a significant holding at a given time.
Temp.: Temporary; the Portfolio may purchase these securities, but under nor-
mal market conditions is not expected to do so.
No: The Portfolio may not purchase these securities.
<TABLE>
<CAPTION>
NON FOREIGN
AGENCY/ SECURITIES/
AGENCY COMMERCIAL HIGH YIELD CURRENCY
TREASURIES AGENCIES MBS/1/ MBS/1/ CORP. ABS/2/ SECURITIES RISK MUNICIPALS
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
DE Tax-Free Income Temp. No No No No No No No Yes
KY Tax-Free Income Temp. No No No No No No No Yes
</TABLE>
/1/MBS = mortgage-backed securities
/2/ABS = asset-backed securities
7.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ARE THE PORTFOLIOS' FUNDAMENTAL INVESTMENT LIMITATIONS?
- --------------------------------------------------------------------------------
A Portfolio's investment objective and policies may be changed by the Fund's
Board of Trustees without shareholder approval. However, shareholders will be
given at least 30 days' notice before any change to a Portfolio's investment
objective. No assurance can be provided that a Portfolio will achieve its in-
vestment objective.
Each Portfolio has also adopted certain fundamental investment limitations that
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). The
Portfolios' fundamental investment policies, which are set forth in full in the
Statement of Additional Information, are summarized below.
Neither Portfolio may:
(1) invest 25% or more of its total assets in one or more issuers conducting
their principal business activities in the same industry; and
(2) invest less than 80% of its net assets in Municipal Obligations (as defined
below), except during defensive periods or during periods of unusual market
conditions.
As a non-fundamental investment restriction, each of the Delaware Tax-Free In-
come and Kentucky Tax-Free Income Portfolios will not invest in securities (ex-
cept U.S. Government securities) that would cause, at the end of any tax quar-
ter (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 Portfo-
lio'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 any one issuer
(except U.S. Government securities).
The investment limitations stated above are applied at the time investment se-
curities are purchased.
8.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ADDITIONAL INVESTMENT POLICIES AND RISKS APPLY?
- --------------------------------------------------------------------------------
INVESTMENT QUALITY. Securities acquired by the Portfolios will be rated invest-
ment grade at the time of purchase (within the four highest rating categories
by Standard & Poor's Ratings Group ("S&P"), Moody's Investors Service, Inc.
("Moody's"), Duff & Phelps Credit Co. or Fitch Investor Services, Inc.) or, if
unrated, of comparable quality as determined by the Portfolios' sub-adviser.
Securities rated "Baa" by Moody's or "BBB" by S&P are generally considered to
be investment grade although they have speculative characteristics. If a
security's rating is reduced below the minimum rating that is permitted for a
Portfolio, the Portfolio's sub-adviser will consider whether the Portfolio
should continue to hold the security.
INVESTMENT CONCENTRATION. Each Portfolio will normally invest at least 80% of
the value of its total assets in debt securities. The Portfolios will invest,
during normal market conditions, at least 80% of their net assets in obliga-
tions issued by or on behalf of states, territories and possessions of the
United States, the District of Columbia and their political sub-divisions,
agencies, instrumentalities and authorities and related tax-exempt derivative
securities the interest on which is exempt from regular Federal income tax and
is not an item of tax preference for purposes of the Federal alternative mini-
mum tax ("Municipal Obligations"). In addition, each of the Portfolios intends
to invest at least 65% of its net assets in Municipal Obligations of issuers
located in the particular state indicated by its name ("State-Specific Obliga-
tions"). During temporary defensive periods each of the Portfolios may invest
without limitation in securities that are not Municipal Obligations and may
hold without limitation uninvested cash reserves.
MUNICIPAL INVESTMENTS. The two principal classifications of Municipal Obliga-
tions are "general obligation" securities and "revenue" securities. General ob-
ligation securities are secured by the issuer's pledge of its full faith,
credit and taxing power for the payment of principal and interest. Revenue se-
curities 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 fi-
nanced. 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 in-
clude "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.
Also included within the general category of Municipal Obligations are partici-
pation certificates in a lease, an installment purchase contract, or a condi-
tional sales contract ("lease obligations") entered into by a state or politi-
cal subdivision to finance the acquisition or construction of equipment, land,
or facilities. Although lease obligations are not general obligations of the
issuer for which the state or other governmental body's unlimited taxing power
is pledged, certain lease obligations are backed by a covenant to appropriate
money to make the lease obligation payments. However, under certain lease obli-
gations, the state or governmental body has no obligation to make these pay-
ments in future years unless money is appropriated on a yearly basis. Although
"non-appropriation" lease obligations are secured by the leased property,
disposition of the property in the event of foreclosure might prove difficult.
These securities represent a relatively new type of financing that is not yet
as marketable as more conventional securities.
9.
<PAGE>
- --------------------------------------------------------------------------------
Each Portfolio may invest up to 20% of its total assets in private activity
bonds the interest on which is an item of tax preference for purposes of the
Federal alternative minimum tax ("AMT Paper") when added together with any
other taxable investments held by the Portfolio. In addition, each Portfolio
may invest 25% or more of its assets in Municipal Obligations the interest on
which is paid solely from revenues of similar projects. To the extent a Portfo-
lio's assets are invested in Municipal Obligations payable from the revenues of
similar projects or are invested in private activity bonds, the Portfolio will
be subject to the particular risks presented by the laws and economic condi-
tions relating to such projects and bonds to a greater extent than it would be
if its assets were not so invested.
The Portfolios are classified as non-diversified portfolios under 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 one secu-
rity may affect the overall value of a non-diversified portfolio more than it
would a diversified portfolio.
Each Portfolio may acquire "stand-by commitments" with respect to Municipal Ob-
ligations held by it. Under a stand-by commitment, a dealer agrees to purchase,
at the Portfolio's option, specified Municipal Obligations at a specified
price. The acquisition of a stand-by commitment may increase the cost, and
thereby reduce the yield, of the Municipal Obligations to which the commitment
relates. The Portfolios may invest in tax-exempt derivative securities relating
to Municipal Obligations, including tender option bonds, participations, bene-
ficial interests in trusts and partnership interests.
The amount of information regarding the financial condition of issuers of Mu-
nicipal Obligations may be less extensive than the information for public cor-
porations, and the secondary market for Municipal Obligations may be less liq-
uid than that for taxable obligations. Accordingly, the ability of a Portfolio
to buy and sell Municipal Obligations may, at any particular time and with re-
spect to any particular securities, be limited. In addition, Municipal Obliga-
tions purchased by the Portfolios include obligations backed by letters of
credit and other forms of credit enhancement issued by domestic and foreign
banks, as well as other financial institutions. Changes in the credit quality
of these institutions could cause loss to a Portfolio and affect its share
price.
Opinions relating to the validity of Municipal Obligations and to the exemption
of interest thereon from Federal and state income tax are rendered by counsel
to the respective issuers and sponsors of the obligations at the time of issu-
ance. The Fund and its service providers will rely on such opinions and will
not review independently the underlying proceedings relating to the issuance of
Municipal Obligations, the creation of any tax-exempt derivative securities, or
the bases for such opinions.
STRIPPED AND ZERO COUPON OBLIGATIONS. To the extent consistent with their in-
vestment objectives, 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 obliga-
tions. These participations, 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."
Stripped securities may exhibit greater price volatility than ordinary debt se-
curities because of the manner in which their principal and interest are re-
turned to investors.
10.
<PAGE>
- --------------------------------------------------------------------------------
Each Portfolio may invest in zero-coupon bonds, which are normally issued at a
significant discount from face value and do not provide for periodic interest
payments. Zero-coupon bonds may experience greater volatility in market value
than similar maturity debt obligations which provide for regular interest pay-
ments. Additionally, current federal tax law requires the holder of certain
zero coupon bonds to accrue income with respect to these securities prior to
the receipt of cash payments. To maintain its qualification as a regulated in-
vestment company and avoid liability for federal income and excise taxes, a
Portfolio may be required to distribute income accrued with respect to these
securities and may have to dispose of portfolio securities under disadvanta-
geous circumstances in order to generate cash to satisfy these distribution re-
quirements. See "How Are Fund Distributions Taxed?"
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 Mort-
gage Association are supported by the United States' full faith and credit;
others such as those of the Federal National Mortgage Association and the Stu-
dent 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 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 instrumen-
talities if it is not obligated to do so by law.
INTEREST RATE TRANSACTIONS. The Portfolios may enter into interest rate swaps
and may purchase or sell interest rate caps and floors. The Portfolios may 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 Port-
folio 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 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. 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 inter-
est on a notional principal amount from the party selling such interest rate
floor.
OPTIONS AND FUTURES CONTRACTS. To the extent consistent with its investment ob-
jective, 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 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, 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. A Portfolio will not purchase put and call options when
the aggregate premiums on outstanding options exceed 5% of its net assets at
the time of purchase, and will not write options on more than 25% of the value
of its net assets (measured at the time an option is written). Options trading
is a highly specialized activity that entails greater than ordinary investment
risks. In addition, unlisted options are not subject to the protections af-
forded purchasers of listed options issued by the Options Clearing Corporation,
which performs the obligations of its members if they default.
11.
<PAGE>
- -------------------------------------------------------------------------------
To the extent consistent with its investment objective, each Portfolio may
also invest in futures contracts and options on futures contracts for hedging
purposes or to maintain liquidity. The value of a Portfolio's contracts may
equal or exceed 100% of its total assets, although a Portfolio will not pur-
chase 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 for related futures options entered into for other than bona
fide hedging purposes is 5% or less of its net assets.
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 quan-
tity 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 uti-
lize 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 ob-
ligated to sell or buy a futures contract if the option is exercised. In con-
nection with a Portfolio's position in a futures contract or related option,
the Fund will create a segregated account of 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 in-
struments 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 sub-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 the Statement of Additional Information.
The Fund intends to comply with the regulations of the Commodity Futures Trad-
ing Commission exempting the Portfolios from registration as a "commodity pool
operator."
GUARANTEED INVESTMENT CONTRACTS. The Portfolios may make limited investments
in guaranteed investment contracts ("GICs") issued by highly rated U.S. insur-
ance companies. Under these contracts, a Portfolio makes cash contributions to
a deposit fund of the insurance company's general account. The insurance com-
pany then credits to the Portfolio, on a monthly basis, interest which is
based on an index (such as the Salomon Brothers CD Index), but is guaranteed
not to be less than a certain minimum rate. Each Portfolio does not expect to
invest more than 5% of its net assets in GICs at any time during the current
fiscal year.
SECURITIES LENDING. A Portfolio may seek additional income by lending securi-
ties 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. Se-
curities 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.
VARIABLE AND FLOATING RATE INSTRUMENTS. The Portfolios may purchase rated and
unrated variable and floating rate instruments. These 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.
12.
<PAGE>
- --------------------------------------------------------------------------------
The Portfolios may invest up to 10% of their total assets in leveraged inverse
floating rate debt instruments ("inverse floaters"). The interest rate of an
inverse floater resets in the opposite direction from the market rate of inter-
est to which it is indexed. An inverse floater may be considered to be
leveraged to the extent that its interest rate varies by a magnitude that ex-
ceeds the magnitude of the change in the index rate of interest. The higher de-
gree of leverage inherent in inverse floaters is associated with greater vola-
tility in their market values. Issuers of unrated variable and floating rate
instruments must satisfy the same criteria as set forth above for a Portfolio.
The absence of an active secondary market with respect to particular variable
and floating rate instruments, however, could make it difficult for a Portfolio
to dispose of a variable or floating rate instrument if the issuer defaulted on
its payment obligation or during periods when the Portfolio is not entitled to
exercise its demand rights.
REPURCHASE AGREEMENTS. Each Portfolio may agree to purchase debt securities
from financial institutions subject to the seller's agreement to repurchase
them 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 autho-
rized 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 de-
cline 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 the 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. Reverse repur-
chase agreements involve the risks that the interest income earned in the in-
vestment of the proceeds will be less than the interest expense, that the mar-
ket 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 maintain a segregated account with
the Fund's custodian containing cash, U.S. Government or other appropriate liq-
uid debt securities 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.
INVESTMENT COMPANIES. Each Portfolio may invest in securities issued by other
investment companies within the limits prescribed by the 1940 Act. As a share-
holder 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. GICs, variable and floating rate
instruments that cannot be disposed of within seven days, and repurchase agree-
ments 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 Portfolios' sub-
adviser that an adequate trading market exists for the securities. This invest-
ment practice could have the effect of increasing the level of illiquidity in a
Portfolio during any period that qualified institutional buyers become uninter-
ested in purchasing these restricted securities.
WHEN-ISSUED PURCHASES AND FORWARD COMMITMENTS. Each Portfolio may purchase se-
curities on a "when-issued" basis and may purchase or sell securities on a
"forward commitment" basis. These transactions
13.
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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 securi-
ties delivery takes place. Each Portfolio's when-issued purchases and forward
commitments are not expected to exceed 25% of the value of its total assets ab-
sent unusual market conditions.
SHORT SALES. The Portfolios may only make short sales of securities "against-
the-box." 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 de-
cline. 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 portfolio flexibility. In a short sale "against-the-box," at the time
of sale, the Portfolio owns or has the immediate and unconditional right to ac-
quire the identical security at no additional cost. When selling short
"against-the-box," a Portfolio forgoes an opportunity for capital appreciation
in the security.
PORTFOLIO TURNOVER RATES. Under normal market conditions, it is expected that
the annual portfolio turnover rate for each of the Portfolios will not exceed
150%. A Portfolio's annual portfolio turnover rate will not be a factor pre-
venting a sale or purchase when the sub-adviser believes investment considera-
tions warrant such sale or purchase. Portfolio turnover may vary greatly from
year to year as well as within a particular year. High portfolio turnover rates
(i.e., 100% or more) will generally result in higher transaction costs to a
Portfolio and may result in the realization of short-term capital gains that
are taxable to shareholders as ordinary income.
INTEREST RATE AND EXTENSION RISKS. The value of fixed income securities in the
Portfolios can be expected to vary inversely with changes in prevailing inter-
est rates. Fixed income securities with longer maturities, which tend to pro-
duce higher yields, are subject to potentially greater capital appreciation and
depreci- tion 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 within the limits stated above under "What Are the Differences Among the
Portfolios?" based upon its sub-adviser's assessment of economic and market
conditions. Although the Portfolios' sub-adviser will normally attempt to
structure each Portfolio to have a comparable duration to its benchmark as
stated in that section, there can be no assurance that it will be able to do so
at all times.
STATE-SPECIFIC TAX-FREE PORTFOLIOS--ADDITIONAL RISK CONSIDERATIONS. The concen-
tration of investments by the Portfolios in State-Specific Obligations raises
special investment considerations. In particular, changes in the economic con-
dition and governmental policies of a state and its political subdivisions
could adversely affect the value of a Portfolio's shares. Certain matters re-
lating to the states in which the Portfolios invest are described below. For
further information, see "Special Considerations Regarding State-Specific Obli-
gations" in the Statement of Additional Information.
Delaware. Delaware's economy has expanded throughout most sectors during the
1990's and has diversified beyond its historical emphasis in chemical and auto-
mobile manufacturing to include strong banking and service sectors. Delaware
completed fiscal year 1997 with a cumulative cash balance of $392.8 million, of
which $116.2 million was unencumbered. The State's general obligation debt out-
standing as of December 31, 1997 was $626.7 million. Approximately 80% of this
debt is scheduled to mature within ten years and approximately 90% of this debt
is scheduled to mature within 15 years. While the State has constitutionally-
imposed limits on tax and license fee increases and the imposition of new taxes
or fees (requiring approval by a three-fifths vote of each house of the General
Assembly), there are no constitutionally-imposed limits on debt incurrence.
However, Delaware has instituted several measures designed to manage and reduce
its indebtedness, including legislative debt limits, "pay-as-you-go" financing
for capital projects, bond refundings and cash debt defeasance and
deauthorizations.
14.
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Kentucky. Kentucky is a leader among the states in the production of coal and
tobacco. The Coal Severance Tax is a significant revenue producer for the Com-
monwealth and its political subdivisions, and any substantial decrease in the
amount of coal or other minerals produced could result in revenue shortfalls.
Additionally, any federal legislation or litigation adversely affecting the to-
bacco and/or cigarette industries would have a negative impact on Kentucky's
economy. There is significant diversification in Kentucky's manufacturing sec-
tor, which includes, among other things, tobacco processing plants, distiller-
ies and durable goods production. No single segment of the Commonwealth's econ-
omy consists of as much as one-fourth of the overall state domestic product.
The Commonwealth continues to experience a high unemployment rate in non-urban-
ized areas. Although revenue obligations of the Commonwealth or its political
subdivisions may be payable from a specific project, there can be no assurances
that economic difficulties and the resulting impact on state and local govern-
ment finances will not adversely affect the market value of Kentucky State-Spe-
cific Obligations or the ability of the respective entities to pay debt serv-
ice.
Because of constitutional limitations, the Commonwealth cannot enter into a fi-
nancial obligation of more than two years' duration, and no other municipal is-
suer within the Commonwealth can enter into a financial obligation of more than
one year's duration. As a consequence, the payment and security arrangements
applicable to Kentucky State-Specific Obligations differ significantly from
those generally applicable to municipal revenue obligations in other states.
15.
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WHO MANAGES THE FUND?
- --------------------------------------------------------------------------------
BOARD OF The business and affairs of the Fund are managed under the
TRUSTEES direction of its Board of Trustees. The following persons
currently serve on the Board:
William O. Albertini--Executive Vice President and Chief Fi-
nancial Officer of Bell Atlantic Global Wireless.
Raymond J. Clark--Treasurer of Princeton University.
Robert M. Hernandez--Vice Chairman and Chief Financial Offi-
cer of USX Corporation.
Anthony M. Santomero--Professor of Finance and Director of
the Financial Institutions Center, The Wharton School, Uni-
versity of Pennsylvania.
David R. Wilmerding, Jr.--Chairman, Gee, Wilmerding & Associ-
ates, Inc.
ADVISER AND The Adviser to BlackRock Funds is BlackRock, Inc. Each of the
SUB-ADVISER Portfolios within the BlackRock Funds family is managed by a
specialized portfolio manager who is a member of BlackRock,
Inc.'s fixed income portfolio management affiliate, BlackRock
Financial Management, Inc. ("BlackRock"). BlackRock has its
primary offices at 345 Park Avenue, New York, New York 10154.
The Portfolios and their portfolio managers are as follows:
<TABLE>
<CAPTION>
BLACKROCK PORTFOLIO PORTFOLIO MANAGER
------------------- -----------------
<S> <C>
Delaware Tax-Free Kevin Klingert; Portfolio manager at BlackRock since
Income 1991; prior to joining BlackRock, Assistant Vice
President, Merrill, Lynch, Pierce, Fenner & Smith;
Portfolio manager since commencement of Portfolio
operations and Portfolio manager of predecessor fund
since 1995.
Kentucky Tax-Free Income Kevin Klingert (see above).
</TABLE>
BlackRock, Inc. (formerly PNC Asset Management Group, Inc.)
was organized in 1994 to perform advisory services for in-
vestment companies, and has its principal offices at 1600
Market Street, 29th Floor, Philadelphia, Pennsylvania 19103.
BlackRock, Inc. is an indirect wholly-owned subsidiary of PNC
Bank Corp., a multi-bank holding company.
As adviser, BlackRock, Inc. is responsible for the overall
investment management of the Portfolios. As sub-adviser,
BlackRock Financial Management is responsible for the day-to-
day management of the Portfolios, and generally makes all
purchase and sale investment decisions for the Portfolios.
BlackRock Financial Management also provides research and
credit analysis.
16.
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THE AFFILIATE SUB-ADVISERS OF BLACKROCK, INC. ARE:
. BlackRock Financial Management, Inc.: Domestic and non-dollar
fixed income.
. PNC Equity Advisors: Growth equity.
. Provident Capital Management: Value equity.
. CastleInternational Asset Management: International equity.
. PNC Institutional Management Corporation: Money market.
For their investment advisory and sub-advisory services,
BlackRock, Inc. and the Portfolios' sub-adviser are entitled to
fees, computed daily on a Portfolio-by-Portfolio basis and
payable monthly, at the maximum annual rates set forth below.
As stated under "What Are The Expenses Of The Portfolios?",
BlackRock, Inc. and the sub-adviser intend to waive a portion
of their fees during the current fiscal year. All sub-advisory
fees are paid by BlackRock, Inc., and do not represent an extra
charge to the Portfolios.
MAXIMUM ANNUAL CONTRACTUAL FEE RATE (BEFORE WAIVERS)
<TABLE>
<CAPTION>
AVERAGE DAILY NET INVESTMENT SUB-ADVISORY
ASSETS ADVISORY FEE FEE
----------------- ------------ ------------
<S> <C> <C>
first $1 billion .550% .400%
$1 billion--$2 billion .500 .350
$2 billion--$3 billion .475 .325
greater than $3 billion .450 .300
</TABLE>
The Portfolios' sub-adviser strives to achieve best execution
on all transactions. Infrequently, brokerage transactions for
the Portfolios may be directed through registered
broker/dealers who have entered into dealer agreements with the
Fund's distributor, subject to the requirements of best execu-
tion.
ADMINISTRATORS BlackRock, Inc., PFPC Inc. ("PFPC") and BlackRock Distributors,
Inc. ("BDI") (the "Administrators") serve as the Fund's co-ad-
ministrators. BlackRock, Inc. and PFPC are indirect wholly-
owned subsidiaries of PNC Bank Corp. BDI is a wholly-owned sub-
sidiary of Provident Distributors, Inc. ("PDI"). A majority of
the outstanding stock of PDI is owned by its officers.
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, BlackRock, Inc. is entitled to
receive a fee, computed daily and payable monthly, at an annual
rate of .03% of each Portfolio's average daily net assets. PFPC
and BDI are entitled to receive a combined administration fee,
computed daily and payable monthly, at the aggregate annual
rate of (i) .085% of the first $500 million of each Portfolio's
average daily net assets, .075% of the next $500 million of
each Portfolio's average daily net assets and .065% of the av-
erage daily net assets of each Portfolio in excess of $1 bil-
lion and (ii) .115% of the first $500 million of the average
daily net assets allocated to Service Shares of each Portfolio,
.105% of the next $500 million of such average daily net assets
and .095% of the average daily net assets allocated to Service
Shares of each Portfolio in excess of $1 billion. From time to
time the Administrators may waive some or all of their adminis-
tration fees from a Portfolio.
17.
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For information about the operating expenses the Portfolios
expect to incur in the current fiscal year, see "What Are
the Expenses of the Portfolios?"
TRANSFER PNC Bank, whose principal offices are located at 1600 Market
AGENT, Street, Philadelphia, Pennsylvania 19103, serves as the
DIVIDEND Portfolios' custodian and PFPC, whose principal offices are
DISBURSING located at 400 Bellevue Parkway, Wilmington, Delaware 19809,
AGENT AND serves as their transfer agent and dividend disbursing
CUSTODIAN agent.
SHAREHOLDER The Fund intends to enter into service arrangements with in-
SERVICING stitutional investors ("Institutions") (including PNC Bank
and its affiliates) which provide that the Institutions will
render support services to their customers who are the bene-
ficial owners of Service Shares. These services are intended
to supplement the services provided by the Fund's Adminis-
trators and transfer agent to the Fund's shareholders of
record. In consideration for payment of a shareholder
processing fee of up to .15% (on an annualized basis) of the
average daily net asset value of Service Shares owned bene-
ficially by their customers, Institutions may provide one or
more of the following services: processing purchase and re-
demption requests from customers and placing orders with the
Fund's transfer agent or the distributor; processing divi-
dend payments from the Fund on behalf of customers; provid-
ing sub-accounting with respect to Service Shares benefi-
cially owned by customers or the information necessary for
sub-accounting; and providing other similar services. In
consideration for payment of a separate shareholder servic-
ing fee of up to .15% (on an annualized basis) of the aver-
age daily net asset value of Service Shares owned benefi-
cially by their customers, Institutions may provide one or
more of these additional services to such customers: re-
sponding to customer inquiries relating to the services per-
formed by the Institution and to customer inquiries concern-
ing their investments in Service Shares; assisting customers
in designating and changing dividend options, account desig-
nations and addresses; and providing other similar share-
holder liaison services. Customers who are beneficial owners
of Service Shares should read this Prospectus in light of
the terms and fees governing their accounts with Institu-
tions.
Conflict-of-interest restrictions may apply to the receipt
of compensation paid by the Fund in connection with the in-
vestment of fiduciary funds in Portfolio shares. Institu-
tions, including banks regulated by the Comptroller of the
Currency, Federal Reserve Board and state banking commis-
sions, and investment advisers and other money managers sub-
ject to the jurisdiction of the SEC, the Department of Labor
or state securities commissions, are urged to consult their
legal counsel before entering into agreements with the Fund.
The Glass-Steagall Act and other applicable laws, among
other things, prohibit banks from engaging in the business
of underwriting securities. It is intended that the services
provided by Institutions under their service agreements will
not be prohibited under these laws. Under state securities
laws, banks and financial institutions that receive payments
from the Fund may be required to register as dealers.
EXPENSES
Expenses are deducted from the total income of each Portfo-
lio before dividends and distributions are paid. Expenses
include, but are not limited to, fees paid to BlackRock,
Inc. and the Administrators, transfer agency and custodian
fees, trustee fees, taxes, interest, professional fees,
shareholder servicing and processing fees, fees and expenses
in registering and qualifying the Portfolios and their
shares for distribution
18.
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under Federal and state securities laws, expenses of preparing
prospectuses and statements of additional information and of
printing and distributing prospectuses and statements of addi-
tional information to existing shareholders, expenses relating
to shareholder reports, shareholder meetings and proxy solici-
tations, insurance premiums, the expense of independent pricing
services, and other expenses which are not expressly assumed by
BlackRock, Inc. or the Fund's service providers under their
agreements with the Fund. Any general expenses of the Fund that
do not belong to a particular investment portfolio will be al-
located among all investment portfolios by or under the direc-
tion of the Board of Trustees in a manner the Board determines
to be fair and equitable.
19.
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HOW ARE SHARES PURCHASED AND REDEEMED?
- -------------------------------------------------------------------------------
DISTRIBUTOR. Shares of the Portfolios are offered on a continuous basis by BDI
as distributor (the "Distributor"). BDI maintains its principal offices at
Four Falls Corporate Center, 6th Floor, West Conshohocken, PA 19428-2961.
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 Service Shares. However, the Plan
permits BDI, 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 Arrange-
ments" in the Statement of Additional Information.
PURCHASE OF SHARES. Service Shares are offered without a sales load to Insti-
tutions acting on behalf of their customers, certain persons who were share-
holders of The Compass Capital Group at the time of its combination with The
PNC(R) Fund during the first quarter of 1996, and investors that participate
in the Capital Directions /SM/ asset allocation program.
Service Shares will normally be held of record by Institutions or in the names
of nominees of Institutions. Share purchases are normally effected through a
customer's account at an Institution through procedures established in connec-
tion with the requirements of the account. In these cases, confirmations of
share purchases and redemptions will be sent to the Institutions. Beneficial
ownership of shares will be recorded by the Institutions and reflected in the
account statements provided by such Institutions to their customers. Investors
wishing to purchase shares should contact their Institutions.
Service Shares are sold at their net asset value per share next computed after
an order is received by PFPC. Orders received by PFPC by 4:00 p.m. (Eastern
Time) on a Business Day are priced the same day. A "Business Day" is any week-
day that the New York Stock Exchange (the "NYSE") and the Federal Reserve Bank
of Philadelphia (the "FRB") are open for business. Purchase orders may be
placed by telephoning PFPC at (800) 441-7450. Orders received by PFPC after
4:00 p.m. (Eastern Time) are priced on the following Business Day.
Payment for Service Shares must normally be made in Federal funds or other
funds immediately available to the Fund's custodian. Payment may also, in the
discretion of the Fund, 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 minimum initial investment is $5,000;
however, Institutions may set a higher minimum for their customers. There is
no minimum subsequent investment requirement. The Fund does not accept third
party checks for initial or subsequent investments.
The Fund may in its discretion waive or modify the minimum investment amount,
may reject any order for Service Shares and may suspend and resume the sale of
shares of any share class of the Portfolio at any time.
In the event that a shareholder acquiring Service Shares on or after May 1,
1998 (other than a former shareholder of The Compass Capital Group as de-
scribed above) ceases to meet the eligibility standards for purchasing Service
Shares, then the shareholder's Service Shares will, upon the direction of the
Fund's distributor, automatically be converted to Investor A Shares of the
Portfolio having the same aggregate net asset value as the shares converted.
Investor A Shares are currently authorized to bear additional service and dis-
tribution
20.
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fees at the aggregate annual rate of .20% of average daily net assets. In the
event that a shareholder acquiring Service Shares on or after May 1, 1998 sub-
sequently satisfies the eligibility standards for purchasing Institutional
Shares (other than due to fluctuations in market value), then the shareholder's
Service Shares will, upon the direction of the Fund's distributor, automati-
cally be converted to Institutional Shares of the Portfolio having the same ag-
gregate net asset value as the shares converted.
REDEMPTION OF SHARES. Customers of Institutions may redeem Service Shares in
accordance with the procedures applicable to their accounts with the Institu-
tions. These procedures will vary according to the type of account and the In-
stitution involved, and customers should consult their account managers in this
regard. It is the responsibility of Institutions to transmit redemption orders
to PFPC and credit their customers' accounts with redemption proceeds on a
timely basis. In the case of shareholders holding share certificates, the cer-
tificates must accompany the redemption request.
Institutions may place redemption orders 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 Fund, the Administrators and the
Distributor will employ reasonable procedures to confirm that instructions com-
municated 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.
Payment for redeemed shares for which a redemption order is received by PFPC
before 4:00 p.m. (Eastern Time) on a Business Day is normally made in Federal
funds wired to the redeeming Institution on the next Business Day, provided
that the Fund's custodian is also open for business. Payment for redemption or-
ders received after 4:00 p.m. (Eastern Time) or on a day when the Fund's custo-
dian is closed is normally wired in Federal funds on the next Business Day fol-
lowing redemption on which the Fund's custodian is open for business. The Fund
reserves the right to wire redemption proceeds within seven days after receiv-
ing a redemption order if, in the judgment of BlackRock, Inc., an earlier pay-
ment could adversely affect a Portfolio. No charge for wiring redemption pay-
ments is imposed by the Fund, although Institutions may charge their customer
accounts for redemption services. Information relating to such redemption serv-
ices and charges, if any, should be obtained by customers from their Institu-
tions.
During periods of substantial economic or market change, telephone redemptions
may be difficult to complete. Redemption requests may also be mailed to PFPC at
400 Bellevue Parkway, Wilmington, DE 19809.
The Fund may redeem Service Shares in any shareholder's account if the account
balance drops below $5,000 as the result of redemption requests and the share-
holder does not increase the balance to at least $5,000 upon thirty days' writ-
ten notice. If a customer has agreed with an Institution to maintain a minimum
balance in his or her account with the Institution, and the balance in the ac-
count falls below that minimum, the customer may be obligated to redeem all or
part of his or her shares in the Portfolios to the extent necessary to maintain
the minimum balance required.
The Fund may also suspend the right of redemption or postpone the date of pay-
ment 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 Fund's responsibili-
ties under the 1940 Act. See "Purchase and Redemption Information" in the
Statement of Additional Information for examples of when such redemption might
be appropriate.
21.
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WHAT SPECIAL PURCHASE AND REDEMPTION PROCEDURES MAY APPLY?
- --------------------------------------------------------------------------------
PURCHASES. Purchase orders may be placed through PFPC. The minimum investment
is $100. Purchases through the Automatic Investment Plan described below are
subject to a lower purchase minimum. The name of the Portfolio with respect to
which shares are purchased must appear on the check or Federal Reserve Draft.
Investors may also wire Federal funds in connection with the purchase of
shares. The wire instructions must include the name of the Portfolio, class of
the Portfolio, the name of the account registration, and the shareholder ac-
count number. Before wiring any funds, however, an investor must call PFPC at
(800) 441-7762 in order to confirm the wire instructions. Purchase orders which
are received by PFPC, together with payment, before the close of regular trad-
ing hours on the NYSE (currently 4:00 p.m. Eastern Time) on any Business Day
(as defined above) are priced according to the net asset value next determined
on that day.
The Portfolios offer an Automatic Investment Plan ("AIP") whereby an investor
in shares of a Portfolio may arrange for periodic investments in that Portfolio
through automatic deductions from a checking or savings account by completing
the AIP Application Form which may be obtained from PFPC. The minimum pre- au-
thorized investment amount is $50.
REDEMPTIONS. Shareholders may redeem for cash some or all of their shares of
the Portfolios at any time by sending a written redemption request in proper
form to BlackRock Funds c/o PFPC Inc., P.O. Box 8907, Wilmington, Delaware
19899-8907.
Except as noted below, a request for redemption must be signed by all persons
in whose names the shares are registered. Signatures must conform exactly to
the account registration. If the proceeds of the redemption would exceed
$25,000, or if the proceeds are not to be paid to the record owner at the rec-
ord address, or if the shareholder is a corporation, partnership, trust or fi-
duciary, signature(s) must be guaranteed by any eligible guarantor institution.
Eligible guarantor institutions generally include banks, broker/dealers, credit
unions, national securities exchanges, registered securities associations,
clearing agencies and savings associations.
Generally, a properly signed written request with any required signature guar-
antee is all that is required for a redemption. In some cases, however, other
documents may be necessary. Shareholders holding share certificates must send
their certificates with the redemption request. Additional documentary evidence
of authority is required by PFPC in the event redemption is requested by a cor-
poration, partnership, trust, fiduciary, executor or administrator.
If a shareholder has given authorization for expedited redemption, shares can
be redeemed by telephone and the proceeds sent by check to the shareholder or
by Federal wire transfer to a single previously designated bank account. Once
authorization is on file, PFPC will honor requests by any person by telephone
at (800) 441-7762 or other means. The minimum amount that may be sent by check
is $500, while the minimum amount that may be wired is $10,000. The Fund re-
serves the right to change these minimums or to terminate these redemption
privileges. If the proceeds of a redemption would exceed $25,000, the redemp-
tion request must be in writing and will be subject to the signature guarantee
requirement described above. This privilege may not be used to redeem shares in
certificated form.
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 Fund is not responsible for the efficiency of the Federal wire system or
the shareholder's firm or bank. The Fund does not currently charge for wire
transfers. The shareholder is responsible for any charges imposed by the share-
holder's bank. To change the name of the single designated bank account to re-
ceive wire
22.
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redemption proceeds, it is necessary to send a written request (with a guaran-
teed signature as described above) to BlackRock Funds c/o PFPC, P.O. Box 8907,
Wilmington, Delaware 19899-8907.
The Fund reserves the right to refuse a telephone redemption if it believes it
advisable to do so. The Fund, the Administrators and the Distributor will em-
ploy reasonable procedures to confirm that instructions communicated by tele-
phone are genuine. The Fund, the Administrators and the Distributor will not be
liable for any loss, liability, cost or expense for acting upon telephone in-
structions reasonably believed to be genuine in accordance with such proce-
dures.
The Fund offers a Systematic Withdrawal Plan ("SWP") which may be used by in-
vestors who wish to receive regular distributions from their accounts. Upon
commencement of the SWP, the account must have a current value of $10,000 or
more in a Portfolio. Shareholders may elect to receive automatic cash payments
of $50 or more either monthly, every other month, quarterly, three times a
year, semi-annually, or annually. Automatic withdrawals are normally processed
on the 25th day of the applicable month or, if such day is not a Business Day,
on the next Business Day and are paid promptly thereafter. An investor may uti-
lize the SWP by completing the SWP Application Form which may be obtained from
PFPC.
Shareholders should realize that if withdrawals exceed income dividends their
invested principal in the account will be depleted. To participate in the SWP,
shareholders must have their dividends automatically reinvested. Shareholders
may change or cancel the SWP at any time, upon written notice to PFPC.
Persons who were shareholders of an investment portfolio of the Compass Capital
Group of Funds at the time of the portfolio's combination with The PNC(R) Fund
may also purchase and redeem Service Shares of the same Portfolio and for the
same account in which they held shares on that date through the procedures de-
scribed in this section.
23.
<PAGE>
- --------------------------------------------------------------------------------
HOW IS NET ASSET VALUE CALCULATED?
- --------------------------------------------------------------------------------
Net asset value is calculated separately for Service Shares of each Portfolio
as of the close of regular trading hours on the NYSE (currently 4:00 p.m. East-
ern Time) on each Business Day by dividing the value of all securities and
other assets owned by a Portfolio that are allocated to its Service Shares,
less the liabilities charged to its Service Shares, by the number of its Serv-
ice Shares that are outstanding.
Most securities held by a Portfolio are priced based on their market value as
determined by reported sales prices, or the mean between bid and asked prices,
that are provided by securities dealers or pricing services. Portfolio securi-
ties which are primarily traded on foreign securities exchanges are normally
valued at the preceding closing values of such securities on their respective
exchanges. Securities for which market quotations are not readily available are
valued at fair market value as determined in good faith by or under the direc-
tion 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 a Portfolio's sub-adviser under the supervision of the Board of
Trustees determines such method does not represent fair value.
HOW FREQUENTLY ARE DIVIDENDS AND DISTRIBUTIONS MADE TO INVESTORS?
- --------------------------------------------------------------------------------
Each Portfolio will distribute substantially all of its net investment income
and net realized capital gains, if any, to shareholders. All distributions are
reinvested at net asset value in the form of additional full and fractional
Service Shares of the relevant Portfolio unless a shareholder 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.
Each Portfolio declares a dividend each day on "settled" shares (i.e. shares
for which the particular Portfolio has received payment in Federal funds) on
the first Business Day after a purchase order is placed with the Fund. Payments
by check are normally converted to Federal funds within two Business Days of
receipt. Over the course of a year, substantially all of the Portfolios' net
investment income will be declared as dividends. The amount of the daily divi-
dend for each Portfolio will be based on periodic projections of its net in-
vestment income. All dividends are paid within ten days after the end of each
month. Net realized capital gains (including net short-term capital gains), if
any, will be distributed by each Portfolio at least annually.
24.
<PAGE>
- --------------------------------------------------------------------------------
HOW ARE FUND DISTRIBUTIONS TAXED?
- --------------------------------------------------------------------------------
Each Portfolio intends to qualify as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). If
a Portfolio qualifies, 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 distributions (except distributions
that are "exempt interest dividends" or are treated as a return of capital),
whether the distributions are paid in cash or reinvested in additional shares.
Distributions paid out of a Portfolio's "net capital gain" (the excess of 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 shares. All other distributions, to the extent taxable, are
taxed to shareholders as ordinary income.
Each Portfolio intends to pay substantially all of its dividends as "exempt in-
terest dividends." However, taxpayers are required to report the receipt of
"exempt interest dividends" on their Federal income tax returns, and in two
circumstances such amounts, while exempt from regular Federal income tax, are
taxable to persons subject to alternative minimum tax. First, "exempt interest
dividends" derived from certain private activity bonds issued after August 7,
1986 generally will constitute an item of tax preference for corporate and non-
corporate taxpayers in determining alternative minimum tax liability. Second,
"exempt interest dividends" must be taken into account by corporate taxpayers
in determining certain adjustments for alternative minimum tax purposes. In ad-
dition, investors should be aware of the possibility of state and local alter-
native minimum or minimum income tax liability on interest from private activ-
ity bonds. Shareholders who are recipients of Social Security Act or Railroad
Retirement Act benefits should note that "exempt interest dividends" will be
taken into account in determining the taxability of their benefit payments.
Each Portfolio will determine annually the percentages of its net investment
income which are exempt from the regular Federal income tax, which constitute
an item of tax preference for Federal alternative minimum tax purposes, and
which are fully taxable. These percentages will apply uniformly to all distri-
butions declared from net investment income during that year and may differ
significantly from the actual percentages for any particular day.
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 speci-
fied date in those months will be deemed to have been received by the share-
holders on December 31 of such year, if the dividends are paid during the fol-
lowing January.
An investor considering buying shares on or just before a dividend record date
should be aware that the amount of the forthcoming dividend payment, although
in effect a return of capital, will be taxable.
A taxable gain or loss may be realized by a shareholder upon the redemption,
transfer or exchange of shares depending upon their tax basis and their price
at the time of redemption, transfer or exchange. Any loss upon the sale or ex-
change of shares held for six months or less will be disallowed for Federal in-
come tax purposes to the extent of any exempt interest dividends received by
the shareholder. For the Delaware Tax-Free Income Portfolio, any loss upon the
sale or exchange of shares held for six months or less will also be disallowed
for Delaware income tax purposes to the extent of any exempt interest dividends
received by the shareholder[, without regard to whether all or any portion of
such exempt interest dividends may have been subject to Delaware income tax.
25.
<PAGE>
- --------------------------------------------------------------------------------
A Portfolio may make investments that produce income that is not matched by a
corresponding cash distribution to the Portfolio, such as investments in pay-
in-kind bonds or in obligations such as zero coupon securities having original
issue discount (i.e., an amount equal to the excess of the stated redemption
price of the security at maturity over its issue price), or market discount
(i.e., an amount equal to the excess of the stated redemption price of the se-
curity over the basis of such bond immediately after it was acquired) if the
Portfolio elects to accrue market discount on a current basis. In addition, in-
come may continue to accrue for federal income tax purposes with respect to a
non-performing investment. Any such income would be treated as income earned by
a Portfolio and therefore would be subject to the distribution requirements of
the Code. Because such income may not be matched by a corresponding cash dis-
tribution to a Portfolio, such Portfolio may be required to borrow money or
dispose of other securities to be able to make distributions to its investors.
In addition, if an election is not made to currently accrue market discount
with respect to a market discount bond, all or a portion of any deduction or
any interest expenses incurred to purchase or hold such bond may be deferred
until such bond is sold or otherwise disposed.
This is not an exhaustive discussion of applicable tax consequences, and in-
vestors may wish to contact their tax advisers concerning investments in the
Portfolios. Except as discussed below, 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 addi-
tion, shareholders who are non-resident alien individuals, foreign trusts or
estates, foreign corporations or foreign partnerships may be subject to differ-
ent Federal income tax treatment. Future legislative or administrative changes
or court decisions may materially affect the tax consequences of investing in a
Portfolio. For additional information concerning the tax treatment of dividends
and distributions by the states listed below including certain restrictions ap-
plicable to such treatment, see "Taxes" in the Statement of Additional Informa-
tion.
DELAWARE TAX CONSIDERATIONS. Individuals, estates and trusts that are subject
to Delaware personal income tax will be subject to such tax on distributions
from the Delaware Tax-Free Income Portfolio (other than distributions
qualifying as "exempt interest dividends" under the Code which are subject to
such tax as discussed below and distributions attributable to interest paid on
certain U.S. government obligations) to the same extent as such distributions
are includible in the gross income of such shareholders for Federal income tax
purposes. Unlike the Code, however, Delaware tax law does not provide for
different tax rates for distributions paid out of "net capital gain" and other
distributions.
Individuals, estates and trusts that are subject to Delaware personal income
tax will not be subject to such tax on distributions that qualify as "exempt
interest dividends" under the Code to the extent that such distributions are
attributable to interest on Delaware State-Specific Obligations and provided
that the Delaware Tax-Free Income Portfolio sends shareholders a written state-
ment of the dollar amount or percentage of the exempt interest dividends that
are attributable to interest on Delaware State-Specific Obligations. Similarly,
if the Delaware Tax-Free Income Portfolio qualifies as a regulated investment
company under the Code, individuals, estates and trusts that are subject to
Delaware personal income tax will not be subject to such tax on distributions
that are attributable to interest paid on certain U.S. government obligations,
provided that the Delaware Tax-Free Income Portfolio sends shareholders a writ-
ten statement of the dollar amount or percentage of such distributions that are
attributable to interest paid on such U.S. government obligations. The Fund
will send written notices to shareholders annually regarding the Delaware tax
status of distributions made by the Delaware Tax-Free Income Portfolio.
For corporations and other entities that are subject to Delaware corporate in-
come tax, distributions will be excluded from the Delaware taxable income of
such shareholders to the same extent as such distributions are excluded from
the Federal taxable income of such shareholders.
26.
<PAGE>
- --------------------------------------------------------------------------------
KENTUCKY TAX CONSIDERATIONS. Exempt interest dividends paid by the Kentucky
Tax-Free Income Portfolio that are attributable to Kentucky State-Specific Ob-
ligations will be excludible from a shareholder's gross income for Kentucky in-
come tax purposes. Further, distributions attributable to interest on certain
U.S. government obligations will similarly be excluded from gross income for
Kentucky income tax purposes. All other distributions by the Kentucky Tax-Free
Income Portfolio will be included in a shareholder's gross income for Kentucky
income tax purposes. Kentucky taxes distributions of net capital gain at the
same rates as ordinary income. Under the laws of Kentucky relating to ad valo-
rem taxation of property, the shareholders rather than the Kentucky Tax-Free
Income Portfolio are considered the owners of the Portfolio's assets. Each
shareholder will be deemed to be the owner of a pro-rata portion of the Ken-
tucky Tax-Free Income Portfolio's assets. According to the Kentucky Revenue
Cabinet, the portion of the Portfolio's assets that consists of Kentucky State-
Specific Obligations will be exempt from intangible property taxes, but the
portion that consists of cash on hand, cash in out-of-state banks, futures, op-
tions and other nonexempt assets will be subject to intangible property taxes.
27.
<PAGE>
- --------------------------------------------------------------------------------
HOW IS THE FUND ORGANIZED?
- --------------------------------------------------------------------------------
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 com-
pany. 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 num-
ber of shares in thirty-eight investment portfolios. Each of the Portfolios de-
scribed herein offers five separate classes of shares--Institutional Shares,
Service Shares, Investor A Shares, Investor B Shares and Investor C Shares.
This prospectus relates only to Service Shares of the Portfolios described
herein.
Shares of each class bear their pro rata portion of all operating expenses paid
by a Portfolio, except transfer agency fees, certain administrative/servicing
fees and amounts payable under the Fund's Distribution and Service Plan. In ad-
dition, each class of Investor Shares is sold with different sales charges. Be-
cause of these "class expenses" and sales charges, the performance of the Port-
folio's Institutional Shares is expected to be higher than the performance of
the Portfolio's Service Shares, and the performance of each of the Institu-
tional Shares and Service Shares of a Portfolio is expected to be higher than
the performance of the Portfolio's classes of Investor Shares. The performance
of each class of Investor Shares may be different. The Fund offers various
services and privileges in connection with its Investor Shares that are not
generally offered in connection with its Institutional and Service Shares, in-
cluding an automatic investment plan and an automatic withdrawal plan. For fur-
ther information regarding the Fund's Institutional or Investor Share classes,
contact PFPC at (800) 441-7764 (Institutional Shares) or (800) 441-7762 (In-
vestor Shares).
Each share of a Portfolio has a par value of $.001, represents an interest in
that Portfolio and is entitled to the dividends and distributions earned on
that Portfolio's assets that 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 February 14, 1998, PNC Bank held of record approximately 78% of the Fund's
outstanding shares, as trustee on behalf of individual and institutional in-
vestors, 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.
28.
<PAGE>
- --------------------------------------------------------------------------------
HOW IS PERFORMANCE CALCULATED?
- --------------------------------------------------------------------------------
Performance information for Service Shares of the Portfolios may be quoted in
advertisements and communications to shareholders. Total return will be calcu-
lated on an average annual total return basis for various periods. Average an-
nual total return reflects the average annual percentage change in value of an
investment in Service Shares of a Portfolio over the measuring period. Total
return may also be calculated on an aggregate total return basis. Aggregate to-
tal return reflects the total percentage change in value over the measuring pe-
riod. Both methods of calculating total return assume that dividend and capital
gain distributions made by a Portfolio with respect to its Service Shares are
reinvested in Service Shares.
The yield of Service Shares is computed by dividing the Portfolio's net income
per share allocated to its Service 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. Each Portfolio's "tax-equivalent yield" may
also be quoted, which shows the level of taxable yield needed to produce an af-
ter-tax equivalent to a Portfolio's tax-free yield. This is done by increasing
the Portfolio's yield (calculated above) by the amount necessary to reflect the
payment of Federal and/or state income tax at a stated tax rate.
The performance of a Portfolio's Service Shares may be compared to the perfor-
mance of other mutual funds with similar investment objectives and to relevant
indices, as well as to ratings or rankings prepared by independent services or
other financial or industry publications that monitor the performance of mutual
funds. For example, the performance of a Portfolio's Service Shares may be com-
pared to data prepared by Lipper Analytical Services, Inc., CDA Investment
Technologies, Inc. and Weisenberger Investment Company Service, and with the
performance of the Lehman GNMA Index, the T-Bill Index, the "stocks, bonds and
inflation index" published annually by Ibbotson Associates and the Lehman Gov-
ernment Corporate Bond Index, as well as the benchmarks attached to this Pro-
spectus. Performance information may also include evaluations of the Portfolios
and their Service Shares published by nationally recognized ranking services,
and information as reported in 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 re-
gional nature.
In addition to providing performance information that demonstrates the actual
yield or return of Service Shares of a particular Portfolio, a Portfolio may
provide other information demonstrating hypothetical investment returns. This
information may include, but is not limited to, illustrating the compounding
effects of dividends in a dividend reinvestment plan or the impact of tax-de-
ferred investing.
Performance quotations for shares of a Portfolio 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 Service Shares, when redeemed, may be worth
more or less than their original cost. Since performance will fluctuate, per-
formance data for Service Shares of a 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. Performance is generally a function of
the kind and quality of the instruments held in a portfolio, portfolio maturi-
ty, operating expenses and market conditions. Any fees charged by brokers or
other institutions directly to their customer accounts in connection with in-
vestments in Service Shares will not be included in the Portfolio performance
calculations.
29.
<PAGE>
- --------------------------------------------------------------------------------
HOW CAN I GET MORE INFORMATION?
- --------------------------------------------------------------------------------
Below is a brief description of how investors can easily access information
about the BlackRock Funds.
<TABLE>
<CAPTION>
FUND INFORMATION HOURS AVAILABLE PHONE INFORMATION
<S> <C> <C>
INTERNAL 9 AM to 6 PM, E.S.T. toll-free 888-8BLACKROCK
WHOLESALERS/BROKER-DEALER Monday through Friday toll-free 888-825-2257
SUPPORT:
PORTFOLIO MANAGERS
COMMENTARY: 24 Hours, 7 days a week toll-free 800-FUTURE4
(Audio recording updated toll-free 800-388-8734
periodically)
SHAREHOLDER SERVICES
TELEPHONE ACCESS: 24 Hours, 7 days a week toll-free 800-441-7764
ACCOUNT SERVICE 8:30 to 5 PM, E.S.T. toll-free 800-441-7764
REPRESENTATIVES: Monday through Friday
Available to discuss
account balance
information, mutual fund
prospectus, literature and
discuss programs and
services available.
PURCHASES AND REDEMPTIONS: 8:30 to 5 PM, E.S.T. toll-free 800-441-7450
Monday through Friday
WORLD WIDE WEB:
Access general fund 24 Hours, 7 days a week http://www.blackrock.com
information and specific
fund performance. Request
mutual fund prospectuses
and literature. Forward
mutual fund inquiries.
E-MAIL:
Request prospectuses and 24 Hours, 7 days a week [email protected]
literature. Forward mutual
fund inquiries.
WRITTEN CORRESPONDENCE: POST OFFICE BOX ADDRESS STREET ADDRESS
BlackRock Funds BlackRock Funds
c/o PFPC Inc. c/o PFPC Inc.
P.O. Box 8907 400 Bellevue Parkway
Wilmington, DE 19899-8907 Wilmington, DE 19809
</TABLE>
30.
<PAGE>
, 1998
- --------------------------------------------------------------------------------
THE DELAWARE TAX-FREE INCOME AND KENTUCKY TAX-FREE INCOME PORTFOLIOS
INSTITUTIONAL SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASKING THE KEY
QUESTIONS
PAGE
<S> <C>
What Are The Expenses Of The Portfolios?.................... 4
What Are The Portfolios?.................................... 5
What Are The Characteristics Of The Portfolios?............. 6
What Types Of Securities Are In The Portfolios?............. 7
What Are The Portfolios' Fundamental Investment
Limitations?............................................... 8
What Additional Investment Policies And Risks Apply?........ 9
Who Manages The Fund?....................................... 15
How Are Shares Purchased And Redeemed?...................... 18
How Is Net Asset Value Calculated?.......................... 20
How Frequently Are Dividends And Distributions Made To
Investors?................................................. 20
How Are Fund Distributions Taxed?........................... 21
How Is The Fund Organized?.................................. 24
How Is Performance Calculated?.............................. 25
How Can I Get More Information?............................. 26
</TABLE>
This Prospectus sets forth concisely information about the Black-
Rock Delaware Tax-Free Income Portfolio and the Kentucky Tax-Free
Income Portfolio (collectively, the "Portfolios") that a prospec-
tive investor needs to know before investing. Please keep it for
future reference. A Statement of Additional Information dated
, 1998 has been filed with the Securities and Exchange
Commission (the "SEC"). The Statement of Additional Information
may be obtained free of charge from BlackRock Funds /SM/ (the
"Fund") by calling (800) 441-7764. The Statement of Additional
Information, as supplemented from time to time, is incorporated
by reference into 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 infor-
mation regarding the Fund that has been filed with the SEC.
SHARES OF THE PORTFOLIOS ARE NOT DEPOSITS OR OBLIGATIONS OF, OR
GUARANTEED OR ENDORSED BY, PNC BANK, NATIONAL ASSOCIATION OR ANY
OTHER BANK AND ARE NOT INSURED BY, GUARANTEED BY, OBLIGATIONS OF
OR OTHERWISE SUPPORTED BY THE U.S. GOVERNMENT, THE FEDERAL DE-
POSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY
OTHER GOVERNMENTAL AGENCY. INVESTMENTS IN THE PORTFOLIOS INVOLVE
INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF PRINCIPAL AMOUNT IN-
VESTED.
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 AC-
CURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE. SHARES OF THE STATE-SPECIFIC TAX-FREE PORTFOLIOS ARE INTENDED
ONLY FOR RESIDENTS OF THE RESPECTIVE STATES INDICATED.
2.
<PAGE>
- --------------------------------------------------------------------------------
THE DELAWARE TAX-FREE AND KENTUCKY TAX-FREE INCOME PORTFOLIOS OF BLACKROCK
FUNDS
- --------------------------------------------------------------------------------
The BLACKROCK FUND Family consists of 35 portfolios and has
been structured to include many different investment styles so
that investors may participate across multiple disciplines in
order to seek their long-term financial goals.
Effective January 31, 1998, the Fund has changed its name from
Compass Capital Funds /SM/ to BlackRock Funds /SM/.
The Delaware Tax-Free Income and Kentucky Tax-Free Income Port-
folios of BLACKROCK FUNDS are two of fourteen investment port-
folios that provide investors with a broad spectrum of invest-
ment alternatives within the fixed income sector. Eight of
these portfolios invest in taxable bonds, and six of these
portfolios invest in tax-exempt bonds. A detailed description
of the Delaware Tax-Free Income and Kentucky Tax-Free Income
Portfolios begins on page . To obtain a prospectus describing
the Fund's other fixed income portfolios, call (800) 441-7762.
BLACKROCK PORTFOLIO PERFORMANCE LIPPER PEER GROUP
BENCHMARK
DE TAX-FREE Lehman Local GO Other States
INCOME Index Intermediate Muni Debt
Funds
KY TAX-FREE Lehman Local GO KY Municipal Debt
INCOME Index
BlackRock, Inc serves as investment adviser to the Portfolios.
BlackRock Financial Management, Inc., an affiliate of Black-
Rock, Inc., serves as subadviser to each of the Portfolios.
UNDERSTANDING This Prospectus has been crafted to provide detailed, accurate
THE and comprehensive information on the BlackRock Delaware Tax-
BLACKROCK Free Income and Kentucky Tax-Free Income Portfolios. We intend
DELAWARE this document to be an effective tool as you explore different
TAX-FREE directions in fixed income investing.
INCOME AND
KENTUCKY
TAX-FREE
INCOME
PORTFOLIOS
CONSIDERING There can be no assurance that any mutual fund will achieve its
THE RISKS IN investment objective. Both of the Portfolios may purchase il-
BOND liquid securities; enter into repurchase and reverse repurchase
INVESTING agreements and engage in leveraging, which is a speculative
technique; lend portfolio securities to third parties; and en-
ter into futures contracts and options. Each of the Delaware
Tax-Free Income and Kentucky Tax-Free Income Portfolios is a
state-specific tax-free portfolio which concentrates in the se-
curities of issuers located in a particular state, and is non-
diversified, which means that its performance may be dependent
upon the performance of a smaller number of securities than the
other bond portfolios of the Fund, which are considered diver-
sified. See "What Additional Investment Policies And Risks Ap-
ply?"
INVESTING IN
THE
BLACKROCK
FUNDS
For information on how to purchase and redeem shares of the
Portfolios, see "How Are Shares Purchased And Redeemed?"
3.
<PAGE>
- -------------------------------------------------------------------------------
WHAT ARE THE EXPENSES OF THE PORTFOLIOS?
- -------------------------------------------------------------------------------
Below is a summary of the annual operating expenses expected to be incurred by
Institutional Shares of the Portfolios for the current fiscal year as a per-
centage of average daily net assets. The figures shown under "Other expenses"
are estimated for the current fiscal year. An example based on the summary is
also shown.
<TABLE>
<CAPTION>
DELAWARE KENTUCKY
TAX-FREE TAX-FREE
INCOME INCOME
PORTFOLIO PORTFOLIO
<S> <C> <C> <C> <C>
ANNUAL PORTFOLIO OPERATING EXPENSES (AS A PERCENTAGE OF
AVERAGE NET ASSETS)
Advisory fees (after fee waivers)(/1/) .40% .40%
Other operating expenses .30 .30
--- ---
Administration fees (after fee waivers)(/1/) .17 .17
Other expenses .13 .13
--- ---
Total Portfolio operating expenses (after fee
waivers)(/1/) .70% .70%
=== ===
</TABLE>
(1) Without waivers, advisory fees would be .55% and administration fees would
be .23% for each Portfolio. BlackRock, Inc. and the Portfolios' adminis-
trators are under no obligation to waive fees or reimburse expenses, but
have informed the Fund that they expect to waive fees and reimburse ex-
penses during the remainder of the current fiscal year as necessary to
maintain the Portfolios' total operating expenses at the levels set forth
in the table. Without waivers, "Other operating expenses" would be .36%
and "Total Portfolio operating expenses" would be .91% for each Portfolio.
EXAMPLE
An investor in Institutional Shares would pay the following expenses on a
$1,000 investment assuming (1) a 5% annual return, and (2) redemption at the
end of each time period:
<TABLE>
<CAPTION>
ONE YEAR THREE YEARS
<S> <C> <C>
Delaware Tax-Free Income Portfolio $ 7 $22
Kentucky Tax-Free Income Portfolio 7 22
</TABLE>
In addition to the compensation itemized in the expense table, institutions
that sell shares of the Portfolios and/or their salespersons may receive com-
pensation for the sale and distribution of shares or for services to the Port-
folios. For information regarding such compensation, see "Investment Advisory,
Administration, Distribution and Servicing Arrangements" in the Statement of
Additional Information.
The foregoing Table and Example are intended to assist investors in under-
standing 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 im-
posed by brokers or other institutions directly on their customer accounts in
connection with investments in the Portfolios. For a detailed description of
the expenses, see "Who Manages The Fund?"
THE EXAMPLE SHOWN ABOVE SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE
INVESTMENT RETURN OR OPERATING EXPENSES. ACTUAL INVESTMENT RETURN AND OPERAT-
ING EXPENSES MAY BE MORE OR LESS THAN THOSE SHOWN.
4.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ARE THE PORTFOLIOS?
- --------------------------------------------------------------------------------
The Delaware Tax-Free Income and Kentucky Tax-Free Income Port-
folios of BLACKROCK FUNDS are two of fourteen investment port-
folios that provide investors with a broad spectrum of invest-
ment alternatives within the fixed income sector. Eight of
these portfolios invest solely in taxable bonds and six of
these portfolios invest in tax-exempt bonds.
In certain investment cycles and over certain holding periods,
a fund that invests in any one of these styles may perform
above or below the market. An investment program that combines
these multiple disciplines allows investors to select from
among these various product options in the way that most
closely fits the investor's goals and sentiments.
PORTFOLIO INVESTMENT OBJECTIVE
Delaware To seek as high a level of current
Tax-Free income exempt from Federal income tax
Income and, to the extent possible, income
tax of the State of Delaware, as is
consistent with the preservation of
capital.
Kentucky To seek as high a level of current
Tax-Free income exempt from Federal income tax
Income and, to the extent possible, income
tax of the State of Kentucky, as is
consistent with the preservation of
capital.
5.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ARE THE CHARACTERISTICS OF THE PORTFOLIOS?
- --------------------------------------------------------------------------------
PORTFOLIO CHARACTERISTICS:
<TABLE>
<CAPTION>
DOLLAR-
WEIGHTED
AVERAGE MIN
PERFORMANCE MATURITY CREDIT QUALITY CREDIT
PORTFOLIO BENCHMARK* (APPROXIMATE)** CONCENTRATION QUALITY
<S> <C> <C> <C> <C>
DE Tax-Free Income Lehman Local GO Index 5-10 Years Investment Grade BBB
Spectrum
KY Tax-Free Income Lehman Local GO Index 5-10 Years Investment Grade BBB
Spectrum
</TABLE>
* The Lehman Local GO Index contains local general obligation bonds.
** The Portfolios' sub-adviser will normally attempt to structure the Portfo-
lios to have comparable durations to the benchmarks. Duration, which mea-
sures price sensitivity to interest rate changes, is not necessarily equal
to average maturity.
6.
<PAGE>
- --------------------------------------------------------------------------------
WHAT TYPES OF SECURITIES ARE IN THE PORTFOLIOS?
- --------------------------------------------------------------------------------
The following table summarizes the types of securities found in each Portfolio,
according to the following designations:
Yes:The Portfolio will hold a significant concentration of these securities
at all times.
Elig.: Eligible; the Portfolio may purchase these securities, but they may or
may not be a significant holding at a given time.
Temp.: Temporary; the Portfolio may purchase these securities, but under nor-
mal market conditions is not expected to do so.
No:The Portfolio may not purchase these securities.
<TABLE>
<CAPTION>
NON FOREIGN
AGENCY/ SECURITIES/
AGENCY COMMERCIAL HIGH YIELD CURRENCY
TREASURIES AGENCIES MBS/1/ MBS/1/ CORP. ABS/2/ SECURITIES RISK MUNICIPALS
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
DE Tax-Free Income Temp. No No No No No No No Yes
KY Tax-Free Income Temp. No No No No No No No Yes
</TABLE>
/1/MBS = mortgage-backed securities
/2/ABS = asset-backed securities
7.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ARE THE PORTFOLIOS' FUNDAMENTAL INVESTMENT LIMITATIONS?
- --------------------------------------------------------------------------------
A Portfolio's investment objective and policies may be changed by the Fund's
Board of Trustees without shareholder approval. However, shareholders will be
given at least 30 days' notice before any change to a Portfolio's investment
objective. No assurance can be provided that a Portfolio will achieve its in-
vestment objective.
Each Portfolio has also adopted certain fundamental investment limitations that
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). The
Portfolios' fundamental investment policies, which are set forth in full in the
Statement of Additional Information, are summarized below.
Neither Portfolio may:
(1) invest 25% or more of its total assets in one or more issuers conducting
their principal business activities in the same industry; and
(2) invest less than 80% of its net assets in Municipal Obligations (as defined
below), except during defensive periods or during periods of unusual market
conditions.
As a non-fundamental investment restriction, each of the Delaware Tax-Free In-
come and Kentucky Tax-Free Income Portfolios will not invest in securities (ex-
cept U.S. Government securities) that would cause, at the end of any tax quar-
ter (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 Portfo-
lio'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 any one issuer
(except U.S. Government securities).
The investment limitations stated above are applied at the time investment se-
curities are purchased.
8.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ADDITIONAL INVESTMENT POLICIES AND RISKS APPLY?
- --------------------------------------------------------------------------------
INVESTMENT QUALITY. Securities acquired by the Portfolios will be rated invest-
ment grade at the time of purchase (within the four highest rating categories
by Standard & Poor's Ratings Group ("S&P"), Moody's Investors Service, Inc.
("Moody's"), Duff & Phelps Credit Co. or Fitch Investor Services, Inc.) or, if
unrated, of comparable quality as determined by the Portfolios' sub-adviser.
Securities rated "Baa" by Moody's or "BBB" by S&P are generally considered to
be investment grade although they have speculative characteristics. If a
security's rating is reduced below the minimum rating that is permitted for a
Portfolio, the Portfolio's sub-adviser will consider whether the Portfolio
should continue to hold the security.
INVESTMENT CONCENTRATION. Each Portfolio will normally invest at least 80% of
the value of its total assets in debt securities. The Portfolios will invest,
during normal market conditions, at least 80% of their net assets in obliga-
tions issued by or on behalf of states, territories and possessions of the
United States, the District of Columbia and their political sub-divisions,
agencies, instrumentalities and authorities and related tax-exempt derivative
securities the interest on which is exempt from regular Federal income tax and
is not an item of tax preference for purposes of the Federal alternative mini-
mum tax ("Municipal Obligations"). In addition, each of the Portfolios intends
to invest at least 65% of its net assets in Municipal Obligations of issuers
located in the particular state indicated by its name ("State-Specific Obliga-
tions"). During temporary defensive periods each of the Portfolios may invest
without limitation in securities that are not Municipal Obligations and may
hold without limitation uninvested cash reserves.
MUNICIPAL INVESTMENTS. The two principal classifications of Municipal Obliga-
tions are "general obligation" securities and "revenue" securities. General ob-
ligation securities are secured by the issuer's pledge of its full faith,
credit and taxing power for the payment of principal and interest. Revenue se-
curities 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 fi-
nanced. 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 in-
clude "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.
Also included within the general category of Municipal Obligations are partici-
pation certificates in a lease, an installment purchase contract, or a condi-
tional sales contract ("lease obligations") entered into by a state or politi-
cal subdivision to finance the acquisition or construction of equipment, land,
or facilities. Although lease obligations are not general obligations of the
issuer for which the state or other governmental body's unlimited taxing power
is pledged, certain lease obligations are backed by a covenant to appropriate
money to make the lease obligation payments. However, under certain lease obli-
gations, the state or governmental body has no obligation to make these pay-
ments in future years unless money is appropriated on a yearly basis. Although
"non-appropriation" lease obligations are secured by the leased property, dis-
position of the property in the event of foreclosure might prove difficult.
These securities represent a relatively new type of financing that is not yet
as marketable as more conventional securities.
Each Portfolio may invest up to 20% of its total assets in private activity
bonds the interest on which is an item of tax preference for purposes of the
Federal alternative minimum tax ("AMT Paper") when added together with any
other taxable investments held by the Portfolio. In addition, each Portfolio
may invest 25% or more of its assets in Municipal Obligations the interest on
which is paid solely from revenues of similar projects. To the extent a Portfo-
lio's assets are invested in Municipal Obligations payable from the revenues of
similar
9.
<PAGE>
- --------------------------------------------------------------------------------
projects or are invested in private activity bonds, the Portfolio will be sub-
ject to the particular risks presented by the laws and economic conditions re-
lating to such projects and bonds to a greater extent than it would be if its
assets were not so invested.
The Portfolios are classified as non-diversified portfolios under 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 one secu-
rity may affect the overall value of a non-diversified portfolio more than it
would a diversified portfolio.
Each Portfolio may acquire "stand-by commitments" with respect to Municipal Ob-
ligations held by it. Under a stand-by commitment, a dealer agrees to purchase,
at the Portfolio's option, specified Municipal Obligations at a specified
price. The acquisition of a stand-by commitment may increase the cost, and
thereby reduce the yield, of the Municipal Obligations to which the commitment
relates. The Portfolios may also invest in tax-exempt derivative securities re-
lating to Municipal Obligations, including tender option bonds, participations,
beneficial interests in trusts and partnership interests.
The amount of information regarding the financial condition of issuers of Mu-
nicipal Obligations may be less extensive than the information for public cor-
porations, and the secondary market for Municipal Obligations may be less liq-
uid than that for taxable obligations. Accordingly, the ability of a Portfolio
to buy and sell Municipal Obligations may, at any particular time and with re-
spect to any particular securities, be limited. In addition, Municipal Obliga-
tions purchased by the Portfolios include obligations backed by letters of
credit and other forms of credit enhancement issued by domestic and foreign
banks, as well as other financial institutions. Changes in the credit quality
of these institutions could cause loss to a Portfolio and affect its share
price.
Opinions relating to the validity of Municipal Obligations and to the exemption
of interest thereon from Federal and state income tax are rendered by counsel
to the respective issuers and sponsors of the obligations at the time of issu-
ance. The Fund and its service providers will rely on such opinions and will
not review independently the underlying proceedings relating to the issuance of
Municipal Obligations, the creation of any tax-exempt derivative securities, or
the bases for such opinions.
STRIPPED AND ZERO COUPON OBLIGATIONS. To the extent consistent with their in-
vestment objectives, 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 obliga-
tions. These participations, 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."
Stripped securities may exhibit greater price volatility than ordinary debt se-
curities because of the manner in which their principal and interest are re-
turned to investors.
Each Portfolio may invest in zero-coupon bonds, which are normally issued at a
significant discount from face value and do not provide for periodic interest
payments. Zero-coupon bonds may experience greater volatility in market value
than similar maturity debt obligations which provide for regular interest pay-
ments. Additionally, current federal tax law requires the holder of certain
zero coupon bonds to accrue income with respect to these securities prior to
the receipt of cash payments. To maintain its qualification as a regulated in-
vestment company and avoid liability for federal income and excise taxes, a
Portfolio may be required to distribute income accrued with respect to these
securities and may have to dispose of portfolio securities under disadvanta-
geous circumstances in order to generate cash to satisfy these distribution re-
quirements. See "How Are Fund Distributions Taxed?"
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 Mort-
gage Association are supported by the United States' full faith and credit;
others such as those of the Federal National Mortgage Association and the Stu-
dent Loan Marketing Association are supported by the right of the issuer to
borrow from the Treasury; others such as those of the Federal Farm
10.
<PAGE>
- --------------------------------------------------------------------------------
Credit Banks or the Federal Home Loan Mortgage Corporation 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.
INTEREST RATE TRANSACTIONS. The Portfolios may enter into interest rate swaps
and may purchase or sell interest rate caps and floors. The Portfolios may en-
ter into these transactions primarily to preserve a return or spread on a par-
ticular investment or portion of their holdings, as a duration management tech-
nique 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 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. 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 inter-
est on a notional principal amount from the party selling such interest rate
floor.
OPTIONS AND FUTURES CONTRACTS. To the extent consistent with its investment ob-
jective, 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 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, 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. A Portfolio will not purchase put and call options when
the aggregate premiums on outstanding options exceed 5% of its net assets at
the time of purchase, and will not write options on more than 25% of the value
of its net assets (measured at the time an option is written). Options trading
is a highly specialized activity that entails greater than ordinary investment
risks. In addition, unlisted options are not subject to the protections af-
forded purchasers of listed options issued by the Options Clearing Corporation,
which performs the obligations of its members if they default.
To the extent consistent with its investment objective, each Portfolio may also
invest in futures contracts and options on futures contracts for hedging pur-
poses or to maintain liquidity. The value of a Portfolio's contracts may equal
or exceed 100% of its total assets, although 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 for related futures options entered into for other than bona fide hedging
purposes is 5% or less of its net assets.
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 quan-
tity 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 ob-
ligated to sell or buy a futures contract if the option is exercised. In con-
nection with a Portfolio's position in a futures contract or related option,
the Fund will create a segregated account of liquid assets or will otherwise
cover its position in accordance with applicable SEC requirements.
11.
<PAGE>
- --------------------------------------------------------------------------------
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 instru-
ments 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 re-
sulting inability to close a futures contract when desired; (c) losses caused
by unanticipated market movements, which are potentially unlimited; (d) the
sub-adviser's inability to predict correctly the direction of securities pric-
es, 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 the Statement of Additional Information.
The Fund intends to comply with the regulations of the Commodity Futures Trad-
ing Commission exempting the Portfolios from registration as a "commodity pool
operator."
GUARANTEED INVESTMENT CONTRACTS. The Portfolios may make limited investments in
guaranteed investment contracts ("GICs") issued by highly rated U.S. insurance
companies. Under these contracts, a Portfolio makes cash contributions to a de-
posit fund of the insurance company's general account. The insurance company
then credits to the Portfolio, on a monthly basis, interest which is based on
an index (such as the Salomon Brothers CD Index), but is guaranteed not to be
less than a certain minimum rate. Each Portfolio does not expect to invest more
than 5% of its net assets in GICs at any time during the current fiscal year.
SECURITIES LENDING. A Portfolio may seek additional income by lending securi-
ties 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 ir-
revocable 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 recover-
ing the loaned securities, or possibly loss of rights in the collateral if the
borrower of the securities becomes insolvent.
VARIABLE AND FLOATING RATE INSTRUMENTS. The Portfolios may purchase rated and
unrated variable and floating rate instruments. These 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 Portfolios may invest up to 10% of their total assets in leveraged inverse
floating rate debt instruments ("inverse floaters"). The interest rate of an
inverse floater resets in the opposite direction from the market rate of inter-
est to which it is indexed. An inverse floater may be considered to be
leveraged to the extent that its interest rate varies by a magnitude that ex-
ceeds the magnitude of the change in the index rate of interest. The higher de-
gree of leverage inherent in inverse floaters is associated with greater vola-
tility in their market values. Issuers of unrated variable and floating rate
instruments must satisfy the same criteria as set forth above for a Portfolio.
The absence of an active secondary market with respect to particular variable
and floating rate instruments, however, could make it difficult for a Portfolio
to dispose of a variable or floating rate instrument if the issuer defaulted on
its payment obligation or during periods when the Portfolio is not entitled to
exercise its demand rights.
REPURCHASE AGREEMENTS. Each Portfolio may agree to purchase debt securities
from financial institutions subject to the seller's agreement to repurchase
them 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 autho-
rized 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 de-
cline 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 the proceeds of reverse
12.
<PAGE>
- --------------------------------------------------------------------------------
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. 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 ob-
ligated to repurchase and that the securities may not be returned to the Port-
folio. During the time a reverse repurchase agreement is outstanding, a Portfo-
lio will maintain a segregated account with the Fund's custodian containing
cash, U.S. Government or other appropriate liquid securities having a value at
least equal to the repurchase price. A Portfolio's reverse repurchase agree-
ments, together with any other borrowings, will not exceed, in the aggregate,
33 1/3% of the value of its total assets.
INVESTMENT COMPANIES. Each Portfolio may invest in securities issued by other
investment companies within the limits prescribed by the 1940 Act. As a share-
holder 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. GICs, variable and floating rate
instruments that cannot be disposed of within seven days, and repurchase agree-
ments 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 Portfolios' sub-
adviser that an adequate trading market exists for the securities. This invest-
ment practice could have the effect of increasing the level of illiquidity in a
Portfolio during any period that qualified institutional buyers become uninter-
ested in purchasing these restricted securities.
WHEN-ISSUED PURCHASES AND FORWARD COMMITMENTS. Each Portfolio may purchase se-
curities on a "when-issued" basis and may purchase or sell securities on a
"forward commitment" basis. These transactions involve a commitment by a Port-
folio to purchase or sell particular securities with payment and delivery tak-
ing 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 are not
expected to exceed 25% of the value of its total assets absent unusual market
conditions.
SHORT SALES. The Portfolios may only make short sales of securities "against-
the-box." 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 de-
cline. 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 portfolio flexibility. In a short sale "against-the-box," at the time
of sale, the Portfolio owns or has the immediate and unconditional right to ac-
quire the identical security at no additional cost. When selling short
"against-the-box," a Portfolio forgoes an opportunity for capital appreciation
in the security.
PORTFOLIO TURNOVER RATES. Under normal market conditions, it is expected that
the annual portfolio turnover rate for each of the Portfolios will not exceed
150%. A Portfolio's annual portfolio turnover rate will not be a factor pre-
venting a sale or purchase when the sub-adviser believes investment considera-
tions warrant such sale or purchase. Portfolio turnover may vary greatly from
year to year as well as within a particular year. High portfolio turnover rates
(i.e., 100% or more) will generally result in higher transaction costs to a
Portfolio and may result in the realization of short-term capital gains that
are taxable to shareholders as ordinary income.
13.
<PAGE>
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INTEREST RATE AND EXTENSION RISK. The value of fixed income securities in the
Portfolios can be expected to vary inversely with changes in prevailing inter-
est rates. Fixed income securities with longer maturities, which tend to pro-
duce higher yields, are subject to 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 within the limits stated above under "What Are the Differences Among the
Portfolios?" based upon its sub-adviser's assessment of economic and market
conditions. Although the Portfolios' sub-adviser will normally attempt to
structure each Portfolio to have a comparable duration to its benchmark as
stated in that section, there can be no assurance that it will be able to do so
at all times.
STATE-SPECIFIC TAX-FREE PORTFOLIOS--ADDITIONAL RISK CONSIDERATIONS. The concen-
tration of investments by the Portfolios in State-Specific Obligations raises
special investment considerations. In particular, changes in the economic con-
dition and governmental policies of a state and its political subdivisions
could adversely affect the value of a Portfolio's shares. Certain matters re-
lating to the states in which the Portfolios invest are described below. For
further information, see "Special Considerations Regarding State-Specific Obli-
gations" in the Statement of Additional Information.
Delaware. Delaware's economy has expanded throughout most sectors during the
1990's and has diversified beyond its historical emphasis in chemical and auto-
mobile manufacturing to include strong banking and service sectors. Delaware
completed fiscal year 1997 with a cumulative cash balance of $392.8 million, of
which $116.2 million was unencumbered. The State's general obligation debt out-
standing as of December 31, 1997 was $626.7 million. Approximately 80% of this
debt is scheduled to mature within ten years and approximately 90% of this debt
is scheduled to mature within 15 years. While the State has constitutionally-
imposed limits on tax and license fee increases and the imposition of new taxes
or fees (requiring approval by a three-fifths vote of each house of the General
Assembly), there are no constitutionally-imposed limits on debt incurrence.
However, Delaware has instituted several measures designed to manage and reduce
its indebtedness, including legislative debt limits, "pay-as-you-go" financing
for capital projects, bond refundings and cash debt defeasance and
deauthorizations.
Kentucky. Kentucky is a leader among the states in the production of coal and
tobacco. The Coal Severance Tax is a significant revenue producer for the Com-
monwealth and its political subdivisions, and any substantial decrease in the
amount of coal or other minerals produced could result in revenue shortfalls.
Additionally, any federal legislation or litigation adversely affecting the to-
bacco and/or cigarette industries would have a negative impact on Kentucky's
economy. There is significant diversification in Kentucky's manufacturing sec-
tor, which includes, among other things, tobacco processing plants, distiller-
ies and durable goods production. No single segment of the Commonwealth's econ-
omy consists of as much as one-fourth of the overall state domestic product.
The Commonwealth continues to experience a high unemployment rate in non-urban-
ized areas. Although revenue obligations of the Commonwealth or its political
subdivisions may be payable from a specific project, there can be no assurances
that economic difficulties and the resulting impact on state and local govern-
ment finances will not adversely affect the market value of Kentucky State-Spe-
cific Obligations or the ability of the respective entities to pay debt serv-
ice.
Because of constitutional limitations, the Commonwealth cannot enter into a fi-
nancial obligation of more than two years' duration, and no other municipal is-
suer within the Commonwealth can enter into a financial obligation of more than
one year's duration. As a consequence, the payment and security arrangements
applicable to Kentucky State-Specific Obligations differ significantly from
those generally applicable to municipal revenue obligations in other states.
14.
<PAGE>
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WHO MANAGES THE FUND?
- --------------------------------------------------------------------------------
BOARD OF The business and affairs of the Fund are managed under the di-
TRUSTEES rection of its Board of Trustees. The following persons cur-
rently serve on the Board:
William O. Albertini--Executive Vice President and Chief Finan-
cial 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 Institutional Center, The Wharton School, University
of Pennsylvania.
David R. Wilmerding, Jr.--Chairman, Gee, Wilmerding & Associ-
ates, Inc.
ADVISER AND The Adviser to the BlackRock Funds is BlackRock, Inc. Each of
SUB-ADVISER the Portfolios within the BlackRock Funds family is managed by
a specialized portfolio manager who is a member of BlackRock,
Inc.'s fixed income portfolio management affiliate, BlackRock
Financial Management, Inc. ("BlackRock"). BlackRock has its
primary offices at 345 Park Avenue, New York, New York 10154.
The Portfolios and their portfolio managers are as follows:
<TABLE>
<CAPTION>
BLACKROCK FUNDS PORTFOLIO PORTFOLIO MANAGER
------------------------- -----------------
<S> <C>
Delaware Tax-Free Income Kevin Klingert; Portfolio manager at
BlackRock since 1991; prior to joining
BlackRock, Assistant Vice President,
Merrill, Lynch, Pierce, Fenner & Smith;
Portfolio manager since commencement of
Portfolio operations and Portfolio manager
of predecessor fund since 1995.
Kentucky Tax-Free Income Kevin Klingert (see above).
</TABLE>
BlackRock, Inc. (formerly PNC Asset Management Group, Inc.) was
organized in 1994 to perform advisory services for investment
companies, and has its principal offices at 1600 Market Street,
29th Floor, Philadelphia, Pennsylvania 19103. BlackRock, Inc.
is an indirect wholly-owned subsidiary of PNC Bank Corp., a
multi-bank holding company.
As adviser, BlackRock, Inc. is responsible for the overall in-
vestment management of the Portfolios. As sub-adviser, Black-
Rock Financial Management is responsible for the day-to-day
management of the Portfolios, and generally makes all purchase
and sale investment decisions for the Portfolios. BlackRock Fi-
nancial Management also provides research and credit analysis.
THE AFFILIATE SUB-ADVISERS OF BLACKROCK, INC. ARE:
. BlackRock Financial Management, Inc.: Domestic and non-dollar
fixed income.
. PNC Equity Advisors: Growth equity.
. Provident Capital Management: Value equity.
. CastleInternational Asset Management: International equity.
. PNC Institutional Management Corporation: Money market.
15.
<PAGE>
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For their investment advisory and sub-advisory services,
BlackRock, Inc. and the Portfolios' sub-adviser are entitled
to fees, computed daily on a Portfolio-by-Portfolio basis
and payable monthly, at the maximum annual rates set forth
below. As stated under "What Are The Expenses Of The Portfo-
lios?", BlackRock, Inc. and the sub-adviser intend to waive
a portion of their fees during the current fiscal year. All
sub-advisory fees are paid by BlackRock, Inc., and do not
represent an extra charge to the Portfolios.
MAXIMUM ANNUAL CONTRACTUAL FEE RATE (BEFORE WAIVERS)
<TABLE>
<CAPTION>
AVERAGE DAILY NET INVESTMENT SUB-ADVISORY
ASSETS ADVISORY FEE FEE
<S> <C> <C>
first $1 billion .550% .400%
$1 billion--$2 billion .500 .350
$2 billion--$3 billion .475 .325
greater than $3 billion .450 .300
</TABLE>
The Portfolios' sub-adviser strives to achieve best execu-
tion on all transactions. Infrequently, brokerage transac-
tions for the Portfolios may be directed through registered
broker/dealers who have entered into dealer agreements with
the Fund's distributor, subject to the requirements of best
execution.
ADMINISTRATORS BlackRock, Inc., PFPC Inc. ("PFPC") and BlackRock Distribu-
tors, Inc. ("BDI") (the "Administrators") serve as the
Fund's co-administrators. BlackRock, Inc. and PFPC are indi-
rect wholly-owned subsidiaries of PNC Bank Corp. BDI is a
wholly-owned subsidiary of Provident Distributors, Inc.
("PDI"). A majority of the outstanding stock of PDI is owned
by its officers.
The Administrators generally assist the Fund in all aspects
of its administration and operation, including matters re-
lating to the maintenance of financial records and fund ac-
counting. As compensation for these services, BlackRock,
Inc. is entitled to receive a fee, computed daily and pay-
able monthly, at an annual rate of .03% of each Portfolio's
average daily net assets. PFPC and BDI are entitled to re-
ceive a combined administration fee, computed daily and pay-
able monthly, at the aggregate annual rate of (i) .085% of
the first $500 million of each Portfolio's average daily net
assets, .075% of the next $500 million of each Portfolio's
average daily net assets and .065% of the average daily net
assets of each Portfolio in excess of $1 billion and (ii)
.115% of the first $500 million of the average daily net as-
sets allocated to Institutional Shares of each Portfolio,
.105% of the next $500 million of such average daily net as-
sets and .095% of the average daily net assets allocated to
Institutional Shares of each Portfolio in excess of $1 bil-
lion. From time to time the Administrators may waive some or
all of their administration fees from a Portfolio.
For information about the operating expenses the Portfolios
expect to incur in the current fiscal year, see "What Are
The Expenses Of The Portfolios?"
TRANSFER PNC Bank, whose principal offices are located at 1600 Market
AGENT, Street, Philadelphia, Pennsylvania 19103, serves as the
DIVIDEND Portfolios' custodian and PFPC, whose principal offices are
DISBURSING located at 400 Bellevue Parkway, Wilmington, Delaware 19809,
AGENT AND serves as their transfer agent and dividend disbursing
CUSTODIAN agent.
16.
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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, Inc. and the
Administrators, transfer agency and custodian fees, trustee
fees, taxes, interest, professional fees, fees and expenses in
registering and qualifying the Portfolios and their shares for
distribution under Federal and state securities laws, expenses
of preparing prospectuses and statements of additional informa-
tion and of printing and distributing prospectuses and state-
ments of additional information to existing shareholders, ex-
penses relating to shareholder reports, shareholder meetings
and proxy solicitations, insurance premiums, the expense of in-
dependent pricing services, and other expenses which are not
expressly assumed by BlackRock, Inc. or the Fund's service
providers under their agreements with the Fund. Any general ex-
penses of the Fund that do not belong to a particular invest-
ment portfolio will be allocated among all investment portfo-
lios by or under the direction of the Board of Trustees in a
manner the Board determines to be fair and equitable.
17.
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HOW ARE SHARES PURCHASED AND REDEEMED?
- -------------------------------------------------------------------------------
DISTRIBUTOR. Shares of the Portfolios are offered on a continuous basis by BDI
as distributor (the "Distributor"). BDI maintains its principal offices at
Four Falls Corporate Center, 6th Floor, West Conshohocken, PA 19428-2961.
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 Institutional Shares. However, the
Plan permits BDI, the Administrators and other companies that receive fees
from the Fund to make payments relating to distribution and sales support ac-
tivities 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 promo-
tions in which participants may receive reimbursement of expenses, entertain-
ment and prizes such as travel awards, merchandise and cash. For further in-
formation, see "Investment Advisory, Administration, Distribution and Servic-
ing Arrangements" in the Statement of Additional Information.
PURCHASE OF SHARES. Institutional Shares are offered to institutional invest-
ors, including (a) registered investment advisers with a minimum investment of
$500,000 and (b) the trust departments of PNC Bank and its affiliates (collec-
tively, "PNC") on behalf of clients for whom PNC (i) acts in a fiduciary ca-
pacity (excluding participant-directed employee benefit plans) or otherwise
has investment discretion or (ii) acts as custodian with respect to at least
$2,000,000 in assets, and individuals with a minimum investment of $2,000,000.
Institutional Shares are sold at their net asset value per share next computed
after an order is received by PFPC. Orders received by PFPC by 4:00 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") and the Federal Re-
serve Bank of Philadelphia (the "FRB") are open for business.
Purchase orders may be placed by telephoning PFPC at (800) 441-7450. Orders
received by PFPC after 4:00 p.m. (Eastern Time) are priced on the following
Business Day.
Payment for Institutional Shares must normally be made in Federal funds or
other funds immediately available to the Fund's custodian. Payment may also,
in the discretion of the Fund, be made in the form of securities that are per-
missible investments for the respective Portfolios. For further information,
see the Statement of Additional Information. The minimum initial investment
for institutions is $5,000. There is no minimum subsequent investment require-
ment. The Fund does not accept third party checks for initial or subsequent
investments.
The Fund may in its discretion waive or modify the minimum investment amount,
may reject any order for Institutional Shares and may suspend and resume the
sale of shares of any share class of the Portfolio at any time.
In the event that a shareholder acquiring Institutional Shares on or after May
1, 1998 ceases to meet the eligibility standards for purchasing Institutional
Shares (other than due to fluctuations in market value), then the sharehold-
er's Institutional Shares will, upon the direction of the Fund's distributor,
automatically be converted to shares of another class of the Portfolio having
the same aggregate net asset value as the shares converted. If, at the time of
conversion, an institution offering Service Shares of the Portfolio is acting
on the shareholder's behalf, then the shareholder's Institutional Shares will
be converted to Service Shares of the Portfolio. If not, then the sharehold-
er's Institutional Shares will be converted to Investor A Shares of the Port-
folio. Service Shares are currently authorized to bear additional service and
processing fees at the aggregate annual rate of .30% of average daily net as-
sets, while Investor A Shares are currently authorized to bear additional
service, processing and distribution fees at the aggregate annual rate of .50%
of average daily net assets.
18.
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REDEMPTION OF SHARES. Redemption orders for Institutional Shares may be placed
by telephoning PFPC at (800) 441-7450. Institutional Shares are redeemed at
their net asset value per share next determined after PFPC's receipt of the re-
demption order. 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.
Payment for redeemed shares for which a redemption order is received by PFPC
before 4:00 p.m. (Eastern Time) on a Business Day is normally made in Federal
funds wired to the redeeming Institution on the next Business Day, provided
that the Fund's custodian is also open for business. Payment for redemption or-
ders received after 4:00 p.m. (Eastern Time) or on a day when the Fund's custo-
dian is closed is normally wired in Federal funds on the next Business Day fol-
lowing redemption on which the Fund's custodian is open for business. The Fund
reserves the right to wire redemption proceeds within seven days after receiv-
ing a redemption order if, in the judgment of BlackRock, Inc., an earlier pay-
ment could adversely affect a Portfolio. No charge for wiring redemption pay-
ments is imposed by the Fund.
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 Fund may redeem Institutional Shares in any shareholder's account if the
account balance drops below $5,000 as the result of redemption requests and the
shareholder does not increase the balance to at least $5,000 on thirty days'
written notice.
The Fund may also suspend the right of redemption or postpone the date of pay-
ment 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 Fund's responsibili-
ties under the 1940 Act. See "Purchase and Redemption Information" in the
Statement of Additional Information for examples of when such redemption might
be appropriate.
Shares of the Portfolios may be purchased by customers of broker-dealers and
agents which have established a servicing relationship with the Fund on behalf
of their customers. These broker-dealers and agents may impose additional or
different conditions on the purchase or redemption of Portfolio shares by their
customers and may charge their customers transaction, account or other fees on
the purchase and redemption of Portfolio shares. Each broker-dealer or agent is
responsible for transmitting to its customers a schedule of any such fees and
information regarding any additional or different conditions regarding pur-
chases and redemptions. Shareholders who are customers of such broker-dealers
or agents should consult them for information regarding these fees and condi-
tions.
19.
<PAGE>
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HOW IS NET ASSET VALUE CALCULATED?
- --------------------------------------------------------------------------------
Net asset value is calculated separately for Institutional Shares of each Port-
folio as of the close of regular trading hours on the NYSE (currently 4:00 p.m.
Eastern Time) on each Business Day by dividing the value of all securities and
other assets owned by a Portfolio that are allocated to its Institutional
Shares, less the liabilities charged to its Institutional Shares, by the number
of its Institutional Shares that are outstanding.
Most securities held by a Portfolio are priced based on their market value as
determined by reported sales prices, or the mean between bid and asked prices,
that are provided by securities dealers or pricing services. Portfolio securi-
ties which are primarily traded on foreign securities exchanges are normally
valued at the preceding closing values of such securities on their respective
exchanges. Securities for which market quotations are not readily available are
valued at fair market value as determined in good faith by or under the direc-
tion 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 a Portfolio's sub-adviser under the supervision of the Board of
Trustees determines such method does not represent fair value.
HOW FREQUENTLY ARE DIVIDENDS AND DISTRIBUTIONS MADE TO INVESTORS?
- --------------------------------------------------------------------------------
Each Portfolio will distribute substantially all of its net investment income
and net realized capital gains, if any, to shareholders. All distributions are
reinvested at net asset value in the form of additional full and fractional
shares of Institutional Shares of the relevant Portfolio unless a shareholder
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. Each Portfolio declares a dividend each day on "settled"
shares (i.e. shares for which the particular Portfolio has received payment in
Federal funds) on the first Business day after a purchase order is placed with
the Fund. Payments by check are normally converted to Federal funds within two
Business Days of receipt. Over the course of a year, substantially all of the
Portfolios' 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 within ten days after the end
of each month. Net realized capital gains (including net short-term capital
gains), if any, will be distributed by each Portfolio at least annually.
20.
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HOW ARE FUND DISTRIBUTIONS TAXED?
- --------------------------------------------------------------------------------
Each Portfolio intends to qualify as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). If
a Portfolio qualifies, 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 distributions (except distributions
that are "exempt interest dividends" or are treated as a return of capital),
whether the distributions are paid in cash or reinvested in additional shares.
Distributions paid out of a Portfolio's "net capital gain" (the excess of 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 shares. All other distributions, to the extent taxable, are
taxed to shareholders as ordinary income.
Each Portfolio intends to pay substantially all of its dividends as "exempt in-
terest dividends." However, taxpayers are required to report the receipt of
"exempt interest dividends" on their Federal income tax returns, and in two
circumstances such amounts, while exempt from regular Federal income tax, are
taxable to persons subject to alternative minimum tax. First, "exempt interest
dividends" derived from certain private activity bonds issued after August 7,
1986 generally will constitute an item of tax preference for corporate and non-
corporate taxpayers in determining alternative minimum tax liability. Second,
"exempt interest dividends" must be taken into account by corporate taxpayers
in determining certain adjustments for alternative minimum tax purposes. In ad-
dition, investors should be aware of the possibility of state and local alter-
native minimum or minimum income tax liability on interest from private activ-
ity bonds. Shareholders who are recipients of Social Security Act or Railroad
Retirement Act benefits should note that "exempt interest dividends" will be
taken into account in determining the taxability of their benefit payments.
Each Portfolio will determine annually the percentages of its net investment
income which are exempt from the regular Federal income tax, which constitute
an item of tax preference for Federal alternative minimum tax purposes, and
which are fully taxable. These percentages will apply uniformly to all distri-
butions declared from net investment income during that year and may differ
significantly from the actual percentages for any particular day.
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 speci-
fied date in those months will be deemed to have been received by the share-
holders on December 31 of such year, if the dividends are paid during the fol-
lowing January.
An investor considering buying shares on or just before a dividend record date
should be aware that the amount of the forthcoming dividend payment, although
in effect a return of capital, will be taxable.
A taxable gain or loss may be realized by a shareholder upon the redemption,
transfer or exchange of shares depending upon their tax basis and their price
at the time of redemption, transfer or exchange. Any loss upon the sale or ex-
change of shares held for six months or less will be disallowed for Federal in-
come tax purposes to the extent of any exempt interest dividends received by
the shareholder. For the Delaware Tax-Free Income Portfolio, any loss upon the
sale or exchange of shares held for six months or less will also be disallowed
for Delaware income tax purposes to the extent of any exempt interest dividends
received by the shareholders, without regard to whether all or any portion of
such exempt interest dividends may have been subject to Delaware income tax.
TAX TREATMENT OF CERTAIN SECURITIES. A Portfolio may make investments that pro-
duce income that is not matched by a corresponding cash distribution to the
Portfolio, such as investments in pay-in-kind bonds or in obligations such as
zero coupon securities having original issue discount (i.e., an amount equal to
the excess
21.
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of the stated redemption price of the security at maturity over its issue
price), or market discount (i.e., an amount equal to the excess of the stated
redemption price of the security over the basis of such bond immediately after
it was acquired) if the Portfolio elects to accrue market discount on a cur-
rent basis. In addition, income may continue to accrue for federal income tax
purposes with respect to a non-performing investment. Any such income would be
treated as income earned by a Portfolio and therefore would be subject to the
distribution requirements of the Code. Because such income may not be matched
by a corresponding cash distribution to a Portfolio, such Portfolio may be re-
quired to borrow money or dispose of other securities to be able to make dis-
tributions to its investors. In addition, if an election is not made to cur-
rently accrue market discount with respect to a market discount bond, all or a
portion of any deduction or any interest expenses incurred to purchase or hold
such bond may be deferred until such bond is sold or otherwise disposed.
This is not an exhaustive discussion of applicable tax consequences, and in-
vestors may wish to contact their tax advisers concerning investments in the
Portfolios. Except as discussed below, 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,shareholders who are non-resident alien individuals, foreign trusts
or estates, foreign corporations or foreign partnerships may be subject to
different Federal income tax treatment. Future legislative or administrative
changes or court decisions may materially affect the tax consequences of in-
vesting in a Portfolio. For additional information concerning the tax treat-
ment of dividends and distributions by the states listed below, including cer-
tain restrictions applicable to such treatment, see "Taxes" in the Statement
of Additional Information.
DELAWARE TAX CONSIDERATIONS. Individuals, estates and trusts that are subject
to Delaware personal income tax will be subject to such tax on distributions
from the Delaware Tax-Free Income Portfolio (other than distributions qualify-
ing as "exempt interest dividends" under the Code which are subject to such
tax as discussed below and distributions attributable to interest paid on cer-
tain U.S. government obligations) to the same extent as such distributions are
includible in the gross income of such shareholders for Federal income tax
purposes. Unlike the Code, however, Delaware tax law does not provide for dif-
ferent tax rates for distributions paid out of "net capital gain" and other
distributions.
Individuals, estates and trusts that are subject to Delaware personal income
tax will not be subject to such tax on distributions that qualify as "exempt
interest dividends" under the Code to the extent that such distributions are
attributable to interest on Delaware State-Specific Obligations and provided
that the Delaware Tax-Free Income Portfolio sends shareholders a written
statement of the dollar amount or percentage of the exempt interest dividends
that are attributable to interest on Delaware State-Specific Obligations. Sim-
ilarly, if the Delaware Tax-Free Income Portfolio qualifies as a regulated in-
vestment company under the Code, individuals, estates and trusts that are sub-
ject to Delaware personal income tax will not be subject to such tax on dis-
tributions that are attributable to interest paid on certain U.S. government
obligations, provided that the Delaware Tax-Free Income Portfolio sends share-
holders a written statement of the dollar amount or percentage of such distri-
butions that are attributable to interest paid on such U.S. government obliga-
tions. The Fund will send written notices to shareholders annually regarding
the Delaware tax status of distributions made by the Delaware Tax-Free Income
Portfolio.
For corporations and other entities that are subject to Delaware corporate in-
come tax, distributions will be excluded from the Delaware taxable income of
such shareholders to the same extent as such distributions are excluded from
the Federal taxable income of such shareholders.
KENTUCKY TAX CONSIDERATIONS. Exempt interest dividends paid by the Kentucky
Tax-Free Income Portfolio that are attributable to Kentucky State-Specific Ob-
ligations will be excludible from a shareholder's gross income for Kentucky
income tax purposes. Further, distributions attributable to interest on cer-
tain U.S. government obligations will similarly be excluded from gross income
for Kentucky income tax purposes. All
22.
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other distributions by the Kentucky Tax-Free Income Portfolio will be included
in a shareholder's gross income for Kentucky income tax purposes. Kentucky
taxes distributions of net capital gain at the same rates as ordinary income.
Under the laws of Kentucky relating to ad valorem taxation of property, the
shareholders rather than the Kentucky Tax-Free Income Portfolio are considered
the owners of the Portfolio's assets. Each shareholder will be deemed to be the
owner of a pro-rata portion of the Kentucky Tax-Free Income Portfolio's assets.
According to the Kentucky Revenue Cabinet, the portion of the Portfolio's as-
sets that consists of Kentucky State-Specific Obligations will be exempt from
intangible property taxes, but the portion that consists of cash on hand, cash
in out-of-state banks, futures, options and other nonexempt assets will be sub-
ject to intangible property taxes.
23.
<PAGE>
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HOW IS THE FUND ORGANIZED?
- --------------------------------------------------------------------------------
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 com-
pany. 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 num-
ber of shares in thirty-eight investment portfolios. Each of the Portfolios de-
scribed herein offers five separate classes of shares--Institutional Shares,
Service Shares, Investor A Shares, Investor B Shares and Investor C Shares.
This prospectus relates only to Institutional Shares of the Portfolios de-
scribed herein.
Shares of each class bear their pro rata portion of all operating expenses paid
by a Portfolio, except transfer agency fees, certain administrative/servicing
fees and amounts payable under the Fund's Distribution and Service Plan. Be-
cause of these "class expenses" and sales charges, the performance of the Port-
folio's Institutional Shares is expected to be higher than the performance of
the Portfolio's Service Shares, and the performance of each of the Institu-
tional Shares and Service Shares of a Portfolio is expected to be higher than
the performance of the Portfolio's classes of Investor Shares. The performance
of each class of Investor Shares may be different. The Fund offers various
services and privileges in connection with its Investor Shares that are not
generally offered in connection with its Institutional and Service Shares, in-
cluding an automatic investment plan and an automatic withdrawal plan. For fur-
ther information regarding the Fund's Service or Investor Share classes, con-
tact PFPC at (800) 441-7764 (Service Shares) or (800) 441-7762 (Investor
Shares).
Each share of a Portfolio has a par value of $.001, represents an interest in
that Portfolio and is entitled to the dividends and distributions earned on
that Portfolio's assets that 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 February 4, 1998, PNC Bank held of record approximately 78% of the Fund's
outstanding shares, as trustee on behalf of individual and institutional in-
vestors, 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.
24.
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HOW IS PERFORMANCE CALCULATED?
- --------------------------------------------------------------------------------
Performance information for Institutional 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. Av-
erage annual total return reflects the average annual percentage change in
value of an investment in Institutional Shares of a Portfolio over the measur-
ing 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
Institutional Shares are reinvested in Institutional Shares.
The yield of Institutional Shares is computed by dividing the Portfolio's net
income per share allocated to its Institutional 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. Each Portfolio's "tax-equiv-
alent yield" may also be quoted, which shows the level of taxable yield needed
to produce an after-tax equivalent to a Portfolio's tax-free yield. This is
done by increasing the Portfolio's yield (calculated above) by the amount nec-
essary to reflect the payment of Federal and/or state income tax at a stated
tax rate.
The performance of a Portfolio's Institutional Shares may be compared to the
performance of other mutual funds with similar investment objectives and to
relevant indices, as well as to ratings or rankings prepared by independent
services or other financial or industry publications that monitor the perfor-
mance of mutual funds. For example, the performance of a Portfolio's Institu-
tional Shares 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 Lehman GNMA Index, the T-Bill Index,
the "stocks, bonds and inflation index" published annually by Ibbotson Associ-
ates and the Lehman Government Corporate Bond Index, as well as the benchmarks
attached to this Prospectus. Performance information may also include evalua-
tions of the Portfolios and their Institutional Shares published by nationally
recognized ranking services, and information as reported in financial publica-
tions such as Business Week, Fortune, Institutional Investor, Money Magazine,
Forbes, Barron's, The Wall Street Journal and The New York Times, or in publi-
cations of a local or regional nature.
In addition to providing performance information that demonstrates the actual
yield or return of Institutional Shares of a particular Portfolio, a Portfolio
may provide other information demonstrating hypothetical investment returns.
This information may include, but is not limited to, illustrating the com-
pounding effects of dividends in a dividend reinvestment plan or the impact of
tax-deferred investing.
Performance quotations for shares of a Portfolio 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 Institutional Shares, when redeemed, may be
worth more or less than their original cost. Since performance will fluctuate,
performance data for Institutional Shares of a Portfolio cannot necessarily be
used to compare an investment in such shares with bank deposits, savings ac-
counts and similar investment alternatives which often provide an agreed or
guaranteed fixed yield for a stated period of time. Performance is generally a
function of the kind and quality of the instruments held in a portfolio, port-
folio maturity, operating expenses and market conditions. Any fees charged by
brokers or other institutions directly to their customer accounts in connection
with investments in Institutional Shares will not be included in the Portfolio
performance calculations.
25.
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HOW CAN I GET MORE INFORMATION?
- --------------------------------------------------------------------------------
CONVENIENT WAYS TO ACCESS FUND INFORMATION
Below is a brief description of how investors can easily access information
about the BlackRock Funds.
<TABLE>
<CAPTION>
FUND INFORMATION HOURS AVAILABLE PHONE INFORMATION
<S> <C> <C>
INTERNAL 9 AM to 6 PM, E.S.T. toll-free 888-8BLACKROCK
WHOLESALERS/BROKER-DEALER Monday through Friday toll-free 888-825-2257
SUPPORT:
PORTFOLIO MANAGERS 24 Hours, 7 days a week toll-free 800-FUTURE4
COMMENTARY: toll-free 800-388-8734
(Audio recording updated
periodically)
SHAREHOLDER SERVICES
TELEPHONE ACCESS: 24 Hours, 7 days a week toll-free 800-441-7764
ACCOUNT SERVICE 8:30 to 5 PM, E.S.T. toll-free 800-441-7764
REPRESENTATIVES: Monday through Friday
Available to discuss
account balance
information, mutual fund
prospectus, literature and
discuss programs and
services available.
PURCHASES AND REDEMPTIONS: 8:30 to 5 PM, E.S.T. toll-free 800-441-7450
Monday through Friday
WORLD WIDE WEB:
Access general fund 24 Hours, 7 days a week http://www.blackrock.com
information and specific
fund performance. Request
mutual fund prospectuses
and literature. Forward
mutual fund inquiries.
E-MAIL:
Request prospectuses and 24 Hours, 7 days a week [email protected]
literature. Forward mutual
fund inquiries.
WRITTEN CORRESPONDENCE: POST OFFICE BOX ADDRESS STREET ADDRESS
BlackRock Funds BlackRock Funds
c/o PFPC Inc. c/o PFPC Inc.
P.O. Box 8907 400 Bellevue Parkway
Wilmington, DE 19899-8907 Wilmington, DE 19809
</TABLE>
26.
<PAGE>
BLACKROCK FUNDS
THE BLACKROCK FUNDS
BlackRock Funds is a leading mutual fund company currently managing in excess
of $14 billion in 35 portfolios designed to fit a broad range of investment
goals. Each portfolio is managed by recognized experts in equity, fixed income,
international, and tax-free investing who adhere to a pure investment style./SM/
STOCK PORTFOLIOS
- --------------------------------------------------------------------------------
Large Cap Growth Equity Select Equity
Large Cap Value Equity Micro-Cap Equity
Mid-Cap Growth Equity International Equity
Mid-Cap Value Equity International Emerging Markets
Small Cap Growth Equity International Small Cap Equity
Small Cap Value Equity Index Equity
STOCK & BOND PORTFOLIO
- --------------------------------------------------------------------------------
Balanced
BOND PORTFOLIOS
- --------------------------------------------------------------------------------
Low Duration Bond Government Income
Intermediate Government Bond Managed Income
Intermediate Bond International Bond
Core Bond GNMA
TAX-FREE BOND PORTFOLIOS
- --------------------------------------------------------------------------------
Tax-Free Income New Jersey Tax-Free Income
Delaware Tax-Free Income Ohio Tax-Free Income
Kentucky Tax-Free Income Pennsylvania Tax-Free Income
MONEY MARKET PORTFOLIOS
- --------------------------------------------------------------------------------
Money Market North Carolina Municipal Money Market
U.S. Treasury Money Market Ohio Municipal Money Market
Municipal Money Market Pennsylvania Municipal Money Market
New Jersey Municipal Money Market Virginia Municipal Money Market
<PAGE>
, 1998
- --------------------------------------------------------------------------------
THE GNMA PORTFOLIO INVESTOR SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASKING THE KEY
QUESTIONS
PAGE
<S> <C>
What Are The Expenses Of The Portfolio?...................... 4
What Is The Portfolio?....................................... 6
What Types Of Securities Are In The Portfolio?............... 7
What Additional Investment Policies And Risks Apply?......... 8
What Are The Portfolio's Fundamental Investment
Limitations?................................................ 15
Who Manages The Fund?........................................ 16
What Pricing Options Are Available To Investors?............. 20
What Are The Key Considerations In Selecting A Pricing
Option?..................................................... 21
How Are Shares Purchased?.................................... 22
How Are Shares Redeemed?..................................... 23
What Are The Shareholder Features Of The Fund?............... 25
What Is The Schedule Of Sales Charges And Exemptions?........ 27
How Is Net Asset Value Calculated?........................... 31
How Frequently Are Dividends And Distributions Made To
Investors?.................................................. 31
How Are Fund Distributions Taxed?............................ 32
How Is The Fund Organized?................................... 34
How Is Performance Calculated?............................... 35
How Can I Get More Information?.............................. 36
</TABLE>
This Prospectus sets forth concisely information about the Black-
Rock GNMA Portfolio (the "Portfolio") that a prospective investor
needs to know before investing. Please keep it for future refer-
ence. A Statement of Additional Information dated , 1998 has
been filed with the Securities and Exchange Commission (the
"SEC"). The Statement of Additional Information may be obtained
free of charge from the BlackRock Funds /SM/ (the "Fund") by call-
ing (800) 441-7762. The Statement of Additional Information, as
supplemented from time to time, is incorporated by reference into
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 infor-
mation regarding the Fund that has been filed with the SEC.
SHARES OF THE PORTFOLIO ARE NOT DEPOSITS OR OBLIGATIONS OF, OR
GUARANTEED OR ENDORSED BY, PNC BANK, NATIONAL ASSOCIATION OR ANY
OTHER BANK AND ARE NOT INSURED BY, GUARANTEED BY, OBLIGATIONS OF
OR OTHERWISE SUPPORTED BY THE U.S. GOVERNMENT, THE FEDERAL DE-
POSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY
OTHER GOVERNMENTAL AGENCY. INVESTMENTS IN THE PORTFOLIOS INVOLVE
INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF PRINCIPAL AMOUNT IN-
VESTED.
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 AC-
CURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
2.
<PAGE>
- --------------------------------------------------------------------------------
THE GNMA PORTFOLIO OF BLACKROCK FUNDS
- --------------------------------------------------------------------------------
The BLACKROCK FUND family consists of 35 portfolios and has
been structured to include many different investment styles
across the spectrum of fixed income investments so that invest-
ors may participate across multiple disciplines in order to
seek their long-term financial goals.
Effective January 31, 1998, the Fund has changed its name from
Compass Capital Funds /SM/ to BlackRock Funds /SM/.
The GNMA Portfolios of BLACKROCK FUNDS is one of fourteen in-
vestment portfolios that provide investors with a broad spec-
trum of investment alternatives within the fixed income sector.
Eight of these portfolios invest in taxable bonds, and six of
these portfolios invest in tax-exempt bonds. A detailed de-
scription of the GNMA Portfolio begins on page . To obtain a
prospectus describing the Fund's other fixed income portfolios,
call (800) 441-7762.
The Portfolio's performance benchmark is the Lehman GNMA Index
and its Lipper peer group is the GNMA Funds category. The Leh-
man GNMA Index is comprised of mortgage-backed pass-through se-
curities of the Government National Mortgage Association(GNMA).
BlackRock, Inc. serves as investment adviser to the Portfolio.
BlackRock Financial Management, Inc. serves as sub-adviser to
the Portfolio.
UNDERSTANDING This Prospectus has been crafted to provide detailed, accurate
THE and comprehensive information on the BlackRock GNMA Portfolio.
BLACKROCK We intend this document to be an effective tool as you explore
GNMA different directions in fixed income investing.
PORTFOLIO
CONSIDERING
THE RISKS IN There can be no assurance that any mutual fund will achieve its
BOND investment objective. The Portfolio may purchase mortgage-re-
INVESTING lated, asset-backed, and illiquid securities; enter into repur-
chase and reverse repurchase agreements and engage in
leveraging, which is a speculative technique; lend portfolio
securities to third parties; and enter into futures contracts
and opinions. See "What Additional Investment Policies And
Risks Apply?"
INVESTING IN For information on how to purchase and redeem shares of the
THE Portfolio, see "How Are Shares Purchased" and "How Are Shares
BLACKROCK Redeemed?"
FUNDS
3.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ARE THE EXPENSES OF THE PORTFOLIO?
- --------------------------------------------------------------------------------
Below is a summary of the annual operating expenses and shareholder transaction
expenses expected to be incurred by Investor Shares of the Portfolio for the
current fiscal year as a percentage of average daily net assets. The figures
shown under "Other expenses" are estimated for the current fiscal year. An ex-
ample based on the summary is also shown.
<TABLE>
<CAPTION>
GNMA
PORTFOLIO
INVESTOR A INVESTOR B INVESTOR C
<S> <C> <C> <C> <C> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES
Maximum Front-End Sales Charge(/1/)
(as a percentage of offering price) 4.0% None None
Maximum Deferred Sales Charge(/1/)(/2/)
(as a percentage of offering price) None 4.5% 1.0%
Sales Charge on Reinvested Dividends None None None
ANNUAL PORTFOLIO OPERATING EXPENSES (AS A
PERCENTAGE OF AVERAGE NET ASSETS)
Advisory fees (after fee waivers)(/3/) .35% .35% .35%
12b-1 fees(/3/)(/4/) .00 .75 .75
Other operating expenses (after fee
waivers)(/3/) .72 .72 .72
--- --- ---
Shareholder servicing fee .25 .25 .25
Shareholder processing fee .15 .15 .15
Other expenses .32 .32 .32
--- --- ---
Total Portfolio operating expenses (after
fee waivers)(/3/) 1.07% 1.82% 1.82%
==== ==== ====
</TABLE>
(1) Reduced front-end sales charges may be available. A deferred sales charge
of up to 1.00% is assessed on certain redemptions of Investor A Shares that
are purchased with no initial sales charge as part of an investment of
$1,000,000 or more. See "What Is the Schedule of Sales Charges and Exemp-
tions?"
(2) This amount applies to redemptions during the first year. The deferred
sales charge for Investor B Shares decreases for redemptions made in subse-
quent years. No deferred sales charge is charged after the sixth year on
Investor B Shares or after the first year on Investor C Shares. See "What
Is the Schedule of Sales Charges and Exemptions?"
(3) "Other expenses" includes the administration fees payable by the Portfolio.
Without waivers, advisory fees would be .55% and administration fees would
be .23% for each class of the Portfolio. BlackRock, Inc. and the Portfo-
lio's administrators are under no obligation to waive fees or reimburse ex-
penses, but have informed the Fund that they expect to waive fees and reim-
burse expenses during the remainder of the current fiscal year as necessary
to maintain the Portfolio's total operating expenses at the levels set
forth in the table. Without waivers, "Other operating expenses" would be
.78% for each of Investor A Shares, Investor B Shares and Investor C
Shares, and "Total Portfolio operating expenses" would be 1.33% for In-
vestor A Shares and 2.08% for each of Investor B Shares and Investor C
Shares. The Portfolios do not expect to incur 12b-1 fees in excess of .005%
with respect to Investor A Shares (otherwise payable at the maximum rate of
.10%) during the current fiscal year.
(4) Investors with a long-term perspective may prefer Investor A Shares, as de-
scribed under "What Are The Key Considerations In Selecting A Pricing Op-
tion?" Long-term investors in Investor Shares may pay more than the eco-
nomic equivalent of the maximum front-end sales charges permitted by the
rules of the National Association of Securities Dealers, Inc. ("NASD").
4.
<PAGE>
- --------------------------------------------------------------------------------
EXAMPLE
An investor in Investor Shares would pay the following expenses on a $1,000 in-
vestment assuming (1) a 5% annual return, (2) redemption at the end of each
time period and (3) with respect to Investor B shares only, no redemption at
the end of each time period:
<TABLE>
<CAPTION>
ONE YEAR THREE YEARS
<S> <C> <C>
GNMA Portfolio
A Shares* $41 $63
B Shares (Redemption)** 63 95
B Shares (No Redemption) 18 57
C Shares 18 57
</TABLE>
* Reflects the imposition of the maximum front-end sales charge at the begin-
ning of the period.
** Reflects the deduction of the deferred sales charge.
In addition to the compensation itemized in the expense table, institutions
that sell Portfolio shares and/or their salespersons may receive compensation
for the sale and distribution of shares or for services to the Portfolio. For
information regarding such compensation, see "Who Manages The Fund?--Distribu-
tion and Service Plan" in the Prospectus and "Investment Advisory, Administra-
tion, Distribution and Servicing Arrangements" in the Statement of Additional
Information.
The foregoing Table and Example are intended to assist investors in understand-
ing the costs and expenses that an investor in the Portfolio will bear either
directly or indirectly. They do not reflect any charges that may be imposed by
brokers or other institutions directly on their customer accounts in connection
with investments in the Portfolio.
THE EXAMPLE SHOWN ABOVE SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE IN-
VESTMENT RETURN OR OPERATING EXPENSES. ACTUAL INVESTMENT RETURN AND OPERATING
EXPENSES MAY BE MORE OR LESS THAN THOSE SHOWN.
5.
<PAGE>
- --------------------------------------------------------------------------------
WHAT IS THE PORTFOLIO?
- --------------------------------------------------------------------------------
The GNMA Portfolio of BLACKROCK FUNDS is one of fourteen
BlackRock investment portfolios that provide investors with a
broad spectrum of investment alternatives within the fixed
income sector. Eight of these portfolios invest solely in
taxable bonds and six of these portfolios invest in tax-ex-
empt bonds.
In certain investment cycles and over certain holding peri-
ods, a fund that invests in any one of these styles may per-
form above or below the market. An investment program that
combines these multiple disciplines allows investors to se-
lect from among these various product options in the way that
most closely fits the investor's goals and sentiments.
<TABLE>
<C> <S>
Investment Objective The GNMA Portfolio seeks to provide current
income consistent with the preservation of
capital.
Investment Style The Portfolio generally pursues securities
issued by the Government National Mortgage
Association ("GNMAs"), as well as other U.S.
Government securities.
Portfolio Emphasis Portfolio assets are invested primarily in
GNMAs. GNMAs are securities issued by the
Government National Mortgage Association which
represent interests in pools of residential
mortgage loans originated by private lenders.
The dollar-weighted average maturity of the
Portfolio will range from approximately 5 to
10 years.*
</TABLE>
--------
* The Portfolio's sub-adviser will normally attempt to struc-
ture the Portfolio to have comparable duration to its per-
formance benchmark. Duration, which measures price sensi-
tivity to interest rate changes, is not necessarily equal
to average maturity.
6.
<PAGE>
- --------------------------------------------------------------------------------
WHAT TYPES OF SECURITIES ARE IN THE PORTFOLIO?
- --------------------------------------------------------------------------------
The following table summarizes the types of securities found in the Portfolio,
according to the following designations:
Yes:The Portfolio will hold a significant concentration of these securities
at all times.
Elig.: Eligible; the Portfolio may purchase these securities, but they may or
may not be a significant holding at a given time.
Temp.: Temporary; the Portfolio may purchase these securities, but under nor-
mal market conditions is not expected to do so.
No:The Portfolio may not purchase these securities.
<TABLE>
<CAPTION>
NON FOREIGN
AGENCY/ SECURITIES/
AGENCY COMMERCIAL HIGH YIELD CURRENCY
TREASURIES AGENCIES MBS/1/ MBS/1/ CORP. ABS/2/ SECURITIES RISK MUNICIPALS
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Yes Yes Yes Elig. Yes Elig. No No Elig.
</TABLE>
/1/MBS = mortgage-backed securities
/2/ABS = asset-backed securities
7.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ADDITIONAL INVESTMENT POLICIES AND RISKS APPLY?
- --------------------------------------------------------------------------------
The Portfolio will normally invest at least 80% of the value of its total as-
sets in debt securities. In addition, under normal market conditions the Port-
folio will invest at least 65% of its total assets in GNMAs. Securities ac-
quired by the Portfolio will be rated in the highest rating category at the
time of purchase (by Standard & Poor's Ratings Group ("S&P"), Moody's Investors
Service, Inc. ("Moody's"), Duff & Phelps Credit Co. or Fitch Investor Services,
Inc.) or, if unrated, of comparable quality as determined by the Portfolio's
sub-adviser. If a security's rating is reduced below the minimum rating that is
permitted for the Portfolio, the Portfolio's sub-adviser will consider whether
the Portfolio should continue to hold the security.
GNMAS AND OTHER MORTGAGE-RELATED AND ASSET-BACKED SECURITIES. The Portfolio
will invest primarily in GNMAs, and may make significant investments in other
residential and commercial mortgage-related and other asset-backed securities
(i.e., securities backed by home equity loans, installment sale contracts,
credit card receivables or other assets) issued by governmental entities and
private issuers.
The Portfolio may acquire several types of mortgage-related securities. GNMAs
are typically mortgage pass-through certificates, which provide the holder with
a pro rata interest in the underlying mortgages. The Portfolio may also acquire
adjustable rate mortgage-related securities ("ARMs") as well as collateralized
mortgage obligations ("CMOs"), which provide the holder with a specified inter-
est in the cash flow of a pool of underlying mortgages or other mortgage-backed
securities. Issuers of CMOs ordinarily elect to be taxed as pass-through enti-
ties known as real estate mortgage investment conduits ("REMICs"). CMOs are is-
sued in multiple classes, each with a specified fixed or floating interest rate
and a final distribution date. The relative payment rights of the various CMO
classes may be structured in a variety of ways. In most cases, however, pay-
ments of principal are applied to the CMO classes in the order of their respec-
tive stated maturities, so that no principal payments will be made on a CMO
class until all other classes having an earlier stated maturity date are paid
in full. The classes may include accrual certificates (also known as "Z-
Bonds"), which only accrue interest at a specified rate until other specified
classes have been retired and are converted thereafter to interest-paying secu-
rities. They may also include planned amortization classes ("PACs") which gen-
erally require, within certain limits, that specified amounts of principal be
applied on each payment date, and generally exhibit less yield and market vola-
tility than other classes.
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 may normally be prepaid at any
time because the underlying assets (i.e., loans) generally may be prepaid at
any time. In calculating the average weighted maturity of the Portfolio, the
maturity of mortgage-related and other asset-backed securities held by the
Portfolio will be based on estimates of average life which take prepayments
into account. 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. In general, the collateral supporting non-mortgage
asset-backed securities is of shorter maturity than mortgage loans and is less
likely to experience substantial prepayments.
The relationship between prepayments and interest rates may give some high-
yielding mortgage-related and asset-backed securities less potential for growth
in value than conventional bonds with comparable maturities. In addition, in
periods of falling interest rates, the rate of prepayments tends to increase.
During such periods, the reinvestment of prepayment proceeds by the Portfolio
will generally be at lower rates than the rates that were carried by the obli-
gations that have been prepaid. Because of these and other reasons, a mortgage-
related or asset-backed security's total return and maturity may be difficult
to predict precisely. To the extent
8.
<PAGE>
- --------------------------------------------------------------------------------
that the Portfolio purchases mortgage-related or asset-backed securities at a
premium, prepayments (which may be made without penalty) may result in loss of
the Portfolio's principal investment to the extent of premium paid.
Non-mortgage asset-backed securities involve risks that are not presented by
mortgage-related securities. Primarily, these securities do not have the bene-
fit of the same security interest in the underlying collateral. Credit card re-
ceivables are generally unsecured, and the debtors are entitled to the protec-
tion of a number of state and Federal consumer credit laws many of which give
debtors the right to set off certain amounts owed on the credit cards, thereby
reducing the balance due. Most issuers of automobile receivables permit the
servicers to retain possession of the underlying obligations. If the servicer
were to sell these obligations to another party, there is a risk that the pur-
chaser would acquire an interest superior to that of the holders of the related
automobile receivables. In addition, because of the large number of vehicles
involved in a typical issuance and technical requirements under state laws, the
trustee for the holders of the automobile receivables may not have an effective
security interest in all of the obligations backing such receivables. There-
fore, there is a possibility that recoveries on repossessed collateral may not,
in some cases, be able to support payments on these securities.
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. (or Sears Mortgage if PNC Mortgage Securities Corp. succeeded
to rights and duties of Sears Mortgage) or mortgage-related securities contain-
ing loans or mortgages originated by PNC Bank, National Association ("PNC
Bank") or its affiliates. It is possible that under some circumstances, PNC
Mortgage Securities Corp. or its 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 Securities Corp. or its affiliates.
STRIPPED AND ZERO COUPON OBLIGATIONS. To the extent consistent with its invest-
ment objective, the Portfolio 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 obliga-
tions. These participations, 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"). Stripped securities, par-
ticularly SMBS, may exhibit greater price volatility than ordinary debt securi-
ties because of the manner in which their principal and interest are returned
to investors.
SMBS are usually structured with two or more classes that receive different
proportions of the interest and principal distributions from a pool of mort-
gage-backed obligations. A common type of SMBS will have one class receiving
all of the interest, while the other class receives all of the principal. How-
ever, in some cases, one class will receive some of the interest and most of
the principal while the other class will receive most of the interest and the
remainder of the principal. If the underlying obligations experience greater
than anticipated prepayments of principal, the Portfolio may fail to fully re-
coup its initial investment. The market value of SMBS can be extremely volatile
in response to changes in interest rates. The yields on a class of SMBS that
receives all or most of the interest are generally higher than prevailing mar-
ket yields on other mortgage-related obligations because their cash flow pat-
terns are also volatile and there is a greater risk that the initial investment
will not be fully recouped.
The Portfolio may invest in zero-coupon bonds, which are normally issued at a
significant discount from face value and do not provide for periodic interest
payments. Zero-coupon bonds may experience greater volatility in market value
than similar maturity debt obligations which provide for regular interest pay-
ments. Additionally, current federal tax law requires the holder of certain
zero coupon bonds to accrue income with respect to these securities prior to
the receipt of cash payments. To maintain its qualification as a regulated in-
vestment company and avoid liability for federal income and excise taxes, the
Portfolio may be required to distribute income accrued with respect to these
securities and may have to dispose of portfolio securities under
9.
<PAGE>
- --------------------------------------------------------------------------------
disadvantageous circumstances in order to generate cash to satisfy these dis-
tribution requirements. See "How Are Fund Distributions Taxed?"
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 Mort-
gage Association are supported by the United States' full faith and credit;
others such as those of the Federal National Mortgage Association and the Stu-
dent 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 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 instrumen-
talities if it is not obligated to do so by law.
CORPORATE AND BANK OBLIGATIONS. To the extent consistent with its investment
objective, the Portfolio may invest in debt obligations of domestic or foreign
corporations and banks, and may acquire commercial obligations issued by Cana-
dian corporations and Canadian counterparts of U.S. corporations, as well as
Europaper, which is U.S. dollar-denominated commercial paper of a foreign issu-
er. Bank obligations may include certificates of deposit, notes, bankers' ac-
ceptances 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 Portfolio 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 INVESTMENTS. The two principal classifications of Municipal Obliga-
tions are "general obligation" securities and "revenue" securities. General ob-
ligation securities are secured by the issuer's pledge of its full faith,
credit and taxing power for the payment of principal and interest. Revenue se-
curities 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 fi-
nanced. 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 in-
clude "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.
Also included within the general category of Municipal Obligations are partici-
pation certificates in a lease, an installment purchase contract, or a condi-
tional sales contract ("lease obligations") entered into by a state or politi-
cal subdivision to finance the acquisition or construction of equipment, land,
or facilities. Although lease obligations are not general obligations of the
issuer for which the state or other governmental body's unlimited taxing power
is pledged, certain lease obligations are backed by a covenant to appropriate
money to make the lease obligation payments. However, under certain lease obli-
gations, the state or governmental body has no obligation to make these pay-
ments in future years unless money is appropriated on a yearly basis. Although
"non-appropriation" lease obligations are secured by the leased property, dis-
position of the property in the event of foreclosure might prove difficult.
These securities represent a relatively new type of financing that is not yet
as marketable as more conventional securities.
To the extent the Portfolio's assets are invested in Municipal Obligations pay-
able from the revenues of similar projects or are invested in private activity
bonds, the Portfolio will be subject to the particular risks presented by the
laws and economic conditions relating to such projects and bonds to a greater
extent than it would be if its assets were not so invested.
The amount of information regarding the financial condition of issuers of Mu-
nicipal Obligations may be less extensive than the information for public cor-
porations, and the secondary market for Municipal Obligations
10.
<PAGE>
- --------------------------------------------------------------------------------
may be less liquid than that for taxable obligations. Accordingly, the ability
of the Portfolio to buy and sell Municipal Obligations may, at any particular
time and with respect to any particular securities, be limited. In addition,
Municipal Obligations purchased by the Portfolio include obligations backed by
letters of credit and other forms of credit enhancement issued by domestic and
foreign banks, as well as other financial institutions.
Opinions relating to the validity of Municipal Obligations and to the exemption
of interest thereon from Federal and state income tax are rendered by counsel
to the respective issuers and sponsors of the obligations at the time of issu-
ance. The Fund and its service providers will rely on such opinions and will
not review independently the underlying proceedings relating to the issuance of
Municipal Obligations, the creation of any tax-exempt derivative securities, or
the bases for such opinions.
INTEREST RATE TRANSACTIONS. The Portfolio may enter into interest rate swaps
and may purchase or sell interest rate caps and floors. The Portfolio may enter
into these transactions primarily to preserve a return or spread on a particu-
lar investment or portion of its holdings, as a duration management technique
or to protect against an increase in the price of securities the Portfolio an-
ticipates purchasing at a later date. The Portfolio intends to use these trans-
actions 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 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. 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 inter-
est on a notional principal amount from the party selling such interest rate
floor.
OPTIONS AND FUTURES CONTRACTS. To the extent consistent with its investment ob-
jective, the Portfolio may write (i.e., sell) covered call options, buy put op-
tions, buy call options and write secured put options for the purpose of hedg-
ing or earning additional income, which may be deemed speculative. For the pay-
ment 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, securities indices
or the yield differential between two securities. The Portfolio will not pur-
chase put and call options when the aggregate premiums on outstanding options
exceed 5% of its net assets at the time of purchase, and will not write options
on more than 25% of the value of its net assets (measured at the time an option
is written). 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.
To the extent consistent with its investment objective, the Portfolio may also
invest in futures contracts and options on futures contracts for hedging pur-
poses or to maintain liquidity. The value of the Portfolio's contracts may
equal or exceed 100% of its total assets, although the Portfolio will not pur-
chase 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 for related futures options entered into for other than bona fide
hedging purposes is 5% or less of its net assets.
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 quan-
tity of a foreign currency. The 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.
The 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 securi-
ties in the value of the securities to be sold. In addition, the Portfolio may
utilize futures contracts in anticipation of changes in the composition of its
holdings or in currency exchange rates.
11.
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The 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 ob-
ligated to sell or buy a futures contract if the option is exercised. In con-
nection with a portfolio's position in a futures contract or related option,
the Fund will create a segregated account of 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 in-
struments 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 sub-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 the Statement of Additional Information.
To maintain greater flexibility, the Portfolio may invest in instruments which
have the characteristics of futures contracts. These instruments may take a
variety of forms, such as debt securities with interest or principal payments
determined by reference to the value of a commodity at a future point in time.
The risks of such investments could reflect the risks of investing in futures
and securities, including volatility and illiquidity.
The Fund intends to comply with the regulations of the Commodity Futures Trad-
ing Commission exempting the Portfolio from registration as a "commodity pool
operator."
GUARANTEED INVESTMENT CONTRACTS. The Portfolio may make limited investments in
guaranteed investment contracts ("GICs") issued by highly rated U.S. insurance
companies. Under these contracts, a portfolio makes cash contributions to a
deposit fund of the insurance company's general account. The insurance company
then credits to the portfolio, on a monthly basis, interest which is based on
an index (such as the Salomon Brothers CD Index), but is guaranteed not to be
less than a certain minimum rate. The Portfolio does not expect to invest more
than 5% of its net assets in GICs at any time during the current fiscal year.
SECURITIES LENDING. The Portfolio may seek additional income by lending secu-
rities 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. The Portfolio may
not make such loans in excess of 33 1/3% of the value of its total assets. Se-
curities 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.
VARIABLE AND FLOATING RATE INSTRUMENTS. The Portfolio may purchase rated and
unrated variable and floating rate instruments. These 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 Portfolio may invest up to 10% of its total assets in leveraged inverse
floating rate debt instruments ("inverse floaters"). The interest rate of an
inverse floater resets in the opposite direction from the market rate of in-
terest to which it is indexed. An inverse floater may be considered to be
leveraged to the extent that its interest rate varies by a magnitude that ex-
ceeds the magnitude of the change in the index rate of interest. The higher
degree of leverage inherent in inverse floaters is associated with greater
volatility in their market values. Issuers of unrated variable and floating
rate instruments must satisfy the same criteria as set forth above for the
Portfolio. The absence of an active secondary market with respect to particu-
lar variable and
12.
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floating rate instruments, however, could make it difficult for the Portfolio
to dispose of a variable or floating rate instrument if the issuer defaulted on
its payment obligation or during periods when the Portfolio is not entitled to
exercise its demand rights.
REPURCHASE AGREEMENTS. The Portfolio may agree to purchase debt securities from
financial institutions subject to the seller's agreement to repurchase them 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. The Portfolio is authorized
to borrow money. If the securities held by the 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 de-
cline 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 Portfolio may use
the proceeds of reverse repurchase agreements to purchase other securities ei-
ther maturing, or under an agreement to resell, on a date simultaneous with or
prior to the expiration of the reverse repurchase agreement. The Portfolio may
use reverse repurchase agreements when it is anticipated that the interest in-
come 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 re-
purchase agreements may be 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 the 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 re-
purchase agreement is outstanding, the Portfolio will maintain a segregated ac-
count with the Fund's custodian containing cash, U.S. Government or other ap-
propriate liquid debt securities having a value at least equal to the repur-
chase price. The 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, the Portfolio may borrow up to an additional 5%
of its total assets for temporary purposes.
INVESTMENT COMPANIES. The Portfolio may invest in securities issued by other
investment companies within the limits prescribed by the 1940 Act. As a share-
holder of another investment company, the Portfolio would bear, along with
other shareholders, its pro rata portion of the other investment company's ex-
penses, including advisory fees. These expenses would be in addition to the ad-
visory and other expenses that the Portfolio bears directly in connection with
its own operations.
ILLIQUID SECURITIES. The Portfolio will not invest more than 15% of the value
of its net assets in securities that are illiquid. GICs, variable and floating
rate 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.
The Portfolio may purchase securities which are not registered under the Secu-
rities Act of 1933 (the "1933 Act") but which can be sold to "qualified insti-
tutional buyers" in accordance with Rule 144A under the 1933 Act. These securi-
ties will not be considered illiquid so long as it is determined by the Portfo-
lio's sub-adviser that an adequate trading market exists for the securities.
This investment practice could have the effect of increasing the level of illi-
quidity in the Portfolio during any period that qualified institutional buyers
become uninterested in purchasing these restricted securities.
WHEN-ISSUED PURCHASES AND FORWARD COMMITMENTS. The Portfolio may purchase secu-
rities on a "when-issued" basis and may purchase or sell securities on a "for-
ward 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 portfo-
lio to lock in a price or yield on a security that it owns or intends to pur-
chase, 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
13.
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in a transaction may be less favorable than the price or yield available in
the market when the securities delivery takes place. The Portfolio's when-is-
sued purchases and forward commitments are not expected to exceed 25% of the
value of its total assets absent unusual market conditions.
DOLLAR ROLL TRANSACTIONS. To take advantage of attractive opportunities in the
mortgage market and to enhance current income, the 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 agree-
ment 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 in-
terest 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, the Portfolio
will not be entitled to receive interest and principal payments on the securi-
ties 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. If such income 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 the Portfolio compared with what the performance would have
been without the use of dollar rolls. At the time the Portfolio enters into a
dollar roll transaction, it will place in a segregated account maintained with
its custodian cash, U.S. Government securities or other liquid securities hav-
ing 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 securi-
ties the Portfolio is required to purchase may decline below the agreed upon
repurchase price of those securities. If the broker/dealer to whom the Portfo-
lio sells securities becomes insolvent, the Portfolio's right to purchase or
repurchase securities may be restricted. Successful use of mortgage dollar
rolls may depend upon the sub-adviser's ability to correctly predict interest
rates and prepayments. There is no assurance that dollar rolls can be success-
fully employed.
SHORT SALES. The Portfolio may only make short sales of securities "against-
the-box." 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 Portfolio may make short sales both as a form of hedging to off-
set potential declines in long positions in similar securities and in order to
maintain portfolio flexibility. In a short sale "against-the-box," at the time
of sale, the portfolio owns or has the immediate and unconditional right to
acquire the identical security at no additional cost. When selling short
"against-the-box," a portfolio forgoes an opportunity for capital appreciation
in the security.
PORTFOLIO TURNOVER RATES. Under normal market conditions, it is expected that
the annual portfolio turnover rate for the Portfolio will not exceed 450%. The
Portfolio's annual portfolio turnover rate will not be a
factor preventing a sale or purchase when the sub-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. High portfolio
turnover rates (i.e., 100% or more) will generally result in higher transac-
tion costs to the Portfolio and may result in the realization of short-term
capital gains that are taxable to shareholders as ordinary income.
INTEREST RATE AND EXTENSION RISK. The value of fixed income securities in the
Portfolio can be expected to vary inversely with changes in prevailing inter-
est rates. Fixed income securities with longer maturities, which tend to pro-
duce higher yields, are subject to potentially greater capital appreciation
and depreciation than securities with shorter maturities. The Portfolio is not
restricted to any maximum or minimum time to maturity in purchasing individual
portfolio securities, and the average maturity of the Portfolio's assets will
vary within the limits stated herein based upon its sub-adviser's assessment
of economic and market conditions. Although the Portfolio's sub-adviser will
normally attempt to structure the Portfolio to have a comparable duration to
its benchmark as stated in that section, there can be no assurance that it
will be able to do so at all times.
14.
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WHAT ARE THE PORTFOLIO'S FUNDAMENTAL INVESTMENT LIMITATIONS?
- --------------------------------------------------------------------------------
The Portfolio's investment objective and policies may be changed by the Fund's
Board of Trustees without shareholder approval. However, shareholders will be
given at least 30 days' notice before any change to the Portfolio's investment
objective. No assurance can be provided that a Portfolio will achieve its in-
vestment objective.
The Portfolio has also adopted certain fundamental investment limitations that
may be changed only with the approval of a "majority of the outstanding shares
of the Portfolio" (as defined in the Statement of Additional Information). Sev-
eral of the Portfolio's fundamental investment policies, which are set forth in
full in the Statement of Additional Information, are summarized below.
The Portfolio may not:
(1) purchase securities (except U.S. Government securities) if more than 5% of
its total assets will be invested in the securities of any one issuer, ex-
cept that up to 25% of the Portfolio's total assets may be invested without
regard to this 5% limitation; or
(2) invest 25% or more of its total assets in one or more issuers conducting
their principal business activities in the same industry.
The investment limitations stated above are applied at the time investment se-
curities are purchased.
15.
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WHO MANAGES THE FUND?
- -------------------------------------------------------------------------------
BOARD OF The business and affairs of the Fund are managed under the
TRUSTEES direction of its Board of Trustees. The following persons
currently serve on the Board:
William O. Albertini--Executive Vice President and Chief Fi-
nancial Officer of Bell Atlantic Global Wireless.
Raymond J. Clark--Treasurer of Princeton University.
Robert M. Hernandez--Vice Chairman and Chief Financial Offi-
cer of USX Corporation.
Anthony M. Santomero--Professor of Finance and Director of
the Financial Institutions Center, The Wharton School, Uni-
versity of Pennsylvania.
David R. Wilmerding, Jr.--Chairman, Gee, Wilmerding & Asso-
ciates, Inc.
ADVISER AND The Adviser to BlackRock Funds is BlackRock, Inc. BlackRock,
SUB-ADVISER Inc. (formerly PNC Asset Management Group, Inc.) was orga-
nized in 1994 to perform advisory services for investment
companies, and has its principal offices at 1600 Market
Street, 29th Floor, Philadelphia, Pennsylvania 19103. Black-
Rock, Inc. is an indirect wholly-owned subsidiary of PNC
Bank Corp., a multi-bank holding company.
The sub-adviser to the Portfolio is BlackRock Financial
Management, Inc. ("BlackRock"), an affiliate of BlackRock,
Inc., with its primary offices at 345 Park Avenue, New York,
New York 10154. BlackRock is a registered investment
adviser, organized in 1988. Robert S. Kapito, Scott Amero
and Michael P. Lustig serve as portfolio managers of the
Portfolio. Mr. Kapito has been Vice Chairman of the sub-
adviser since 1988, Mr. Amero has been Managing Director of
the sub-adviser since 1990, and Mr. Lustig has been a
portfolio manager of the sub-adviser since 1995. As adviser,
BlackRock, Inc. is responsible for the overall investment
management of the Portfolio. As sub-adviser, BlackRock
Financial Management is responsible for the day-to-day
management of the Portfolio, and generally makes all
purchase and sale investment decisions for the Portfolio.
BlackRock Financial Management also provides research and
credit analysis.
THE AFFILIATE SUB-ADVISERS OF BLACKROCK, INC. ARE:
. BlackRock Financial Management, Inc.: Domestic and non-
dollar fixed income.
. PNC Equity Advisors: Growth equity.
. Provident Capital Management: Value equity.
. CastleInternational Asset Management: International
equity.
. PNC Institutional Management Corporation: Money market.
For their investment advisory and sub-advisory services,
BlackRock, Inc. and the Portfolio's sub-adviser are entitled
to fees, computed daily and payable monthly, at the maximum
annual rates set forth below. As stated under "What Are The
Expenses Of The Portfolio?", BlackRock, Inc. and the sub-ad-
viser intend to waive a portion of their fees during the
current fiscal year. All sub-advisory fees are paid by
BlackRock, Inc., and do not represent an extra charge to the
Portfolio.
16.
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MAXIMUM ANNUAL CONTRACTUAL FEE RATE (BEFORE WAIVERS)
<TABLE>
<CAPTION>
AVERAGE DAILY NET INVESTMENT SUB-ADVISORY
ASSETS ADVISORY FEE FEE
----------------- ------------ ------------
<S> <C> <C>
first $1 billion .550% .400%
$1 billion--$2 billion .500 .350
$2 billion--$3 billion .475 .325
greater than $3 billion .450 .300
</TABLE>
The Portfolio's sub-adviser strives to achieve best execution
on all transactions. Infrequently, brokerage transactions for
the Portfolio may be directed through registered broker/dealers
who have entered into dealer agreements with the Fund's dis-
tributor, subject to the requirements of best execution.
ADMINISTRATORS BlackRock, Inc., PFPC Inc. ("PFPC") and BlackRock Distributors,
Inc. ("BDI") (the "Administrators") serve as the Fund's co-ad-
ministrators. BlackRock, Inc. and PFPC are indirect wholly-
owned subsidiaries of PNC Bank Corp. BDI is a wholly-owned sub-
sidiary of Provident Distributors, Inc. ("PDI"). A majority of
the outstanding stock of PDI is owned by its officers.
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, BlackRock, Inc. is entitled to
receive a fee, computed daily and payable monthly, at an annual
rate of .03% of the Portfolio's average daily net assets. PFPC
and BDI are entitled to receive a combined administration fee,
computed daily and payable monthly, at the aggregate annual
rate of (i) .085% of the first $500 million of the Portfolio's
average daily net assets, .075% of the next $500 million of the
Portfolio's average daily net assets and .065% of the average
daily net assets of the Portfolio in excess of $1 billion and
(ii) .115% of the first $500 million of the average daily net
assets allocated to each class of Investor Shares of the Port-
folio, .105% of the next $500 million of such average daily net
assets and .095% of the average daily net assets allocated to
each class of Investor Shares of the Portfolio in excess of $1
billion. From time to time the Administrators may waive some or
all of their administration fees from the Portfolio.
For information about the operating expenses the Portfolio ex-
pects to incur in the current fiscal year, see "What Are the
Expenses of the Portfolio?"
TRANSFER PNC Bank, whose principal offices are located at 1600 Market
AGENT, Street, Philadelphia, Pennsylvania 19103, serves as the Portfo-
DIVIDEND lio's custodian and PFPC, whose principal offices are located
DISBURSING at 400 Bellevue Parkway, Wilmington, Delaware 19809, serves as
AGENT AND their transfer agent and dividend disbursing agent.
CUSTODIAN
DISTRIBUTION Under the Fund's Distribution and Service Plan (the "Plan"),
AND SERVICE Investor Shares of the Portfolios bear the expense of payments
PLAN ("distribution fees") made to BDI, as the Fund's distributor
(the "Distributor"), or affiliates of PNC Bank, for distribu-
tion and sales support services. The distribution fees may be
used to compensate the Distributor for distribution services
and to compensate the Distributor and PNC Bank affiliates for
sales support services provided in connection with the offering
and sale
17.
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of Investor Shares. The distribution fees may also be used to
reimburse the Distributor and PNC Bank affiliates for related
expenses, including payments to brokers, dealers, financial
institutions and industry professionals ("Service Organiza-
tions") for sales support services and related expenses. Dis-
tribution fees payable under the Plan will not exceed .10%
(annualized) of the average daily net asset value of each
Portfolio's outstanding Investor A Shares and .75%
(annualized) of the average daily net asset value of each
Portfolio's outstanding Investor B and Investor C Shares.
Payments under the Plan are not tied directly to out-of-
pocket expenses and therefore may be used by the recipients
as they choose (for example, to defray their overhead ex-
penses). The Plan also permits the Distributor, the
Administrators and other companies that receive fees from the
Fund to make payments relating to distribution and sales sup-
port activities out of their past profits or other sources
available to them. For further information, see "Investment
Advisory, Administration, Distribution and Servicing Arrange-
ments" in the Statement of Additional Information.
Under the Plan, the Fund intends to enter into service ar-
rangements with Service Organizations (including PNC Bank and
its affiliates) with respect to each class of Investor Shares
pursuant to which Service Organizations will render certain
support services to their customers who are the beneficial
owners of Investor Shares. In consideration for a shareholder
servicing fee of up to .25% (annualized) of the average daily
net asset value of Investor Shares owned by their customers,
Service Organizations may provide one or more of the follow-
ing services: responding to customer inquiries relating to
the services performed by the Service Organization and to
customer inquiries concerning their investments in Investor
Shares; assisting customers in designating and changing divi-
dend options, account designations and addresses; and provid-
ing other similar shareholder liaison services. In considera-
tion for a separate shareholder processing fee of up to .15%
(annualized) of the average daily net asset value of Investor
Shares owned by their customers, Service Organizations may
provide one or more of these additional services to such cus-
tomers: processing purchase and redemption requests from
customers and placing orders with the Fund's transfer agent
or the Distributor; processing dividend payments from the
Fund on behalf of customers; providing sub-accounting with
respect to Investor Shares beneficially owned by customers or
the information necessary for sub-accounting; and providing
other similar services.
Service Organizations may charge their clients additional
fees for account services. Customers who are beneficial own-
ers of Investor Shares should read this Prospectus in light
of the terms and fees governing their accounts with Service
Organizations.
The Glass-Steagall Act and other applicable laws, among other
things, prohibit banks from engaging in the business of un-
derwriting securities. It is intended that the services pro-
vided by Service Organizations under their service agreements
will not be prohibited under these laws. Under state securi-
ties laws, banks and financial institutions that receive pay-
ments from the Fund may be required to register as dealers.
EXPENSES Expenses are deducted from the total income of the Portfolio
before dividends and distributions are paid. Expenses in-
clude, but are not limited to, fees paid to BlackRock, Inc.
and the Administrators, transfer agency and custodian fees,
trustee fees, taxes, interest, professional fees, shareholder
servicing and processing fees, distribution fees, fees and
expenses in registering and qualifying the Portfolio and its
shares for distribution under Federal and state securities
laws, expenses of preparing pro-
18.
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spectuses and statements of additional information and of
printing and distributing prospectuses and statements of addi-
tional information to existing shareholders, expenses relating
to shareholder reports, shareholder meetings and proxy solici-
tations, insurance premiums, the expense of independent pricing
services, and other expenses which are not expressly assumed by
BlackRock, Inc. or the Fund's service providers under their
agreements with the Fund. Any general expenses of the Fund that
do not belong to a particular investment portfolio will be al-
located among all investment portfolios by or under the direc-
tion of the Board of Trustees in a manner the Board determines
to be fair and equitable.
19.
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WHAT PRICING OPTIONS ARE AVAILABLE TO INVESTORS?
- --------------------------------------------------------------------------------
The GNMA Portfolio of BlackRock Funds offer different pricing
options to investors in the form of different share classes.
These options are described below:
A SHARES (FRONT-END LOAD)
One time, front-end sales charge at time of purchase
No charges or fees at any time for redeeming shares
Lower ongoing expenses
Free exchanges with other A Shares in the BlackRock Funds
family
A Shares may make sense for investors with a long-term in-
vestment horizon who prefer to pay a one-time front-end sales
charge and have reduced ongoing fees.
B SHARES (BACK-END LOAD)
No front-end sales charge at time of purchase
Contingent deferred sales charge (CDSC) if shares are re-
deemed, declining over 6 years from a high of 4.50%
Free exchanges with other B Shares in the BlackRock Funds
family
Automatically convert to A Shares seven years from purchase
B Shares may make sense for investors who prefer to pay for
professional investment advice on an ongoing basis (asset-
based sales charge) rather than with a traditional, one-time
front-end sales charge.
C SHARES (LEVEL LOAD)
No front-end sales charge at time of purchase
Contingent deferred sales charge (CDSC) of 1.00% if shares
are redeemed within 12 months of purchase
Free exchanges with other C Shares in the BlackRock Funds
family
C Shares may make sense for shorter term (relative to both A
and B Shares) investors who prefer to pay for professional
investment advice on an ongoing basis (asset-based sales
charge) rather than with a traditional, one-time front-end
sales charge. Such investors may plan to make substantial
redemptions within 6 years of purchase.
THE PRICING OPTIONS FOR THE PORTFOLIO ARE DESCRIBED IN THE TABLE BELOW:
<TABLE>
<CAPTION>
A SHARES B SHARES C SHARES
<S> <C> <C> <C>
Maximum Front-End Sales
Charge 4.00% 0.00% 0.00%
12b-1 Fee 0.00%* 0.75% 0.75%
CDSC (Redemption Charge) 0.00% 4.50%-0.00% 1.00%
(Depends on when (If redeemed within
shares are redeemed) 12 months of purchase)
</TABLE>
*The Portfolio does not expect to incur 12b-1 fees in excess of .005% with re-
spect to Investor A Shares during the current fiscal year.
Investors wishing to purchase shares of the Portfolio may do so either by mail-
ing the investment application attached to this Prospectus along with a check
or by wiring money as specified below under "How Are Shares Purchased?"
20.
<PAGE>
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WHAT ARE THE KEY CONSIDERATIONS IN SELECTING A PRICING OPTION?
- --------------------------------------------------------------------------------
In deciding which class of Investor Shares to purchase, investors should con-
sider the following:
INTENDED HOLDING PERIOD. Over time, the cumulative distribution fees on the
Portfolio's Investor B Shares and Investor C Shares will exceed the expense of
the maximum initial sales charge on Investor A Shares. For example, if net as-
set value remains constant, the Investor B Shares' and Investor C Shares' ag-
gregate distribution fees would be equal to the Investor A Shares' initial max-
imum sales charge from four to seven years after purchase. Thereafter, Investor
B Shares and Investor C Shares would bear higher aggregate expenses. Investor B
and Investor C shareholders, however, enjoy the benefit of permitting all their
dollars to work from the time the investments are made. Any positive investment
return on the additional invested amount would partially or wholly offset the
higher annual expenses borne by Investor B Shares and Investor C Shares.
Because the Portfolio's future returns cannot be predicted, however, there can
be no assurance that such a positive return will be achieved.
At the end of seven years after the date of purchase, Investor B Shares will
convert automatically to Investor A Shares, based on the relative net asset
values of shares of each class. Investor B Shares acquired through reinvestment
of dividends or distributions are also converted at the earlier of these
dates--seven years after the reinvestment date or the date of conversion of the
most recently purchased Investor B Shares that were not acquired through rein-
vestment. Investor C Shares have no conversion feature.
Unless a sales charge waiver applies, Investor B shareholders pay a contingent
deferred sales charge if they redeem during the first six years after purchase,
and Investor C shareholders pay a contingent deferred sales charge if they re-
deem during the first twelve months after purchase. Investors expecting to re-
deem during these periods should consider the cost of the applicable contingent
deferred sales charge in addition to the aggregate annual Investor B or In-
vestor C distribution fees, as compared with the cost of the applicable initial
sales charges applicable to the Investor A Shares.
REDUCED SALES CHARGES. Because of reductions in the front-end sales charge for
purchases of Investor A Shares aggregating $25,000 or more, it may be advanta-
geous for investors purchasing large quantities of Investor Shares to purchase
Investor A Shares. In any event, the Fund will not accept any purchase order
for $1,000,000 or more of Investor B Shares or Investor C Shares.
WAIVER OF SALES CHARGES. The entire initial sales charge on Investor A Shares
of the Portfolio may be waived for certain eligible purchasers allowing their
entire purchase price to be immediately invested in the Portfolio. The contin-
gent deferred sales charge may be waived upon redemption of certain Investor B
Shares and Investor C Shares.
21.
<PAGE>
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HOW ARE SHARES PURCHASED?
- -------------------------------------------------------------------------------
GENERAL. Initial and subsequent purchase orders may be placed through securi-
ties brokers, dealers or financial institutions ("brokers"), or the transfer
agent. Generally, individual investors will purchase Investor Shares through a
broker who will then transmit the purchase order directly to the transfer
agent.
The minimum investment for the initial purchase of shares is $500; there is a
$50 minimum for subsequent investments. Purchases through the Automatic In-
vestment Plan described below are subject to a lower initial purchase minimum.
In addition, the minimum initial investment for employees of the Fund, the
Fund's investment adviser, sub-adviser, Distributor or transfer agent or em-
ployees of their affiliates is $100, unless payment is made through a payroll
deduction program in which case the minimum investment is $25.
When placing purchase orders, investors should specify whether the order is
for Investor A, Investor B or Investor C Shares of the Portfolio. All share
purchase orders that fail to specify a class will automatically be invested in
Investor A Shares.
PURCHASES THROUGH BROKERS. Shares of the Portfolio may be purchased through
brokers which have entered into dealer agreements with the Distributor. Pur-
chase orders received by a broker and transmitted to the transfer agent before
the close of regular trading on the New York Stock Exchange (currently 4:00
p.m. Eastern time) on a Business Day will be effected at the net asset value
determined that day, plus any applicable sales charge. Payment for an order
may be made by the broker in Federal funds or other funds immediately avail-
able to the Portfolio's custodian no later than 4:00 p.m. (Eastern time) on
the third Business Day following receipt of the purchase order.
It is the responsibility of brokers to transmit purchase orders and payment on
a timely basis. If payment is not received within the period described above,
the order will be canceled, notice thereof will be given, and the broker and
its customers will be responsible for any loss to the Fund or its sharehold-
ers. Orders of less than $500 may be mailed by a broker to the transfer agent.
PURCHASES THROUGH THE TRANSFER AGENT. Investors may also purchase Investor
Shares by completing and signing the Account Application Form and mailing it
to the transfer agent, together with a check in at least the minimum initial
purchase amount payable to BlackRock Funds. The Fund does not accept third
party checks for initial or subsequent investments. An Account Application
Form may be obtained by calling (800) 441-7762. The name of the Portfolio must
also appear on the check or Federal Reserve Draft. Investors may also wire
Federal funds in connection with the purchase of shares. The wire instructions
must include the name of the Portfolio, specify the class of Investor Shares,
and include the name of the account registration and the shareholder account
number. Before wiring any funds, an investor must call PFPC at (800) 441-7762
in order to confirm the wire instructions. Purchase orders which are received
by PFPC, together with payment, before the close of regular trading hours on
the New York Stock Exchange (currently 4:00 p.m. Eastern time) on any Business
Day (as defined below) are priced at the applicable net asset value next de-
termined on that day, plus any applicable sales charge.
OTHER PURCHASE INFORMATION. Shares of the Portfolio are sold on a continuous
basis by BDI as the Distributor. BDI maintains its principal offices at Four
Falls Corporate Center, 6th Floor, West Conshohocken, PA 19428-2961. Purchases
may be effected on weekdays on which both the New York Stock Exchange and the
Federal Reserve Bank of Philadelphia are open for business (a "Business Day").
Payment for orders which are not received or accepted will be returned after
prompt inquiry. The issuance of shares is recorded on the books of the Fund.
No certificates will be issued for shares. Payments for shares of the Portfo-
lio may, in the discretion of the Fund's investment adviser, be made in the
form of securities that are permissible investments for the Portfolio. The
Fund reserves the right to reject any purchase order, to modify or waive the
minimum initial or subsequent investment requirement and to suspend and resume
the sale of any share class of the Portfolio at any time.
22.
<PAGE>
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HOW ARE SHARES REDEEMED?
- --------------------------------------------------------------------------------
REDEMPTION. Shareholders may redeem their shares for cash at any time. A writ-
ten redemption request in proper form must be sent directly to BlackRock Funds
c/o PFPC, P.O. Box 8907, Wilmington, Delaware 19899-8907. Except for the con-
tingent deferred sales charge, if applicable, there is no charge for a redemp-
tion. Shareholders may also place redemption requests through a broker or other
institution, which may charge a fee for this service.
WHEN REDEEMING INVESTOR SHARES, SHAREHOLDERS SHOULD INDICATE WHETHER THEY ARE
REDEEMING INVESTOR A SHARES, INVESTOR B SHARES OR INVESTOR C SHARES. If a re-
deeming shareholder owns both Investor A Shares and Investor B or Investor C
Shares, the Investor A Shares will be redeemed first unless the shareholder in-
dicates otherwise. If a redeeming shareholder owns both Investor B Shares and
Investor C Shares, the redemption order will be processed to minimize the
amount of the contingent deferred sales charge that will be charged unless the
shareholder indicates otherwise.
Except as noted below, a request for redemption must be signed by all persons
in whose names the shares are registered. Signatures must conform exactly to
the account registration. If the proceeds of the redemption would exceed
$25,000, or if the proceeds are not to be paid to the record owner at the rec-
ord address, or if the shareholder is a corporation, partnership, trust or fi-
duciary, signature(s) must be guaranteed by any eligible guarantor institution.
Eligible guarantor institutions generally include banks, broker/dealers, credit
unions, national securities exchanges, registered securities associations,
clearing agencies and savings associations.
Generally, a properly signed written request with any required signature guar-
antee is all that is required for a redemption. In some cases, however, other
documents may be necessary. Shareholders holding Investor A Share certificates
must send their certificates with the redemption request. Additional documen-
tary evidence of authority is required by PFPC in the event redemption is re-
quested by a corporation, partnership, trust, fiduciary, executor or adminis-
trator.
EXPEDITED REDEMPTIONS. If a shareholder has given authorization for expedited
redemption, shares can be redeemed by telephone and the proceeds sent by check
to the shareholder or by Federal wire transfer to a single previously desig-
nated bank account. Once authorization is on file, PFPC will honor requests by
any person by telephone at (800) 441-7762 or other means. The minimum amount
that may be sent by check is $500, while the minimum amount that may be wired
is $10,000. The Fund reserves the right to change these minimums or to termi-
nate these redemption privileges. If the proceeds of a redemption would exceed
$25,000, the redemption request must be in writing and will be subject to the
signature guarantee requirement described above. This privilege may not be used
to redeem Investor A Shares in certificated form. 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 Fund is not responsible for the efficiency of the Federal wire system or
the shareholder's firm or bank. The Fund does not currently charge for wire
transfers. The shareholder is responsible for any charges imposed by the share-
holder's bank. To change the name of the single designated bank account to re-
ceive wire redemption proceeds, it is necessary to send a written request (with
a guaranteed signature as described above) to BlackRock Funds c/o PFPC, P.O.
Box 8907, Wilmington, Delaware 19899-8907.
The Fund reserves the right to refuse a telephone redemption if it believes it
advisable to do so. The Fund, the Administrators and the Distributor will em-
ploy reasonable procedures to confirm that instructions communicated by tele-
phone are genuine. The Fund, the Administrators and the Distributor will not be
liable for any loss, liability, cost or expense for acting upon telephone in-
structions reasonably believed to be genuine in accordance with such proce-
dures.
23.
<PAGE>
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ACCOUNTS WITH LOW BALANCES. The Fund reserves the right to redeem a sharehold-
er's account in the Portfolio at any time the net asset value of the account
falls below the required minimum initial investment as the result of a redemp-
tion or an exchange request. A shareholder will be notified in writing that
the value of the shareholder's account is less than the required amount and
will be allowed 30 days to make additional investments before the redemption
is processed.
PAYMENT OF REDEMPTION PROCEEDS. The redemption price for shares is their net
asset value per share next determined after the request for redemption is re-
ceived in proper form by BlackRock Funds c/o PFPC, P.O. Box 8907, Wilmington,
Delaware 19899-8907. Proceeds from the redemption of shares will be reduced by
the amount of any applicable contingent deferred sales charge. Unless another
payment option is used as described above, payment for redeemed shares is nor-
mally made by check mailed within seven days after acceptance by PFPC of the
request and any other necessary documents in proper order. Payment may, howev-
er, be postponed or the right of redemption suspended as provided by the rules
of the SEC. If the shares to be redeemed have been recently purchased by
check, the Fund's transfer agent may delay the payment of redemption proceeds,
which may be a period of up to 15 days after the purchase date, pending a de-
termination that the check has cleared.
The Fund may also suspend the right of redemption or postpone the date of pay-
ment 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 Fund's responsi-
bilities under the 1940 Act. See "Purchase and Redemption Information" in the
Statement of Additional Information for examples of when such redemption might
be appropriate.
24.
<PAGE>
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WHAT ARE THE SHAREHOLDER FEATURES OF THE FUND?
- --------------------------------------------------------------------------------
BlackRock Funds offers shareholders many special features which enable an in-
vestor to have greater investment flexibility as well as greater access to in-
formation about the Fund throughout the investment period.
Additional information on each of these features is available from PFPC by
calling (800) 441-7762.
EXCHANGE PRIVILEGE. Investor A, Investor B and Investor C Shares may be ex-
changed for shares of the same class of other portfolios of the Fund which of-
fer that class of shares, based on their respective net asset values. Exchanges
of Investor A Shares may be subject to the difference between the sales charge
previously paid on the exchanged shares and the higher sales charge (if any)
payable with respect to the shares acquired in the exchange.
Investor A Shares of money market portfolios of the Fund that were (1) acquired
through the use of the exchange privilege and (2) can be traced back to a pur-
chase of shares in one or more investment portfolios of the Fund for which a
sales charge was paid, can be exchanged for Investor A Shares of a portfolio
subject to differential sales charges as applicable.
The exchange of Investor B and Investor C Shares will not be subject to a CDSC,
which will continue to be measured from the date of the original purchase and
will not be affected by exchanges.
A shareholder wishing to make an exchange may do so by sending a written re-
quest to PFPC at the address given above. Shareholders are automatically pro-
vided with telephone exchange privileges when opening an account, unless they
indicate on the Application that they do not wish to use this privilege. Share-
holders holding share certificates are not eligible to exchange Investor A
Shares by phone because share certificates must accompany all exchange re-
quests. To add this feature to an existing account that previously did not pro-
vide for this option, a Telephone Exchange Authorization Form must be filed
with PFPC. This form is available from PFPC. Once this election has been made,
the shareholder may simply contact PFPC by telephone at (800) 441-7762 to re-
quest the exchange. During periods of substantial economic or market change,
telephone exchanges may be difficult to complete and shareholders may have to
submit exchange requests to PFPC in writing.
If the exchanging shareholder does not currently own shares of the investment
portfolio whose shares are being acquired, a new account will be established
with the same registration, dividend and capital gain options and broker of
record as the account from which shares are exchanged, unless otherwise speci-
fied in writing by the shareholder with all signatures guaranteed by an eligi-
ble guarantor institution as defined above. In order to participate in the Au-
tomatic Investment Program or establish a Systematic Withdrawal Plan for the
new account, however, an exchanging shareholder must file a specific written
request.
Any share exchange must satisfy the requirements relating to the minimum ini-
tial investment requirement, and must be legally available for sale in the
state of the investor's residence. For Federal income tax purposes, a share ex-
change is a taxable event and, accordingly, a capital gain or loss may be real-
ized. Before making an exchange request, shareholders should consult a tax or
other financial adviser and should consider the investment objective, policies
and restrictions of the investment portfolio into which the shareholder is mak-
ing an exchange, as set forth in the applicable Prospectus. Brokers may charge
a fee for handling exchanges.
The Fund reserves the right to modify or terminate the exchange privilege at
any time. Notice will be given to shareholders of any material modification or
termination except where notice is not required.
25.
<PAGE>
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The Fund reserves the right to reject any telephone exchange request. Tele-
phone exchanges may be subject to limitations as to amount or frequency, and
to other restrictions that may be established from time to time to ensure that
exchanges do not operate to the disadvantage of any portfolio or its share-
holders. The Fund, the Administrators and the Distributor will employ reason-
able procedures to confirm that instructions communicated by telephone are
genuine. The Fund, the Administrators and the Distributor will not be liable
for any loss, liability, cost or expense for acting upon telephone instruc-
tions reasonably believed to be genuine in accordance with such procedures.
Exchange orders may also be sent by mail to the shareholder's broker or to
PFPC at P.O. Box 8907, Wilmington, Delaware 19899-8907.
AUTOMATIC INVESTMENT PLAN ("AIP"). An investor in shares of the Portfolio may
arrange for periodic investments through automatic deductions from a checking
or savings account by completing the AIP Application Form which may be ob-
tained from PFPC. The minimum pre-authorized investment amount is $50.
RETIREMENT PLANS. Portfolio shares may be purchased in conjunction with indi-
vidual retirement accounts ("IRAs") and rollover IRAs where PNC Bank or any of
its affiliates acts as custodian. For further information as to applications
and annual fees, contact the Distributor. To determine whether the benefits of
an IRA are available and/or appropriate, a shareholder should consult with a
tax adviser.
SYSTEMATIC WITHDRAWAL PLAN ("SWP"). The Fund offers a Systematic Withdrawal
Plan which may be used by investors who wish to receive regular distributions
from their accounts. Upon commencement of the SWP, the account must have a
current value of $10,000 or more in a Portfolio. Shareholders may elect to re-
ceive automatic cash payments of $50 or more either monthly, every other
month, quarterly, three times a year, semi-annually, or annually. Automatic
withdrawals are normally processed on the 25th day of the applicable month or,
if such day is not a Business Day, on the next Business Day and are paid
promptly thereafter. An investor may utilize the SWP by completing the SWP Ap-
plication Form which may be obtained from PFPC.
Shareholders should realize that if withdrawals exceed income dividends their
invested principal in the account will be depleted. To participate in the SWP,
shareholders must have their dividends automatically reinvested and may not
hold share certificates. Shareholders may change or cancel the SWP at any
time, upon written notice to PFPC. Purchases of additional Investor A Shares
of the Fund concurrently with withdrawals may be disadvantageous to investors
because of the sales charges involved and, therefore, are discouraged. No con-
tingent deferred sales charge will be assessed on redemptions of Investor B or
Investor C Shares made through the SWP that do not exceed 12% of an account's
net asset value on an annualized basis. For example, monthly, quarterly and
semi-annual SWP redemptions of Investor B or Investor C Shares will not be
subject to the CDSC if they do not exceed 1%, 3% and 6%, respectively, of an
account's net asset value on the redemption date. SWP redemptions of Investor
B or Investor C Shares in excess of this limit are still subject to the appli-
cable CDSC.
26.
<PAGE>
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WHAT IS THE SCHEDULE OF SALES CHARGES AND EXEMPTIONS?
- --------------------------------------------------------------------------------
INVESTOR A Investor A Shares are subject to a front-end sales charge de-
SHARES termined in accordance with the following schedule:
<TABLE>
<CAPTION>
REALLOWANCE OR
SALES CHARGE AS SALES CHARGE AS PLACEMENT FEES
AMOUNT OF TRANSACTION % OF % OF TO DEALERS (AS % OF
AT OFFERING PRICE OFFERING PRICE* NET ASSET VALUE* OFFERING PRICE)**
<S> <C> <C> <C>
Less than $25,000 4.00% 4.17% 3.50%
$25,000 but less than
$50,000 3.75 3.90 3.25
$50,000 but less than
$100,000 3.50 3.63 3.00
$100,000 but less than
$250,000 3.00 3.09 2.50
$250,000 but less than
$500,000 2.00 2.04 1.50
$500,000 but less than
$1,000,000 1.00 1.01 0.75
$1-2 million 0.00 0.00 0.75
$2-3 million 0.00 0.00 0.72
$3-5 million 0.00 0.00 0.63
$5-10 million 0.00 0.00 0.44
$10-15 million 0.00 0.00 0.38
$15-20 million 0.00 0.00 0.35
$20-40 million 0.00 0.00 0.30
</TABLE>
*There is no initial sales charge on purchase of $1,000,000 or more of Investor
A Shares; however, a contingent deferred sales charge of 1.00% will be imposed
on the lesser of the offering price or the net asset value of the shares on the
redemption date for shares redeemed within 18 months after purchase.
**The Distributor may pay placement fees to dealers as shown on purchases of
Investor A Shares of $1,000,000 or more.
During special promotions, the entire sales charge may be reallowed to dealers.
Dealers who receive 90% or more of the sales charge may be deemed to be "under-
writers" under the 1933 Act. The amount of the sales charge not reallowed to
dealers may be paid to broker-dealer affiliates of PNC Bank Corp. who provide
sales support services. The Distributor, BlackRock, Inc. and/or their affili-
ates may also pay additional compensation, out of their assets and not as an
additional charge to the Portfolio, to dealers in connection with the sale and
distribution of shares (such as additional payments based on new sales), and
may, subject to applicable NASD regulations, contribute to various non-cash and
cash incentive arrangements to promote the sale of shares, as well as sponsor
various educational programs, sales contests and promotions in which partici-
pants 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.
SALES CHARGE WAIVERS--INVESTOR A SHARES. The following persons associated with
the Fund, the Distributor, the Fund's investment adviser, sub-adviser or trans-
fer agent and their affiliates may buy Investor A Shares without paying a sales
charge to the extent permitted by these firms: (a) officers, directors and
partners (and their spouses and minor children); (b) employees and retirees
(and their spouses and minor children); (c) registered representatives of bro-
kers who have entered into selling agreements with the Distributor; (d) spouses
or children of such persons; and (e) any trust, pension, profit-sharing or
other benefit plan for any of the persons set forth in (a) through (c). The
following persons may also buy Investor A Shares without paying a sales charge:
(a) persons investing through an authorized payroll deduction plan; (b) persons
investing through an authorized investment plan for organizations which operate
under Section 501(c)(3) of the Internal Revenue Code; (c) registered investment
advisers, trust companies and bank trust departments exercising discretionary
investment authority with respect to amounts to be invested in the Port-
27.
<PAGE>
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folio, provided that the aggregate amount invested pursuant to this exemption
in Investor A Shares that would otherwise be subject to front- end sales
charges equals at least $250,000; and (d) persons participating in a "wrap ac-
count" or similar program under which they pay advisory fees to a broker-
dealer or other financial institution. INVESTORS WHO QUALIFY FOR ANY OF THESE
EXEMPTIONS FROM THE SALES CHARGE MUST PURCHASE INVESTOR A SHARES.
QUALIFIED PLANS. In general, the sales charge (as a percentage of offering
price) payable by qualified employee benefit plans ("Qualified Plans") having
at least 20 employees eligible to participate in purchases of Investor A
Shares of the Portfolio aggregating less than $500,000 will be 1.00%. No sales
charge will apply to purchases by such Qualified Plans of Investor A Shares
aggregating $500,000 and above. The sales charge payable by Qualified Plans
having less than 20 employees eligible to participate in purchases of Investor
A Shares aggregating less than $500,000 will be 2.50%. The above schedule will
apply to purchases by such Qualified Plans of Investor A Shares aggregating
$500,000 and above.
The Fund has established different waiver arrangements with respect to the
sales charge on Investor A Shares of the Portfolio for purchases through cer-
tain Qualified Plans participating in programs whose sponsors or administra-
tors have entered into arrangements with the Fund. For further information,
see "Purchase and Redemption Information" in the Statement of Additional
Information.
QUANTITY DISCOUNTS. As shown above, larger purchases may reduce the sales
charge price. Upon notice to the investor's broker or the transfer agent, pur-
chases of Investor A Shares made at any one time by the following persons may
be considered when calculating the sales charge: (a) an individual, his or her
spouse, and their children under the age of 21; (b) a trustee or fiduciary of
a single trust estate or single fiduciary account; or (c) any organized group
which has been in existence for more than six months, if it is not organized
for the purpose of buying redeemable securities of a registered investment
company, and if the purchase is made through a central administrator, or
through a single dealer, or by other means which result in economy of sales
effort or expense. An organized group does not include a group of individuals
whose sole organizational connection is participation as credit card holders
of a company, policyholders of an insurance company, customers of either a
bank or broker/dealer or clients of an investment adviser. Purchases made by
an organized group may include, for example, a trustee or other fiduciary pur-
chasing for a single fiduciary account or other employee benefit plan pur-
chases made through a payroll deduction plan.
REDUCED SALES CHARGES--INVESTOR A SHARES
RIGHT OF ACCUMULATION. Under the Right of Accumulation, the current value of
an investor's existing Investor A Shares in the Portfolio that are subject to
a front-end sales charge or the total amount of an investor's initial invest-
ment in such shares, less redemptions (whichever is greater) may be combined
with the amount of the investor's current purchase in determining the applica-
ble sales charge. IN ORDER TO RECEIVE THE CUMULATIVE QUANTITY REDUCTION, PRE-
VIOUS PURCHASES OF INVESTOR A SHARES MUST BE CALLED TO THE ATTENTION OF PFPC
BY THE INVESTOR AT THE TIME OF THE CURRENT PURCHASE.
REINVESTMENT PRIVILEGE. Upon redemption of Investor A Shares of the Portfolio
(or Investor A Shares of another non-money market portfolio of the Fund), a
shareholder has a one-time right, to be exercised within 60 days, to reinvest
the redemption proceeds without any sales charges. PFPC must be notified of
the reinvestment in writing by the purchaser, or by his or her broker, at the
time the purchase is made in order to eliminate a sales charge. An investor
should consult a tax adviser concerning the tax consequences of use of the re-
investment privilege.
LETTER OF INTENT. An investor may qualify for a reduced sales charge immedi-
ately by signing a Letter of Intent stating the investor's intention to invest
during the next 13 months a specified amount in Investor A Shares which, if
made at one time, would qualify for a reduced sales charge. The Letter of In-
tent may be signed at any time within 90 days after the first investment to be
included in the Letter of Intent. The initial investment must meet the minimum
initial investment requirement and represent at least 5% of the total intended
investment. THE INVESTOR MUST INSTRUCT PFPC UPON MAKING SUBSEQUENT PURCHASES
THAT SUCH PURCHASES ARE SUBJECT TO A LETTER OF INTENT. All dividends and capi-
tal gains of the Portfolio that are invested in additional Investor A Shares
of the Portfolio are applied to the Letter of Intent.
28.
<PAGE>
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During the term of a Letter of Intent, the Fund's transfer agent will hold In-
vestor A Shares representing 5% of the indicated amount in escrow for payment
of a higher sales load if the full amount indicated in the Letter of Intent is
not purchased. The escrowed Investor A Shares will be released when the full
amount indicated has been purchased. Any redemptions made during the 13-month
period will be subtracted from the amount of purchases in determining whether
the Letter of Intent has been completed.
If the full amount indicated is not purchased within the 13-month period, the
investor will be required to pay an amount equal to the difference between the
sales charge actually paid and the sales charge the investor would have had to
pay on his or her aggregate purchases if the total of such purchases had been
made at a single time. If remittance is not received within 20 days of the ex-
piration of the 13-month period, PFPC, as attorney-in-fact, pursuant to the
terms of the Letter of Intent, will redeem an appropriate number of Investor A
Shares held in escrow to realize the difference.
PURCHASES OF INVESTOR B SHARES. Investor B Shares are subject to a deferred
sales charge at the rates set forth in the chart below if they are redeemed
within six years of purchase. The deferred sales charge on Investor B Shares is
based on the lesser of the offering price or the net asset value of the In-
vestor B Shares on the redemption date. Dealers will generally receive commis-
sions equal to 4.00% of the Investor B Shares sold by them plus ongoing fees
under the Fund's Distribution and Service Plan and described under "Who Manages
The Fund?" Dealers may not receive a commission in connection with sales of In-
vestor B Shares to certain retirement plans sponsored by the Fund, BlackRock,
Inc. or its affiliates, but may receive fees under the Distribution and Service
Plan. These commissions and payments may be different than the reallowances,
placement fees and commissions paid to dealers in connection with sales of In-
vestor A Shares and Investor C Shares. See "What Is The Schedule Of Sales
Charges And Exemptions--Investor A Shares" for information on additional sales
incentives which the Distributor, BlackRock, Inc. and/or their affiliates may
provide to dealers in connection with the sale of shares.
The amount of any contingent deferred sales charge an investor must pay on In-
vestor B Shares depends on the number of years that elapse between the purchase
date and the date the Investor B Shares are redeemed as set forth in the fol-
lowing chart:
<TABLE>
<CAPTION>
CONTINGENT DEFERRED
SALES CHARGE (AS A
NUMBER OF YEARS PERCENTAGE OF DOLLAR AMOUNT
ELAPSED SINCE PURCHASE SUBJECT TO THE CHARGE)
<S> <C>
Less than one 4.50%
More than one, but less than two 4.00
More than two, but less than three 3.50
More than three, but less than four 3.00
More than four, but less than five 2.00
More than five, but less than six 1.00
More than six, but less than seven 0.00
</TABLE>
PURCHASES OF INVESTOR C SHARES. Investor C Shares are subject to a deferred
sales charge of 1.00% based on the lesser of the offering price or the net as-
set value of the Investor C Shares on the redemption date if redeemed within
twelve months after purchase. Dealers will generally receive commissions equal
to 1.00% of the Investor C Shares sold by them plus ongoing fees under the
Fund's Distribution and Service Plan as described above under "Who Manages the
Fund?" Dealers may not receive a commission in connection with sales of In-
vestor C Shares to certain retirement plans sponsored by the Fund, BlackRock,
Inc. or its affiliates, but may receive fees under the Distribution and Service
Plan. These commissions and payments may be different than the reallowances,
placement fees and commissions paid to dealers in connection with sales of In-
vestor A Shares and Investor B Shares. See "What Is The Schedule Of Sales
Charges And Exemptions--Investor A Shares" for information on additional sales
incentives which the Distributor, BlackRock, Inc. and/or their affiliates may
provide to dealers in connection with the sale of shares.
29.
<PAGE>
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EXEMPTIONS FROM THE CONTINGENT DEFERRED SALES CHARGE. The contingent deferred
sales charge on Investor B Shares and Investor C Shares is not charged in con-
nection with: (1) exchanges described in "What Are the Shareholder Features of
the Fund?--Exchange Privilege"; (2) redemptions made in connection with minimum
required distributions from IRA, 403(b)(7) and Qualified Plan accounts due to
the shareholder reaching age 70 1/2; (3) redemptions made with respect to cer-
tain retirement plans sponsored by the Fund, BlackRock, Inc. or its affiliates;
(4) redemptions in connection with a shareholder's death or disability (as de-
fined in the Internal Revenue Code) subsequent to the purchase of Investor B or
Investor C Shares; (5) involuntary redemptions of Investor B or Investor C
Shares in accounts with low balances as described in "How Are Shares Re-
deemed?"; and (6) redemptions made pursuant to the Systematic Withdrawal Plan,
subject to the limitations set forth above under "What Are the Shareholder Fea-
tures of the Fund?--Systematic Withdrawal Plan." In addition, no contingent de-
ferred sales charge is charged on Investor B or Investor C Shares acquired
through the reinvestment of dividends or distributions. The Fund also waives
the contingent deferred sales charge on redemptions of Investor B Shares of the
Portfolio purchased through certain Qualified Plans participating in programs
whose sponsors or administrators have entered into arrangements with the Fund.
For further information, see "Purchase and Redemption Information" in the
Statement of Additional Information.
When an investor redeems Investor B or Investor C Shares, the redemption order
is processed to minimize the amount of the contingent deferred sales charge
that will be charged. Investor B and Investor C Shares are redeemed first from
those shares that are not subject to the deferred sales load (i.e., shares that
were acquired through reinvestment of dividends or distributions) and after
that from the shares that have been held the longest.
30.
<PAGE>
- --------------------------------------------------------------------------------
HOW IS NET ASSET VALUE CALCULATED?
- --------------------------------------------------------------------------------
Net asset value is calculated separately for each class of Investor Shares of
the Portfolio as of the close of regular trading hours on the NYSE (currently
4:00 p.m. Eastern Time) on each Business Day by dividing the value of all secu-
rities and other assets owned by the Portfolio that are allocated to a particu-
lar class of shares, less the liabilities charged to that class, by the number
of shares of the class that are outstanding.
Most securities held by the Portfolio are priced based on their market value as
determined by reported sales prices, or the mean between bid and asked prices,
that are provided by securities dealers or pricing services. Portfolio securi-
ties which are primarily traded on foreign securities exchanges are normally
valued at the preceding closing values of such securities on their respective
exchanges. Securities for which market quotations are not readily available are
valued at fair market value as determined in good faith by or under the direc-
tion 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 Portfolio's sub-adviser under the supervision of the Board
of Trustees determines such method does not represent fair value.
HOW FREQUENTLY ARE DIVIDENDS AND DISTRIBUTIONS MADE TO INVESTORS?
- --------------------------------------------------------------------------------
The Portfolio will distribute substantially all of its net investment income
and net realized capital gains, if any, to shareholders. All distributions are
reinvested at net asset value in the form of additional full and fractional
shares of the same class of shares of the Portfolio unless a shareholder 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 Portfolio declares a dividend each day on "settled" shares
(i.e., shares for which the Portfolio has received payment in Federal funds) on
the first Business Day after a purchase order is placed with the Fund. Payments
by check are normally converted to Federal funds within two Business Days of
receipt. Over the course of a year, substantially all of the Portfolio's net
investment income will be declared as dividends. The amount of the daily
dividend for the Portfolio will be based on periodic projections of its net
investment income. All dividends are paid within ten days after the end of each
month. Net realized capital gains (including net short-term capital gains), if
any, will be distributed by the Portfolio at least annually.
31.
<PAGE>
- --------------------------------------------------------------------------------
HOW ARE FUND DISTRIBUTIONS TAXED?
- --------------------------------------------------------------------------------
Each Portfolio intends to qualify as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). If
the Portfolio qualifies, 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 distributions (except distributions
that are "exempt interest dividends" or are treated as a return of capital),
whether the distributions are paid in cash or reinvested in additional shares.
Distributions paid out of the Portfolio's "net capital gain" (the excess of 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 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 the Portfolio. Dividends declared in October,
November or December of any year payable to shareholders of record on a speci-
fied date in those months will be deemed to have been received by the share-
holders on December 31 of such year, if the dividends are paid during the fol-
lowing January.
An investor considering buying shares on or just before a dividend record date
should be aware that the amount of the forthcoming dividend payment, although
in effect a return of capital, will be taxable.
A taxable gain or loss may be realized by a shareholder upon the redemption,
transfer or exchange of shares depending upon their tax basis and their price
at the time of redemption, transfer or exchange. Generally, shareholders may
include sales charges paid on the purchase of shares in their tax basis for the
purposes of determining gain or loss on a redemption, transfer or exchange of
such shares. However, if a shareholder exchanges the shares for shares of an-
other portfolio within 90 days of purchase and is able to reduce the sales
charges applicable to the new shares (by virtue of the Fund's exchange privi-
lege), the amount equal to such reduction may not be included in the tax basis
of the shareholder's exchanged shares for the purpose of determining gain or
loss but may be included (subject to the same limitation) in the tax basis of
the new shares.
Any loss upon the sale or exchange of shares held for six months or less will
be disallowed for Federal income tax purposes to the extent of any exempt in-
terest dividends received by the shareholder.
The Portfolio may make investments that produce income that is not matched by a
corresponding cash distribution to the Portfolio, such as investments in pay-
in-kind bonds or in obligations such as zero coupon securities having original
issue discount (i.e., an amount equal to the excess of the stated redemption
price of the security at maturity over its issue price), or market discount
(i.e., an amount equal to the excess of the stated redemption price of the se-
curity over the basis of such bond immediately after it was acquired) if the
Portfolio elects to accrue market discount on a current basis. In addition, in-
come may continue to accrue for federal income tax purposes with respect to a
non-performing investment. Any such income would be treated as income earned by
the Portfolio and therefore would be subject to the distribution requirements
of the Code. Because such income may not be matched by a corresponding cash
distribution to the Portfolio, the Portfolio may be required to borrow money or
dispose of other securities to be able to make distributions to its investors.
In addition, if an election is not made to currently accrue market discount
with respect to a market discount bond, all or a portion of any deduction or
any interest expenses incurred to purchase or hold such bond may be deferred
until such bond is sold or otherwise disposed.
This is not an exhaustive discussion of applicable tax consequences, and in-
vestors may wish to contact their tax advisers concerning investments in the
Portfolio. Except as discussed below, dividends paid by the Portfolio may be
taxable to investors under state or local law as dividend income even though
all or a portion
32.
<PAGE>
- --------------------------------------------------------------------------------
of the dividends may be derived from interest on obligations which, if realized
directly, would be exempt from such income taxes. In addition, shareholders who
are non-resident alien individuals, foreign trusts or estates, foreign corpora-
tions or foreign partnerships may be subject to different Federal income tax
treatment. Future legislative or administrative changes or court decisions may
materially affect the tax consequences of investing in the Portfolio. For addi-
tional information concerning the tax treatment of dividends and distributions
by the states listed below, including certain restrictions applicable to such
treatment, see "Taxes" in the Statement of Additional Information.
33.
<PAGE>
- --------------------------------------------------------------------------------
HOW IS THE FUND ORGANIZED?
- --------------------------------------------------------------------------------
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. 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 thirty-eight investment portfolios. The Portfolio offers
five separate classes of shares--Institutional Shares, Service Shares, Investor
A Shares, Investor B Shares and Investor C Shares. This prospectus relates only
to Investor A Shares, Investor B Shares and Investor C Shares of the Portfolio
described herein.
Shares of each class bear their pro rata portion of all operating expenses paid
by the Portfolio, except transfer agency fees, certain administrative/servicing
fees and amounts payable under the Fund's Distribution and Service Plan. In ad-
dition, each class of Investor Shares is sold with different sales charges. Be-
cause of these "class expenses" and sales charges, the performance of the Port-
folio's Institutional Shares is expected to be higher than the performance of
the Portfolio's Service Shares, and the performance of each of the Institu-
tional Shares and Service Shares of the Portfolio is expected to be higher than
the performance of the Portfolio's classes of Investor Shares. The performance
of each class of Investor Shares may be different. The Fund offers various
services and privileges in connection with its Investor Shares that are not
generally offered in connection with its Institutional and Service Shares, in-
cluding an automatic investment plan and an automatic withdrawal plan. For fur-
ther information regarding the Fund's Institutional or Service Share classes,
contact PFPC at (800) 441-7764.
Each share of the Portfolio has a par value of $.001, represents an interest in
the Portfolio and is entitled to the dividends and distributions earned on the
Portfolio's assets that are declared in the discretion of the Board of Trust-
ees. 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 re-
quired 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 February 4, 1998, PNC Bank held of record approximately 78% of the Fund's
outstanding shares, as trustee on behalf of individual and institutional in-
vestors, 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.
34.
<PAGE>
- --------------------------------------------------------------------------------
HOW IS PERFORMANCE CALCULATED?
- --------------------------------------------------------------------------------
Performance information for each class of Investor Shares of the Portfolio 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 Investor 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 dividend
and capital gain distributions made by the Portfolio with respect to a class of
shares are reinvested in shares of the same class, and also reflect the maximum
sales load charged by the Portfolio with respect to a class of shares. When,
however, the Portfolio compares the total return of a share class to that of
other funds or relevant indices, total return may also be computed without re-
flecting the sales load.
The yield of a class of shares is computed by dividing the Portfolio's net in-
come per share allocated to that class during a 30-day (or one month) period by
the maximum offering price per share on the last day of the period and
annualizing the result on a semi-annual basis.
The performance of a class of the Portfolio's Investor Shares may be compared
to the performance of other mutual funds with similar investment objectives and
to relevant indices, as well as to ratings or rankings prepared by independent
services or other financial or industry publications that monitor the perfor-
mance of mutual funds. For example, the performance of a class of the Portfo-
lio's Investor Shares 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 Lehman GNMA Index, the T-Bill
Index, the "stocks, bonds and inflation index" published annually by Ibbotson
Associates and the Lehman Government Corporate Bond Index, as well any other
benchmarks attached to this Prospectus. Performance information may also in-
clude evaluations of the Portfolio and its share classes published by nation-
ally recognized ranking services, and information as reported in financial pub-
lications such as Business Week, Fortune, Institutional Investor, Money Maga-
zine, 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 return of a class of shares of the Portfolio, the Portfolio may pro-
vide other information demonstrating hypothetical investment returns. This in-
formation may include, but is not limited to, illustrating the compounding ef-
fects of dividends in a dividend reinvestment plan or the impact of tax-de-
ferred investing.
Performance quotations for shares of the Portfolio represent past performance
and should not be considered representative of future results.
The investment return and principal value of an investment in the Portfolio
will fluctuate so that an investor's Investor Shares, when redeemed, may be
worth more or less than their original cost. Since performance will fluctuate,
performance data for Investor Shares of the Portfolio cannot necessarily be
used to compare an investment in such shares with bank deposits, savings ac-
counts and similar investment alternatives which often provide an agreed or
guaranteed fixed yield for a stated period of time. Performance is generally a
function of the kind and quality of the instruments held in a portfolio, port-
folio maturity, operating expenses and market conditions. Any fees charged by
brokers or other institutions directly to their customer accounts in connection
with investments in Investor Shares will not be included in the Portfolio per-
formance calculations.
35.
<PAGE>
- --------------------------------------------------------------------------------
HOW CAN I GET MORE INFORMATION?
- --------------------------------------------------------------------------------
Below is a brief description of how investors can easily access information
about the BlackRock Funds.
<TABLE>
<CAPTION>
FUND INFORMATION HOURS AVAILABLE PHONE INFORMATION
<S> <C> <C>
INTERNAL 9 AM to 6 PM, E.S.T. toll-free 888-8BLACKROCK
WHOLESALERS/BROKER-DEALER Monday through Friday toll-free 888-825-2257
SUPPORT:
PORTFOLIO MANAGERS 24 Hours, 7 days a week toll-free 800-FUTURE4
COMMENTARY: toll-free 800-388-8734
(Audio recording updated
periodically)
SHAREHOLDER SERVICES
TELEPHONE ACCESS: 24 Hours, 7 days a week toll-free 800-441-7762
ACCOUNT SERVICE 8:30 to 5 PM, E.S.T. toll-free 800-441-7762
REPRESENTATIVES: Monday through Friday
Available to discuss
account balance
information, mutual fund
prospectus, literature and
discuss programs and
services available.
PURCHASES AND REDEMPTIONS: 8:30 to 5 PM, E.S.T. toll-free 800-441-7762
Monday through Friday
WORLD WIDE WEB:
Access general fund 24 Hours, 7 days a week http://www.blackrock.com
information and specific
fund performance. Request
mutual fund prospectuses
and literature. Forward
mutual fund inquiries.
E-MAIL:
Request prospectuses and 24 Hours, 7 days a week [email protected]
literature. Forward mutual
fund inquiries.
WRITTEN CORRESPONDENCE: POST OFFICE BOX ADDRESS STREET ADDRESS
BlackRock Funds BlackRock Funds
c/o PFPC Inc. c/o PFPC Inc.
P.O. Box 8907 400 Bellevue Parkway
Wilmington, DE 19899-8907 Wilmington, DE 19809
</TABLE>
36.
<PAGE>
BLACKROCK FUNDS
THE BLACKROCK FUNDS
BlackRock Funds is a leading mutual fund company currently managing in excess
of $14 billion in 35 portfolios designed to fit a broad range of investment
goals. Each portfolio is managed by recognized experts in equity, fixed income,
international, and tax-free investing who adhere to a pure investment style/SM/.
STOCK PORTFOLIOS
- --------------------------------------------------------------------------------
Large Cap Growth Equity Select Equity
Large Cap Value Equity Micro-Cap Equity
Mid-Cap Growth Equity International Equity
Mid-Cap Value Equity International Emerging Markets
Small Cap Growth Equity International Small Cap Equity
Small Cap Value Equity Index Equity
STOCK & BOND PORTFOLIO
- --------------------------------------------------------------------------------
Balanced
BOND PORTFOLIOS
- --------------------------------------------------------------------------------
Low Duration Bond Government Income
Intermediate Government Bond Managed Income
Intermediate Bond International Bond
Core Bond GNMA
TAX-FREE BOND PORTFOLIOS
- --------------------------------------------------------------------------------
Tax-Free Income New Jersey Tax-Free Income
Delaware Tax-Free Income Ohio Tax-Free Income
Kentucky Tax-Free Income Pennsylvania Tax-Free Income
MONEY MARKET PORTFOLIOS
- --------------------------------------------------------------------------------
Money Market North Carolina Municipal Money Market
U.S. Treasury Money Market Ohio Municipal Money Market
Municipal Money Market Pennsylvania Municipal Money Market
New Jersey Municipal Money Market Virginia Municipal Money Market
<PAGE>
, 1998
- --------------------------------------------------------------------------------
THE GNMA PORTFOLIO SERVICE SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASKING THE KEY
QUESTIONS
PAGE
<S> <C>
What Are The Expenses Of The Portfolio?...................... 4
What Is The Portfolio?....................................... 6
What Types Of Securities Are In The Portfolio?............... 7
What Additional Investment Policies And Risks Apply?......... 8
What Are The Portfolio's Fundamental Investment
Limitations?................................................ 15
Who Manages The Fund?........................................ 16
How Are Shares Purchased And Redeemed?....................... 19
What Special Purchase And Redemption Procedures May Apply?... 21
How Is Net Asset Value Calculated?........................... 23
How Frequently Are Dividends And Distributions Made To
Investors?.................................................. 23
How Are Fund Distributions Taxed?............................ 24
How Is The Fund Organized?................................... 25
How Is Performance Calculated?............................... 26
How Can I Get More Information?.............................. 27
</TABLE>
This Prospectus sets forth concisely information about the Black-
Rock GNMA Portfolio (the "Portfolio") that a prospective investor
needs to know before investing. Please keep it for future refer-
ence. A Statement of Additional Information dated , 1998 has
been filed with the Securities and Exchange Commission (the
"SEC"). The Statement of Additional Information may be obtained
free of charge from the BlackRock Funds /SM/ (the "Fund") by call-
ing (800) 441-7764. The Statement of Additional Information, as
supplemented from time to time, is incorporated by reference into
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 infor-
mation regarding the Fund that has been filed with the SEC.
SHARES OF THE PORTFOLIO ARE NOT DEPOSITS OR OBLIGATIONS OF, OR
GUARANTEED OR ENDORSED BY, PNC BANK, NATIONAL ASSOCIATION OR ANY
OTHER BANK AND ARE NOT INSURED BY, GUARANTEED BY, OBLIGATIONS OF
OR OTHERWISE SUPPORTED BY THE U.S. GOVERNMENT, THE FEDERAL DE-
POSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY
OTHER GOVERNMENTAL AGENCY. INVESTMENTS IN THE PORTFOLIOS INVOLVE
INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF PRINCIPAL AMOUNT IN-
VESTED.
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 AC-
CURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
2.
<PAGE>
- --------------------------------------------------------------------------------
THE GNMA PORTFOLIO OF BLACKROCK FUNDS
- --------------------------------------------------------------------------------
The BLACKROCK FUND family consists of 35 portfolios and has
been structured to include many different investment styles
across the spectrum of fixed income investments so that invest-
ors may participate across multiple disciplines in order to
seek their long-term financial goals.
Effective January 31, 1998, the Fund has changed its name from
Compass Capital Funds /SM/ to BlackRock Funds/SM/.
The GNMA Portfolio of BLACKROCK FUNDS is one of fourteen in-
vestment portfolios that provide investors with a broad spec-
trum of investment alternatives within the fixed income sector.
Eight of these portfolios invest in taxable bonds, and six of
these portfolios invest in tax-exempt bonds. A detailed de-
scription of the GNMA Portfolio begins on page . To obtain a
prospectus describing the Fund's other fixed income portfolios,
call (800) 441-7762.
The Portfolio's performance benchmark is the Lehman GNMA Index
and its Lipper peer group is the GNMA Funds category. The Leh-
man GNMA Index is comprised of mortgage-backed pass-through se-
curities of the Government National Mortgage Association
(GNMA).
BlackRock, Inc. serves as investment adviser to the Portfolio.
BlackRock Financial Management, Inc. serves as sub-adviser to
the Portfolio.
UNDERSTANDING This Prospectus has been crafted to provide detailed, accurate
THE and comprehensive information on the BlackRock GNMA Portfolio.
BLACKROCK We intend this document to be an effective tool as you explore
GNMA different directions in fixed income investing.
PORTFOLIO
CONSIDERING There can be no assurance that any mutual fund will achieve its
THE RISKS IN investment objective. The Portfolio may purchase mortgage-
BOND related, asset-backed, and illiquid securities; enter into re-
INVESTING purchase and reverse repurchase agreements and engage in
leveraging, which is a speculative technique; lend portfolio
securities to third parties; and enter into futures contracts
and options. See "What Additional Investment Policies And Risks
Apply?"
INVESTING IN For information on how to purchase and redeem shares of the
THE Portfolio, see "How Are Shares Purchased And Redeemed?" and
BLACKROCK "What Special Purchase And Redemption Procedures May Apply?"
FUNDS
3.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ARE THE EXPENSES OF THE PORTFOLIO?
- --------------------------------------------------------------------------------
Below is a summary of the annual operating expenses expected to be incurred by
Service Shares of the Portfolio after fee waivers for the current fiscal year
as a percentage of average daily net assets. The figures shown under "Other ex-
penses" are estimated for the current fiscal year. An example based on the sum-
mary is also shown.
<TABLE>
<CAPTION>
GNMA
PORTFOLIO
<S> <C> <C>
ANNUAL PORTFOLIO OPERATING EXPENSES
(AS A PERCENTAGE OF AVERAGE NET ASSETS)
Advisory fees (after fee waivers)(/1/) .35%
Other operating expenses .55
-----
Administration fees (after fee waivers)(/1/) .17
Shareholder servicing fees .30
Other expenses .08
----
Total Portfolio operating expenses (after fee waivers)(/1/) .90%
=====
</TABLE>
(1) Without waivers, advisory fees would be .55% and administration fees would
be .23% for the Portfolio. BlackRock, Inc. and the Portfolio's administra-
tors are under no obligation to waive fees or reimburse expenses, but have
informed the Fund that they expect to waive fees and reimburse expenses
during the remainder of the current fiscal year as necessary to maintain
the Portfolio's total operating expenses at the levels set forth in the ta-
ble. Without waivers, "Other operating expenses" would be .61% and Total
Portfolio operating expenses" would be 1.16%.
4.
<PAGE>
- --------------------------------------------------------------------------------
EXAMPLE
An investor in Service Shares would pay the following expenses on a $1,000 in-
vestment assuming (1) a 5% annual return, and (2) redemption at the end of each
time period:
<TABLE>
<CAPTION>
ONE YEAR THREE YEARS
<S> <C> <C>
GNMA Portfolio $ 9 $29
</TABLE>
In addition to the compensation itemized in the expense table, institutions
that sell Portfolio shares and/or their salespersons may receive compensation
for the sale and distribution of shares or for services to the Portfolio. For
information regarding such compensation, see "Who Manages The Fund?--Share-
holder Servicing" in the Prospectus and "Investment Advisory, Administration,
Distribution and Servicing Arrangements" in the Statement of Additional Infor-
mation.
The foregoing Table and Example are intended to assist investors in understand-
ing the costs and expenses that an investor in the Portfolio will bear either
directly or indirectly. They do not reflect any charges that may be imposed by
brokers or other institutions directly on their customer accounts in connection
with investments in the Portfolio.
THE EXAMPLE SHOWN ABOVE SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE IN-
VESTMENT RETURN OR OPERATING EXPENSES. ACTUAL INVESTMENT RETURN AND OPERATING
EXPENSES MAY BE MORE OR LESS THAN THOSE SHOWN.
5.
<PAGE>
- --------------------------------------------------------------------------------
WHAT IS THE PORTFOLIO?
- --------------------------------------------------------------------------------
The GNMA Portfolio of BLACKROCK FUNDS is one of fourteen
BlackRock investment portfolios that provide investors with a
broad spectrum of investment alternatives within the fixed
income sector. Eight of these portfolios invest solely in
taxable bonds and six of these portfolios invest in tax-ex-
empt bonds.
In certain investment cycles and over certain holding peri-
ods, a fund that invests in any one of these styles may per-
form above or below the market. An investment program that
combines these multiple disciplines allows investors to se-
lect from among these various product options in the way that
most closely fits the investor's goals and sentiments.
<TABLE>
<C> <S>
Investment Objective The GNMA Portfolio seeks to provide current
income consistent with the preservation of
capital.
Investment Style The Portfolio generally pursues securities
issued by the Government National Mortgage
Association ("GNMAs"), as well as other U.S.
Government securities.
Portfolio Emphasis Portfolio assets are invested primarily in
GNMAs. GNMAs are securities issued by the
Government National Mortgage Association which
represent interests in pools of residential
mortgage loans originated by private lenders.
The dollar-weighted average maturity of the
Portfolio will range from approximately 5 to
10 years.*
</TABLE>
--------
* The Portfolio's sub-adviser will normally attempt to struc-
ture the Portfolio to have comparable duration to its per-
formance benchmark. Duration, which measures price sensi-
tivity to interest rate changes, is not necessarily equal
to average maturity.
6.
<PAGE>
- --------------------------------------------------------------------------------
WHAT TYPES OF SECURITIES ARE IN THE PORTFOLIO?
- --------------------------------------------------------------------------------
The following table summarizes the types of securities found in the Portfolio,
according to the following designations:
Yes:The Portfolio will hold a significant concentration of these securities
at all times.
Elig.: Eligible; the Portfolio may purchase these securities, but they may or
may not be a significant holding at a given time.
Temp.: Temporary; the Portfolio may purchase these securities, but under nor-
mal market conditions is not expected to do so.
No:The Portfolio may not purchase these securities.
<TABLE>
<CAPTION>
NON FOREIGN
AGENCY/ SECURITIES/
AGENCY COMMERCIAL HIGH YIELD CURRENCY
TREASURIES AGENCIES MBS/1/ MBS/1/ CORP. ABS/2/ SECURITIES RISK MUNICIPALS
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Yes Yes Yes Elig. Yes Elig. No No Elig.
</TABLE>
/1/MBS = mortgage-backed securities
/2/ABS = asset-backed securities
7.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ADDITIONAL INVESTMENT POLICIES AND RISKS APPLY?
- --------------------------------------------------------------------------------
The Portfolio will normally invest at least 80% of the value of its total as-
sets in debt securities. In addition, under normal market conditions the Port-
folio will invest at least 65% of its total assets in GNMAs. Securities ac-
quired by the Portfolio will be rated in the highest rating category at the
time of purchase (by Standard & Poor's Ratings Group ("S&P"), Moody's Investors
Service, Inc. ("Moody's"), Duff & Phelps Credit Co. or Fitch Investor Services,
Inc.) or, if unrated, of comparable quality as determined by the Portfolio's
sub-adviser. If a security's rating is reduced below the minimum rating that is
permitted for the Portfolio, the Portfolio's sub-adviser will consider whether
the Portfolio should continue to hold the security.
GNMAS AND OTHER MORTGAGE-RELATED AND ASSET-BACKED SECURITIES. The Portfolio
will invest primarily in GNMAs, and may make significant investments in other
residential and commercial mortgage-related and other asset-backed securities
(i.e., securities backed by home equity loans, installment sale contracts,
credit card receivables or other assets) issued by governmental entities and
private issuers.
The Portfolio may acquire several types of mortgage-related securities. GNMAs
are typically mortgage pass-through certificates, which provide the holder with
a pro rata interest in the underlying mortgages. The Portfolio may also acquire
adjustable rate mortgage-related securities ("ARMs") as well as collateralized
mortgage obligations ("CMOs"), which provide the holder with a specified inter-
est in the cash flow of a pool of underlying mortgages or other mortgage-backed
securities. Issuers of CMOs ordinarily elect to be taxed as pass-through enti-
ties known as real estate mortgage investment conduits ("REMICs"). CMOs are is-
sued in multiple classes, each with a specified fixed or floating interest rate
and a final distribution date. The relative payment rights of the various CMO
classes may be structured in a variety of ways. In most cases, however, pay-
ments of principal are applied to the CMO classes in the order of their respec-
tive stated maturities, so that no principal payments will be made on a CMO
class until all other classes having an earlier stated maturity date are paid
in full. The classes may include accrual certificates (also known as "Z-
Bonds"), which only accrue interest at a specified rate until other specified
classes have been retired and are converted thereafter to interest-paying secu-
rities. They may also include planned amortization classes ("PACs") which gen-
erally require, within certain limits, that specified amounts of principal be
applied on each payment date, and generally exhibit less yield and market vola-
tility than other classes.
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 may normally be prepaid at any
time because the underlying assets (i.e., loans) generally may be prepaid at
any time. In calculating the average weighted maturity of the Portfolio, the
maturity of mortgage-related and other asset-backed securities held by the
Portfolio will be based on estimates of average life which take prepayments
into account. 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. In general, the collateral supporting non-mortgage
asset-backed securities is of shorter maturity than mortgage loans and is less
likely to experience substantial prepayments.
The relationship between prepayments and interest rates may give some high-
yielding mortgage-related and asset-backed securities less potential for growth
in value than conventional bonds with comparable maturities. In addition, in
periods of falling interest rates, the rate of prepayments tends to increase.
During such periods, the reinvestment of prepayment proceeds by the Portfolio
will generally be at lower rates than the rates that were carried by the obli-
gations that have been prepaid. Because of these and other reasons, a mortgage-
related or asset-backed security's total return and maturity may be difficult
to predict precisely. To the extent
8.
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that the Portfolio purchases mortgage-related or asset-backed securities at a
premium, prepayments (which may be made without penalty) may result in loss of
the Portfolio's principal investment to the extent of premium paid.
Non-mortgage asset-backed securities involve risks that are not presented by
mortgage-related securities. Primarily, these securities do not have the bene-
fit of the same security interest in the underlying collateral. Credit card re-
ceivables are generally unsecured, and the debtors are entitled to the protec-
tion of a number of state and Federal consumer credit laws many of which give
debtors the right to set off certain amounts owed on the credit cards, thereby
reducing the balance due. Most issuers of automobile receivables permit the
servicers to retain possession of the underlying obligations. If the servicer
were to sell these obligations to another party, there is a risk that the pur-
chaser would acquire an interest superior to that of the holders of the related
automobile receivables. In addition, because of the large number of vehicles
involved in a typical issuance and technical requirements under state laws, the
trustee for the holders of the automobile receivables may not have an effective
security interest in all of the obligations backing such receivables. There-
fore, there is a possibility that recoveries on repossessed collateral may not,
in some cases, be able to support payments on these securities.
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. (or Sears Mortgage if PNC Mortgage Securities Corp. succeeded
to rights and duties of Sears Mortgage) or mortgage-related securities contain-
ing loans or mortgages originated by PNC Bank, National Association ("PNC
Bank") or its affiliates. It is possible that under some circumstances, PNC
Mortgage Securities Corp. or its 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 Securities Corp. or its affiliates.
STRIPPED AND ZERO COUPON OBLIGATIONS. To the extent consistent with its invest-
ment objective, the Portfolio 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 obliga-
tions. These participations, 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"). Stripped securities, par-
ticularly SMBS, may exhibit greater price volatility than ordinary debt securi-
ties because of the manner in which their principal and interest are returned
to investors.
SMBS are usually structured with two or more classes that receive different
proportions of the interest and principal distributions from a pool of mort-
gage-backed obligations. A common type of SMBS will have one class receiving
all of the interest, while the other class receives all of the principal. How-
ever, in some cases, one class will receive some of the interest and most of
the principal while the other class will receive most of the interest and the
remainder of the principal. If the underlying obligations experience greater
than anticipated prepayments of principal, the Portfolio may fail to fully re-
coup its initial investment. The market value of SMBS can be extremely volatile
in response to changes in interest rates. The yields on a class of SMBS that
receives all or most of the interest are generally higher than prevailing mar-
ket yields on other mortgage-related obligations because their cash flow pat-
terns are also volatile and there is a greater risk that the initial investment
will not be fully recouped.
The Portfolio may invest in zero-coupon bonds, which are normally issued at a
significant discount from face value and do not provide for periodic interest
payments. Zero-coupon bonds may experience greater volatility in market value
than similar maturity debt obligations which provide for regular interest pay-
ments. Additionally, current federal tax law requires the holder of certain
zero coupon bonds to accrue income with respect to these securities prior to
the receipt of cash payments. To maintain its qualification as a regulated in-
vestment company and avoid liability for federal income and excise taxes, the
Portfolio may be required to distribute income accrued with respect to these
securities and may have to dispose of portfolio securities under
9.
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disadvantageous circumstances in order to generate cash to satisfy these dis-
tribution requirements. See "How Are Fund Distributions Taxed?"
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 Mort-
gage Association are supported by the United States' full faith and credit;
others such as those of the Federal National Mortgage Association and the Stu-
dent 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 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 instrumen-
talities if it is not obligated to do so by law.
CORPORATE AND BANK OBLIGATIONS. To the extent consistent with its investment
objective, the Portfolio may invest in debt obligations of domestic or foreign
corporations and banks, and may acquire commercial obligations issued by Cana-
dian corporations and Canadian counterparts of U.S. corporations, as well as
Europaper, which is U.S. dollar-denominated commercial paper of a foreign issu-
er. Bank obligations may include certificates of deposit, notes, bankers' ac-
ceptances 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 Portfolio 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 INVESTMENTS. The two principal classifications of Municipal Obliga-
tions are "general obligation" securities and "revenue" securities. General ob-
ligation securities are secured by the issuer's pledge of its full faith,
credit and taxing power for the payment of principal and interest. Revenue se-
curities 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 fi-
nanced. 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 in-
clude "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.
Also included within the general category of Municipal Obligations are partici-
pation certificates in a lease, an installment purchase contract, or a condi-
tional sales contract ("lease obligations") entered into by a state or politi-
cal subdivision to finance the acquisition or construction of equipment, land,
or facilities. Although lease obligations are not general obligations of the
issuer for which the state or other governmental body's unlimited taxing power
is pledged, certain lease obligations are backed by a covenant to appropriate
money to make the lease obligation payments. However, under certain lease obli-
gations, the state or governmental body has no obligation to make these pay-
ments in future years unless money is appropriated on a yearly basis. Although
"non-appropriation" lease obligations are secured by the leased property, dis-
position of the property in the event of foreclosure might prove difficult.
These securities represent a relatively new type of financing that is not yet
as marketable as more conventional securities.
To the extent the Portfolio's assets are invested in Municipal Obligations pay-
able from the revenues of similar projects or are invested in private activity
bonds, the Portfolio will be subject to the particular risks presented by the
laws and economic conditions relating to such projects and bonds to a greater
extent than it would be if its assets were not so invested.
The amount of information regarding the financial condition of issuers of Mu-
nicipal Obligations may be less extensive than the information for public cor-
porations, and the secondary market for Municipal Obligations
10.
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may be less liquid than that for taxable obligations. Accordingly, the ability
of the Portfolio to buy and sell Municipal Obligations may, at any particular
time and with respect to any particular securities, be limited. In addition,
Municipal Obligations purchased by the Portfolio include obligations backed by
letters of credit and other forms of credit enhancement issued by domestic and
foreign banks, as well as other financial institutions.
Opinions relating to the validity of Municipal Obligations and to the exemption
of interest thereon from Federal and state income tax are rendered by counsel
to the respective issuers and sponsors of the obligations at the time of issu-
ance. The Fund and its service providers will rely on such opinions and will
not review independently the underlying proceedings relating to the issuance of
Municipal Obligations, the creation of any tax-exempt derivative securities, or
the bases for such opinions.
INTEREST RATE TRANSACTIONS. The Portfolio may enter into interest rate swaps
and may purchase or sell interest rate caps and floors. The Portfolio may enter
into these transactions primarily to preserve a return or spread on a particu-
lar investment or portion of its holdings, as a duration management technique
or to protect against an increase in the price of securities the Portfolio an-
ticipates purchasing at a later date. The Portfolio intends to use these trans-
actions 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 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. 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 inter-
est on a notional principal amount from the party selling such interest rate
floor.
OPTIONS AND FUTURES CONTRACTS. To the extent consistent with its investment ob-
jective, the Portfolio may write (i.e., sell) covered call options, buy put op-
tions, buy call options and write secured put options for the purpose of hedg-
ing or earning additional income, which may be deemed speculative. For the pay-
ment 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, securities indices
or the yield differential between two securities. The Portfolio will not pur-
chase put and call options when the aggregate premiums on outstanding options
exceed 5% of its net assets at the time of purchase, and will not write options
on more than 25% of the value of its net assets (measured at the time an option
is written). 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.
To the extent consistent with its investment objective, the Portfolio may also
invest in futures contracts and options on futures contracts for hedging pur-
poses or to maintain liquidity. The value of the Portfolio's contracts may
equal or exceed 100% of its total assets, although the Portfolio will not pur-
chase 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 for related futures options entered into for other than bona fide
hedging purposes is 5% or less of its net assets.
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 quan-
tity of a foreign currency. The 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.
The 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 securi-
ties in the value of the securities to be sold. In addition, the Portfolio may
utilize futures contracts in anticipation of changes in the composition of its
holdings or in currency exchange rates.
11.
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The 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 ob-
ligated to sell or buy a futures contract if the option is exercised. In con-
nection with a portfolio's position in a futures contract or related option,
the Fund will create a segregated account of 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 in-
struments 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 sub-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 the Statement of Additional Information.
To maintain greater flexibility, the Portfolio may invest in instruments which
have the characteristics of futures contracts. These instruments may take a
variety of forms, such as debt securities with interest or principal payments
determined by reference to the value of a commodity at a future point in time.
The risks of such investments could reflect the risks of investing in futures
and securities, including volatility and illiquidity.
The Fund intends to comply with the regulations of the Commodity Futures Trad-
ing Commission exempting the Portfolio from registration as a "commodity pool
operator."
GUARANTEED INVESTMENT CONTRACTS. The Portfolio may make limited investments in
guaranteed investment contracts ("GICs") issued by highly rated U.S. insurance
companies. Under these contracts, a portfolio makes cash contributions to a
deposit fund of the insurance company's general account. The insurance company
then credits to the portfolio, on a monthly basis, interest which is based on
an index (such as the Salomon Brothers CD Index), but is guaranteed not to be
less than a certain minimum rate. The Portfolio does not expect to invest more
than 5% of its net assets in GICs at any time during the current fiscal year.
SECURITIES LENDING. The Portfolio may seek additional income by lending secu-
rities 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. The Portfolio may
not make such loans in excess of 33 1/3% of the value of its total assets. Se-
curities 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.
VARIABLE AND FLOATING RATE INSTRUMENTS. The Portfolio may purchase rated and
unrated variable and floating rate instruments. These 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 Portfolio may invest up to 10% of its total assets in leveraged inverse
floating rate debt instruments ("inverse floaters"). The interest rate of an
inverse floater resets in the opposite direction from the market rate of in-
terest to which it is indexed. An inverse floater may be considered to be
leveraged to the extent that its interest rate varies by a magnitude that ex-
ceeds the magnitude of the change in the index rate of interest. The higher
degree of leverage inherent in inverse floaters is associated with greater
volatility in their market values. Issuers of unrated variable and floating
rate instruments must satisfy the same criteria as set forth above for the
Portfolio. The absence of an active secondary market with respect to particu-
lar variable and
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floating rate instruments, however, could make it difficult for the Portfolio
to dispose of a variable or floating rate instrument if the issuer defaulted on
its payment obligation or during periods when the Portfolio is not entitled to
exercise its demand rights.
REPURCHASE AGREEMENTS. The Portfolio may agree to purchase debt securities from
financial institutions subject to the seller's agreement to repurchase them 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. The Portfolio is authorized
to borrow money. If the securities held by the 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 de-
cline 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 Portfolio may use
the proceeds of reverse repurchase agreements to purchase other securities ei-
ther maturing, or under an agreement to resell, on a date simultaneous with or
prior to the expiration of the reverse repurchase agreement. The Portfolio may
use reverse repurchase agreements when it is anticipated that the interest in-
come 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 re-
purchase agreements may be 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 the 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 re-
purchase agreement is outstanding, the Portfolio will maintain a segregated ac-
count with the Fund's custodian containing cash, U.S. Government or other ap-
propriate liquid debt securities having a value at least equal to the repur-
chase price. The 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, the Portfolio may borrow up to an additional 5%
of its total assets for temporary purposes.
INVESTMENT COMPANIES. The Portfolio may invest in securities issued by other
investment companies within the limits prescribed by the 1940 Act. As a share-
holder of another investment company, the Portfolio would bear, along with
other shareholders, its pro rata portion of the other investment company's ex-
penses, including advisory fees. These expenses would be in addition to the ad-
visory and other expenses that the Portfolio bears directly in connection with
its own operations.
ILLIQUID SECURITIES. The Portfolio will not invest more than 15% of the value
of its net assets in securities that are illiquid. GICs, variable and floating
rate 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.
The Portfolio may purchase securities which are not registered under the Secu-
rities Act of 1933 (the "1933 Act") but which can be sold to "qualified insti-
tutional buyers" in accordance with Rule 144A under the 1933 Act. These securi-
ties will not be considered illiquid so long as it is determined by the Portfo-
lio's sub-adviser that an adequate trading market exists for the securities.
This investment practice could have the effect of increasing the level of illi-
quidity in the Portfolio during any period that qualified institutional buyers
become uninterested in purchasing these restricted securities.
WHEN-ISSUED PURCHASES AND FORWARD COMMITMENTS. The Portfolio may purchase secu-
rities on a "when-issued" basis and may purchase or sell securities on a "for-
ward 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 portfo-
lio to lock in a price or yield on a security that it owns or intends to pur-
chase, 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
13.
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in a transaction may be less favorable than the price or yield available in
the market when the securities delivery takes place. The Portfolio's when-is-
sued purchases and forward commitments are not expected to exceed 25% of the
value of its total assets absent unusual market conditions.
DOLLAR ROLL TRANSACTIONS. To take advantage of attractive opportunities in the
mortgage market and to enhance current income, the 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 agree-
ment 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 in-
terest 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, the Portfolio
will not be entitled to receive interest and principal payments on the securi-
ties 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. If such income 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 the Portfolio compared with what the performance would have
been without the use of dollar rolls. At the time the Portfolio enters into a
dollar roll transaction, it will place in a segregated account maintained with
its custodian cash, U.S. Government securities or other liquid securities hav-
ing a value equal to the repurchase price (including accrued interest) and
will subsequently monitor the account to ensure that its value is maintained.
The 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 securi-
ties the Portfolio is required to purchase may decline below the agreed upon
repurchase price of those securities. If the broker/dealer to whom the Portfo-
lio sells securities becomes insolvent, the Portfolio's right to purchase or
repurchase securities may be restricted. Successful use of mortgage dollar
rolls may depend upon the sub-adviser's ability to correctly predict interest
rates and prepayments. There is no assurance that dollar rolls can be success-
fully employed.
SHORT SALES. The Portfolio may only make short sales of securities "against-
the-box." 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 Portfolio may make short sales both as a form of hedging to off-
set potential declines in long positions in similar securities and in order to
maintain portfolio flexibility. In a short sale "against-the-box," at the time
of sale, the portfolio owns or has the immediate and unconditional right to
acquire the identical security at no additional cost. When selling short
"against-the-box," a portfolio forgoes an opportunity for capital appreciation
in the security.
PORTFOLIO TURNOVER RATES. Under normal market conditions, it is expected that
the annual portfolio turnover rate for the Portfolio will not exceed 450%. The
Portfolio's annual portfolio turnover rate will not be a
factor preventing a sale or purchase when the sub-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. High portfolio
turnover rates (i.e., 100% or more) will generally result in higher transac-
tion costs to the Portfolio and may result in the realization of short-term
capital gains that are taxable to shareholders as ordinary income.
INTEREST RATE AND EXTENSION RISK. The value of fixed income securities in the
Portfolio can be expected to vary inversely with changes in prevailing inter-
est rates. Fixed income securities with longer maturities, which tend to pro-
duce higher yields, are subject to potentially greater capital appreciation
and depreciation than securities with shorter maturities. The Portfolio is not
restricted to any maximum or minimum time to maturity in purchasing individual
portfolio securities, and the average maturity of the Portfolio's assets will
vary within the limits stated herein based upon its sub-adviser's assessment
of economic and market conditions. Although the Portfolio's sub-adviser will
normally attempt to structure the Portfolio to have a comparable duration to
its benchmark as stated in that section, there can be no assurance that it
will be able to do so at all times.
14.
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WHAT ARE THE PORTFOLIO'S FUNDAMENTAL INVESTMENT LIMITATIONS?
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The Portfolio's investment objective and policies may be changed by the Fund's
Board of Trustees without shareholder approval. However, shareholders will be
given at least 30 days' notice before any change to the Portfolio's investment
objective. No assurance can be provided that a Portfolio will achieve its in-
vestment objective.
The Portfolio has also adopted certain fundamental investment limitations that
may be changed only with the approval of a "majority of the outstanding shares
of the Portfolio" (as defined in the Statement of Additional Information). Sev-
eral of the Portfolio's fundamental investment policies, which are set forth in
full in the Statement of Additional Information, are summarized below.
The Portfolio may not:
(1) purchase securities (except U.S. Government securities) if more than 5% of
its total assets will be invested in the securities of any one issuer, ex-
cept that up to 25% of the Portfolio's total assets may be invested without
regard to this 5% limitation; or
(2) invest 25% or more of its total assets in one or more issuers conducting
their principal business activities in the same industry.
The investment limitations stated above are applied at the time investment se-
curities are purchased.
15.
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WHO MANAGES THE FUND?
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BOARD OF The business and affairs of the Fund are managed under the
TRUSTEES direction of its Board of Trustees. The following persons
currently serve on the Board:
William O. Albertini--Executive Vice President and Chief Fi-
nancial Officer of Bell Atlantic Global Wireless.
Raymond J. Clark--Treasurer of Princeton University.
Robert M. Hernandez--Vice Chairman and Chief Financial Offi-
cer of USX Corporation.
Anthony M. Santomero--Professor of Finance and Director of
the Financial Institutions Center, The Wharton School, Uni-
versity of Pennsylvania.
David R. Wilmerding, Jr.--Chairman, Gee, Wilmerding & Associ-
ates, Inc.
ADVISER AND The Adviser to BlackRock Funds is BlackRock, Inc. BlackRock,
SUB-ADVISER Inc. (formerly PNC Asset Management Group, Inc.) was orga-
nized in 1994 to perform advisory services for investment
companies, and has its principal offices at 1600 Market
Street, 29th Floor, Philadelphia, Pennsylvania 19103. Black-
Rock, Inc. is an indirect wholly-owned subsidiary of PNC Bank
Corp., a multi-bank holding company.
The sub-adviser to the Portfolio is BlackRock Financial Man-
agement, Inc. ("BlackRock"), an affiliate of BlackRock, Inc.,
with its primary offices at 345 Park Avenue, New York, New
York 10154. BlackRock is a registered investment adviser, or-
ganized in 1988. Robert S. Kapito, Scott Amero and Michael P.
Lustig serve as portfolio managers of the Portfolio. Mr.
Kapito has been Vice Chairman of the sub-adviser since 1988,
Mr. Amero has been Managing Director of the sub-adviser since
1990 and Mr. Lustig has been a portfolio manager of the sub-
adviser since 1995.
As adviser, BlackRock, Inc. is responsible for the overall
investment management of the Portfolio. As sub-adviser,
BlackRock Financial Management is responsible for the day-to-
day management of the Portfolio, and generally makes all pur-
chase and sale investment decisions for the Portfolio. Black-
Rock Financial Management also provides research and credit
analysis.
THE AFFILIATE SUB-ADVISERS OF BLACKROCK, INC. ARE:
. BlackRock Financial Management, Inc.: Domestic and non-
dollar fixed income.
. PNC Equity Advisors: Growth equity.
. Provident Capital Management: Value equity.
. CastleInternational Asset Management: International equity.
. PNC Institutional Management Corporation: Money market.
For their investment advisory and sub-advisory services,
BlackRock, Inc. and the Portfolio's sub-adviser are entitled
to fees, computed daily and payable monthly, at the maximum
annual rates set forth below. As stated under "What Are The
Expenses
16.
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Of The Portfolio?", BlackRock, Inc. and the sub-adviser intend
to waive a portion of their fees during the current fiscal
year. All sub-advisory fees are paid by BlackRock, Inc., and do
not represent an extra charge to the Portfolio.
MAXIMUM ANNUAL CONTRACTUAL FEE RATE (BEFORE WAIVERS)
<TABLE>
<CAPTION>
AVERAGE DAILY NET INVESTMENT SUB-ADVISORY
ASSETS ADVISORY FEE FEE
----------------- ------------ ------------
<S> <C> <C>
first $1 billion .550% .400%
$1 billion--$2 billion .500 .350
$2 billion--$3 billion .475 .325
greater than $3 billion .450 .300
</TABLE>
The Portfolio's sub-adviser strives to achieve best execution
on all transactions. Infrequently, brokerage transactions for
the Portfolio may be directed through registered broker/dealers
who have entered into dealer agreements with the Fund's dis-
tributor, subject to the requirements of best execution.
ADMINISTRATORS BlackRock, Inc., PFPC Inc. ("PFPC") and BlackRock Distributors,
Inc. ("BDI") (the "Administrators") serve as the Fund's co-ad-
ministrators. BlackRock, Inc. and PFPC are indirect wholly-
owned subsidiaries of PNC Bank Corp. BDI is a wholly-owned sub-
sidiary of Provident Distributors, Inc. ("PDI"). A majority of
the outstanding stock of PDI is owned by its officers.
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, BlackRock, Inc. is entitled to
receive a fee, computed daily and payable monthly, at an annual
rate of .03% of the Portfolio's average daily net assets. PFPC
and BDI are entitled to receive a combined administration fee,
computed daily and payable monthly, at the aggregate annual
rate of (i) .085% of the first $500 million of the Portfolio's
average daily net assets, .075% of the next $500 million of the
Portfolio's average daily net assets and .065% of the average
daily net assets of the Portfolio in excess of $1 billion and
(ii) .115% of the first $500 million of the average daily net
assets allocated to Service Shares of the Portfolio, .105% of
the next $500 million of such average daily net assets and
.095% of the average daily net assets allocated to Service
Shares of the Portfolio in excess of $1 billion. From time to
time the Administrators may waive some or all of their adminis-
tration fees from the Portfolio.
For information about the operating expenses the Portfolio ex-
pects to incur in the current fiscal year, see "What Are the
Expenses of the Portfolio?"
TRANSFER PNC Bank, whose principal offices are located at 1600 Market
AGENT, Street, Philadelphia, Pennsylvania 19103, serves as the Portfo-
DIVIDEND lios' custodian and PFPC, whose principal offices are located
DISBURSING at 400 Bellevue Parkway, Wilmington, Delaware 19809, serves as
AGENT AND their transfer agent and dividend disbursing agent.
CUSTODIAN
SHAREHOLDER
SERVICING
The Fund intends to enter into service arrangements with insti-
tutional investors ("Institutions") (including PNC Bank and its
affiliates) which provide that the Institutions will render
support services to their customers who are the beneficial own-
ers
17.
<PAGE>
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of Service Shares. These services are intended to supplement
the services provided by the Fund's Administrators and
transfer agent to the Fund's shareholders of record. In con-
sideration for payment of a shareholder processing fee of up
to .15% (on an annualized basis) of the average daily net
asset value of Service Shares owned beneficially by their
customers, Institutions may provide one or more of the fol-
lowing services: processing purchase and redemption requests
from customers and placing orders with the Fund's transfer
agent or the distributor; processing dividend payments from
the Fund on behalf of customers; providing sub-accounting
with respect to Service Shares beneficially owned by custom-
ers or the information necessary for sub-accounting; and
providing other similar services. In consideration for pay-
ment of a separate shareholder servicing fee of up to .15%
(on an annualized basis) of the average daily net asset
value of Service Shares owned beneficially by their custom-
ers, Institutions may provide one or more of these addi-
tional services to such customers: responding to customer
inquiries relating to the services performed by the Institu-
tion and to customer inquiries concerning their investments
in Service Shares; assisting customers in designating and
changing dividend options, account designations and address-
es; and providing other similar shareholder liaison servic-
es. Customers who are beneficial owners of Service Shares
should read this Prospectus in light of the terms and fees
governing their accounts with Institutions.
Conflict-of-interest restrictions may apply to the receipt
of compensation paid by the Fund in connection with the in-
vestment of fiduciary funds in Portfolio shares. Institu-
tions, including banks regulated by the Comptroller of the
Currency, Federal Reserve Board and state banking commis-
sions, and investment advisers and other money managers sub-
ject to the jurisdiction of the SEC, the Department of Labor
or state securities commissions, are urged to consult their
legal counsel before entering into agreements with the Fund.
The Glass-Steagall Act and other applicable laws, among
other things, prohibit banks from engaging in the business
of underwriting securities. It is intended that the services
provided by Institutions under their service agreements will
not be prohibited under these laws. Under state securities
laws, banks and financial institutions that receive payments
from the Fund may be required to register as dealers.
EXPENSES Expenses are deducted from the total income of the Portfolio
before dividends and distributions are paid. Expenses in-
clude, but are not limited to, fees paid to BlackRock, Inc.
and the Administrators, transfer agency and custodian fees,
trustee fees, taxes, interest, professional fees, share-
holder servicing and processing fees, fees and expenses in
registering and qualifying the Portfolio and its shares for
distribution under Federal and state securities laws, ex-
penses of preparing prospectuses and statements of addi-
tional information and of printing and distributing prospec-
tuses and statements of additional information to existing
shareholders, expenses relating to shareholder reports,
shareholder meetings and proxy solicitations, insurance pre-
miums, the expense of independent pricing services, and
other expenses which are not expressly assumed by BlackRock,
Inc. or the Fund's service providers under their agreements
with the Fund. Any general expenses of the Fund that do not
belong to a particular investment portfolio will be allo-
cated among all investment portfolios by or under the direc-
tion of the Board of Trustees in a manner the Board deter-
mines to be fair and equitable.
18.
<PAGE>
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HOW ARE SHARES PURCHASED AND REDEEMED?
- --------------------------------------------------------------------------------
DISTRIBUTOR. Shares of the Portfolio are offered on a continuous basis by BDI
as distributor (the "Distributor"). BDI maintains its principal offices at Four
Falls Corporate Center, 6th Floor, West Conshohocken, PA 19428-2961.
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 Service Shares. However, the Plan
permits BDI, 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 ap-
plicable NASD regulations, may include contributions to various non-cash and
cash incentive arrangements to promote the sale of shares, as well as sponsor-
ship 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 "In-
vestment Advisory, Administration, Distribution and Servicing Arrangements" in
the Statement of Additional Information.
PURCHASE OF SHARES. Service Shares are offered without a sales load to Institu-
tions acting on behalf of their customers, certain persons who were sharehold-
ers of The Compass Capital Group at the time of its combination with The PNC(R)
Fund during the first quarter of 1996, and investors that participate in the
Capital Directions /SM/ asset allocation program.
Service Shares will normally be held of record by Institutions or in the names
of nominees of Institutions. Share purchases are normally effected through a
customer's account at an Institution through procedures established in connec-
tion with the requirements of the account. In these cases, confirmations of
share purchases and redemptions will be sent to the Institutions. Beneficial
ownership of shares will be recorded by the Institutions and reflected in the
account statements provided by such Institutions to their customers. Investors
wishing to purchase shares should contact their Institutions.
Service Shares are sold at their net asset value per share next computed after
an order is received by PFPC. Orders received by PFPC by 4:00 p.m. (Eastern
Time) on a Business Day are priced the same day. A "Business Day" is any week-
day that the New York Stock Exchange (the "NYSE") and the Federal Reserve Bank
of Philadelphia (the "FRB") are open for business. Purchase orders may be
placed by telephoning PFPC at (800) 441-7450. Orders received by PFPC after
4:00 p.m. (Eastern Time) are priced on the following Business Day.
Payment for Service Shares must normally be made in Federal funds or other
funds immediately available to the Fund's custodian. Payment may also, in the
discretion of the Fund, be made in the form of securities that are permissible
investments for the Portfolio. For further information, see the Statement of
Additional Information. The minimum initial investment is $5,000; however, In-
stitutions may set a higher minimum for their customers. There is no minimum
subsequent investment requirement. The Fund does not accept third party checks
for initial or subsequent investments.
The Fund may in its discretion waive or modify the minimum investment amount,
may reject any order for Service Shares and may suspend and resume the sale of
any share class of the Portfolio at any time.
In the event that a shareholder acquiring Service Shares on or after May 1,
1998 (other than a former shareholder of The Compass Capital Group as described
above) ceases to meet the eligibility standards for purchasing Service Shares,
then the shareholder's Service Shares will, upon the direction of the Fund's
distributor, automatically be converted to Investor A Shares of the Portfolio
having the same aggregate net asset value as the shares converted. Investor A
Shares are currently authorized to bear additional service and distribution
fees at the aggregate annual rate of .20% of average daily net assets. In the
event that a shareholder acquiring
19.
<PAGE>
- --------------------------------------------------------------------------------
Service Shares on or after May 1, 1998 subsequently satisfies the eligibility
standards of purchasing Institutional Shares (other than due to fluctuations in
market value), then the shareholder's Service Shares will, upon the direction
of the Fund's distributor, automatically be converted to Institutional Shares
of the Portfolio having the same aggregate net asset value as the shares con-
verted.
REDEMPTION OF SHARES. Customers of Institutions may redeem Service Shares in
accordance with the procedures applicable to their accounts with the Institu-
tions. These procedures will vary according to the type of account and the In-
stitution involved, and customers should consult their account managers in this
regard. It is the responsibility of Institutions to transmit redemption orders
to PFPC and credit their customers' accounts with redemption proceeds on a
timely basis. In the case of shareholders holding share certificates, the cer-
tificates must accompany the redemption request.
Institutions may place redemption orders 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 Fund, the Administrators and the
Distributor will employ reasonable procedures to confirm that instructions com-
municated 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.
Payment for redeemed shares for which a redemption order is received by PFPC
before 4:00 p.m. (Eastern Time) on a Business Day is normally made in Federal
funds wired to the redeeming Institution on the next Business Day, provided
that the Fund's custodian is also open for business. Payment for redemption or-
ders received after 4:00 p.m. (Eastern Time) or on a day when the Fund's custo-
dian is closed is normally wired in Federal funds on the next Business Day fol-
lowing redemption on which the Fund's custodian is open for business. The Fund
reserves the right to wire redemption proceeds within seven days after receiv-
ing a redemption order if, in the judgment of BlackRock, Inc., an earlier pay-
ment could adversely affect the Portfolio. No charge for wiring redemption pay-
ments is imposed by the Fund, although Institutions may charge their customer
accounts for redemption services. Information relating to such redemption serv-
ices and charges, if any, should be obtained by customers from their Institu-
tions.
During periods of substantial economic or market change, telephone redemptions
may be difficult to complete. Redemption requests may also be mailed to PFPC at
400 Bellevue Parkway, Wilmington, DE 19809.
The Fund may redeem Service Shares in any shareholder's account if the account
balance drops below $5,000 as the result of redemption requests and the share-
holder does not increase the balance to at least $5,000 upon thirty days' writ-
ten notice. If a customer has agreed with an Institution to maintain a minimum
balance in his or her account with the Institution, and the balance in the ac-
count falls below that minimum, the customer may be obligated to redeem all or
part of his or her shares in the Portfolio to the extent necessary to maintain
the minimum balance required.
The Fund may also suspend the right of redemption or postpone the date of pay-
ment 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 Fund's responsibili-
ties under the 1940 Act. See "Purchase and Redemption Information" in the
Statement of Additional Information for examples of when such redemption might
be appropriate.
20.
<PAGE>
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WHAT SPECIAL PURCHASE AND REDEMPTION PROCEDURES MAY APPLY?
- --------------------------------------------------------------------------------
PURCHASES. Purchase orders may be placed through PFPC. The minimum investment
is $100. Purchases through the Automatic Investment Plan described below are
subject to a lower purchase minimum. The name of the Portfolio must appear on
the check or Federal Reserve Draft. Investors may also wire Federal funds in
connection with the purchase of shares. The wire instructions must include the
name of the Portfolio, class of the Portfolio, the name of the account regis-
tration, and the shareholder account number. Before wiring any funds, however,
an investor must call PFPC at (800) 441-7762 in order to confirm the wire in-
structions. Purchase orders which are received by PFPC, together with payment,
before the close of regular trading hours on the NYSE (currently 4:00 p.m.
Eastern Time) on any Business Day (as defined above) are priced according to
the net asset value next determined on that day.
The Portfolio offers an Automatic Investment Plan ("AIP") whereby an investor
in shares of the Portfolio may arrange for periodic investments in the Portfo-
lio through automatic deductions from a checking or savings account by complet-
ing the AIP Application Form which may be obtained from PFPC. The minimum pre-
authorized investment amount is $50.
REDEMPTIONS. Shareholders may redeem for cash some or all of their shares of
the Portfolio at any time by sending a written redemption request in proper
form to BlackRock Funds c/o PFPC Inc., P.O. Box 8907, Wilmington, Delaware
19899-8907.
Except as noted below, a request for redemption must be signed by all persons
in whose names the shares are registered. Signatures must conform exactly to
the account registration. If the proceeds of the redemption would exceed
$25,000, or if the proceeds are not to be paid to the record owner at the rec-
ord address, or if the shareholder is a corporation, partnership, trust or fi-
duciary, signature(s) must be guaranteed by any eligible guarantor institution.
Eligible guarantor institutions generally include banks, broker/dealers, credit
unions, national securities exchanges, registered securities associations,
clearing agencies and savings associations.
Generally, a properly signed written request with any required signature guar-
antee is all that is required for a redemption. In some cases, however, other
documents may be necessary. Shareholders holding share certificates must send
their certificates with the redemption request. Additional documentary evidence
of authority is required by PFPC in the event redemption is requested by a cor-
poration, partnership, trust, fiduciary, executor or administrator.
If a shareholder has given authorization for expedited redemption, shares can
be redeemed by telephone and the proceeds sent by check to the shareholder or
by Federal wire transfer to a single previously designated bank account. Once
authorization is on file, PFPC will honor requests by any person by telephone
at (800) 441-7762 or other means. The minimum amount that may be sent by check
is $500, while the minimum amount that may be wired is $10,000. The Fund re-
serves the right to change these minimums or to terminate these redemption
privileges. If the proceeds of a redemption would exceed $25,000, the redemp-
tion request must be in writing and will be subject to the signature guarantee
requirement described above. This privilege may not be used to redeem shares in
certificated form.
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 Fund is not responsible for the efficiency of the Federal wire system or
the shareholder's firm or bank. The Fund does not currently charge for wire
transfers. The shareholder is responsible for any charges im-
21.
<PAGE>
- -------------------------------------------------------------------------------
posed by the shareholder's bank. To change the name of the single designated
bank account to receive wire redemption proceeds, it is necessary to send a
written request (with a guaranteed signature as described above) to BlackRock
Funds c/o PFPC, P.O. Box 8907, Wilmington, Delaware 19899-8907.
The Fund reserves the right to refuse a telephone redemption if it believes it
advisable to do so. The Fund, the Administrators and the Distributor will em-
ploy reasonable procedures to confirm that instructions communicated by tele-
phone are genuine. The Fund, the Administrators and the Distributor will not
be liable for any loss, liability, cost or expense for acting upon telephone
instructions reasonably believed to be genuine in accordance with such proce-
dures.
The Fund offers a Systematic Withdrawal Plan ("SWP") which may be used by in-
vestors who wish to receive regular distributions from their accounts. Upon
commencement of the SWP, the account must have a current value of $10,000 or
more in the Portfolio. Shareholders may elect to receive automatic cash pay-
ments of $50 or more either monthly, every other month, quarterly, three times
a year, semi-annually, or annually. Automatic withdrawals are normally proc-
essed on the 25th day of the applicable month or, if such day is not a Busi-
ness Day, on the next Business Day and are paid promptly thereafter. An in-
vestor may utilize the SWP by completing the SWP Application Form which may be
obtained from PFPC.
Shareholders should realize that if withdrawals exceed income dividends their
invested principal in the account will be depleted. To participate in the SWP,
shareholders must have their dividends automatically reinvested. Shareholders
may change or cancel the SWP at any time, upon written notice to PFPC.
Persons who were shareholders of an investment portfolio of the Compass Capi-
tal Group of Funds at the time of the portfolio's combination with The PNC(R)
Fund may also purchase and redeem Service Shares of the same Portfolio and for
the same account in which they held shares on that date through the procedures
described in this section.
22.
<PAGE>
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HOW IS NET ASSET VALUE CALCULATED?
- --------------------------------------------------------------------------------
Net asset value is calculated separately for Service Shares of the Portfolio as
of the close of regular trading hours on the NYSE (currently 4:00 p.m. Eastern
Time) on each Business Day by dividing the value of all securities and other
assets owned by the Portfolio that are allocated to its Service Shares, less
the liabilities charged to its Service Shares, by the number of its Service
Shares that are outstanding.
Most securities held by the Portfolio are priced based on their market value as
determined by reported sales prices, or the mean between bid and asked prices,
that are provided by securities dealers or pricing services. Portfolio securi-
ties which are primarily traded on foreign securities exchanges are normally
valued at the preceding closing values of such securities on their respective
exchanges. Securities for which market quotations are not readily available are
valued at fair market value as determined in good faith by or under the direc-
tion 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 Portfolio's sub-adviser under the supervision of the Board
of Trustees determines such method does not represent fair value.
HOW FREQUENTLY ARE DIVIDENDS AND DISTRIBUTIONS MADE TO INVESTORS?
- --------------------------------------------------------------------------------
The Portfolio will distribute substantially all of its net investment income
and net realized capital gains, if any, to shareholders. All distributions are
reinvested at net asset value in the form of additional full and fractional
Service Shares of the Portfolio unless a shareholder 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
Portfolio declares a dividend each day on "settled" shares (i.e. shares for
which the Portfolio has received payment in Federal funds) on the first Busi-
ness Day after a purchase order is placed with the Fund. Payments by check are
normally converted to Federal funds within two Business Days of receipt. Over
the course of a year, substantially all of the Portfolio's net investment in-
come will be declared as dividends. The amount of the daily dividend for the
Portfolio will be based on periodic projections of its net investment income.
All dividends are paid within ten days after the end of each month. Net real-
ized capital gains (including net short-term capital gains), if any, will be
distributed by the Portfolio at least annually.
23.
<PAGE>
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HOW ARE FUND DISTRIBUTIONS TAXED?
- --------------------------------------------------------------------------------
The Portfolio intends to qualify as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). If
the Portfolio qualifies, 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 distributions (except distributions
that are "exempt interest dividends" or are treated as a return of capital),
whether the distributions are paid in cash or reinvested in additional shares.
Distributions paid out of the Portfolio's "net capital gain" (the excess of 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 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 the Portfolio. Dividends declared in October,
November or December of any year payable to shareholders of record on a speci-
fied date in those months will be deemed to have been received by the share-
holders on December 31 of such year, if the dividends are paid during the fol-
lowing January.
An investor considering buying shares on or just before a dividend record date
should be aware that the amount of the forthcoming dividend payment, although
in effect a return of capital, will be taxable.
A taxable gain or loss may be realized by a shareholder upon the redemption,
transfer or exchange of shares depending upon their tax basis and their price
at the time of redemption, transfer or exchange. Any loss upon the sale or ex-
change of shares held for six months or less will be disallowed for Federal in-
come tax purposes to the extent of any exempt interest dividends received by
the shareholder.
The Portfolio may make investments that produce income that is not matched by a
corresponding cash distribution to the Portfolio, such as investments in pay-
in-kind bonds or in obligations such as zero coupon securities having original
issue discount (i.e., an amount equal to the excess of the stated redemption
price of the security at maturity over its issue price), or market discount
(i.e., an amount equal to the excess of the stated redemption price of the se-
curity over the basis of such bond immediately after it was acquired) if the
Portfolio elects to accrue market discount on a current basis. In addition, in-
come may continue to accrue for federal income tax purposes with respect to a
non-performing investment. Any such income would be treated as income earned by
the Portfolio and therefore would be subject to the distribution requirements
of the Code. Because such income may not be matched by a corresponding cash
distribution to the Portfolio, the Portfolio may be required to borrow money or
dispose of other securities to be able to make distributions to its investors.
In addition, if an election is not made to currently accrue market discount
with respect to a market discount bond, all or a portion of any deduction or
any interest expenses incurred to purchase or hold such bond may be deferred
until such bond is sold or otherwise disposed.
This is not an exhaustive discussion of applicable tax consequences, and in-
vestors may wish to contact their tax advisers concerning investments in the
Portfolio. Except as discussed below, dividends paid by the 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 addi-
tion, shareholders who are non-resident alien individuals, foreign trusts or
estates, foreign corporations or foreign partnerships may be subject to differ-
ent Federal income tax treatment. Future legislative or administrative changes
or court decisions may materially affect the tax consequences of investing in
the Portfolio. For additional information concerning the tax treatment of divi-
dends and distributions by the states listed below including certain restric-
tions applicable to such treatment, see "Taxes" in the Statement of Additional
Information.
24.
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HOW IS THE FUND ORGANIZED?
- --------------------------------------------------------------------------------
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 com-
pany. 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 num-
ber of shares in thirty-eight investment portfolios. The Portfolio offers five
separate classes of shares--Institutional Shares, Service Shares, Investor A
Shares, Investor B Shares and Investor C Shares. This prospectus relates only
to Service Shares of the Portfolio.
Shares of each class bear their pro rata portion of all operating expenses paid
by the Portfolio, except transfer agency fees, certain administrative/servicing
fees and amounts payable under the Fund's Distribution and Service Plan. In ad-
dition, each class of Investor Shares is sold with different sales charges. Be-
cause of these "class expenses" and sales charges, the performance of the In-
stitutional Shares of the Portfolio is expected to be higher than the perfor-
mance of the Portfolio's Service Shares, and the performance of each of the In-
stitutional Shares and Service Shares of the Portfolio is expected to be higher
than the performance of the Portfolio's classes of Investor Shares. The perfor-
mance of each class of Investor Shares may be different. The Fund offers vari-
ous services and privileges in connection with its Investor Shares that are not
generally offered in connection with its Institutional and Service Shares, in-
cluding an automatic investment plan and an automatic withdrawal plan. For fur-
ther information regarding the Fund's Institutional or Investor Share classes,
contact PFPC at (800) 441-7764 (Institutional Shares) or (800) 441-7762 (In-
vestor Shares).
Each share of the Portfolio has a par value of $.001, represents an interest in
the Portfolio and is entitled to the dividends and distributions earned on the
Portfolio's assets that are declared in the discretion of the Board of Trust-
ees. 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 re-
quired 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 February 4, 1998, PNC Bank held of record approximately 78% of the Fund's
outstanding shares, as trustee on behalf of individual and institutional in-
vestors, 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.
25.
<PAGE>
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HOW IS PERFORMANCE CALCULATED?
- -------------------------------------------------------------------------------
Performance information for Service Shares of the Portfolio may be quoted in
advertisements and communications to shareholders. Total return will be calcu-
lated on an average annual total return basis for various periods. Average an-
nual total return reflects the average annual percentage change in value of an
investment in Service 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 dividend and cap-
ital gain distributions made by the Portfolio with respect to its Service
Shares are reinvested in Service Shares.
The yield of Service Shares is computed by dividing the Portfolio's net income
per share allocated to its Service Shares during a 30-day (or one month) pe-
riod by the net asset value per share on the last day of the period and
annualizing the result on a semi-annual basis.
The performance of the Portfolio's Service Shares may be compared to the per-
formance of other mutual funds with similar investment objectives and to rele-
vant indices, as well as to ratings or rankings prepared by independent serv-
ices or other financial or industry publications that monitor the performance
of mutual funds. For example, the performance of the Portfolio's Service
Shares 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 Lehman GNMA Index, the T-Bill Index, the
"stocks, bonds and inflation index" published annually by Ibbotson Associates
and the Lehman Government Corporate Bond Index, as well as any other bench-
marks attached to this Prospectus. Performance information may also include
evaluations of the Portfolio and its Service Shares published by nationally
recognized ranking services, and information as reported in financial publica-
tions such as Business Week, Fortune, Institutional Investor, Money Magazine,
Forbes, Barron's, The Wall Street Journal and The New York Times, or in publi-
cations of a local or regional nature.
In addition to providing performance information that demonstrates the actual
yield or return of Service Shares of the Portfolio, the Portfolio may provide
other information demonstrating hypothetical investment returns. This informa-
tion may include, but is not limited to, illustrating the compounding effects
of dividends in a dividend reinvestment plan or the impact of tax-deferred in-
vesting.
Performance quotations for shares of the Portfolio represent past performance
and should not be considered representative of future results.
The investment return and principal value of an investment in the Portfolio
will fluctuate so that an investor's Service Shares, when redeemed, may be
worth more or less than their original cost. Since performance will fluctuate,
performance data for Service Shares of the Portfolio cannot necessarily be
used to compare an investment in such shares with bank deposits, savings ac-
counts and similar investment alternatives which often provide an agreed or
guaranteed fixed yield for a stated period of time. Performance is generally a
function of the kind and quality of the instruments held in a portfolio, port-
folio maturity, operating expenses and market conditions. Any fees charged by
brokers or other institutions directly to their customer accounts in connec-
tion with investments in Service Shares will not be included in the Portfolio
performance calculations.
26.
<PAGE>
- --------------------------------------------------------------------------------
HOW CAN I GET MORE INFORMATION?
- --------------------------------------------------------------------------------
Below is a brief description of how investors can easily access information
about the BlackRock Funds.
<TABLE>
<CAPTION>
FUND INFORMATION HOURS AVAILABLE PHONE INFORMATION
<S> <C> <C>
INTERNAL 9 AM to 6 PM, E.S.T. toll-free 888-8BLACKROCK
WHOLESALERS/BROKER-DEALER Monday through Friday toll-free 888-825-2257
SUPPORT:
PORTFOLIO MANAGERS 24 Hours, 7 days a week
COMMENTARY: toll-free 800-FUTURE4
(Audio recording updated toll-free 800-388-8734
periodically)
SHAREHOLDER SERVICES
TELEPHONE ACCESS: 24 Hours, 7 days a week toll-free 800-441-7764
ACCOUNT SERVICE 8:30 to 5 PM, E.S.T. toll-free 800-441-7764
REPRESENTATIVES: Monday through Friday
Available to discuss
account balance
information, mutual fund
prospectus, literature and
discuss programs and
services available.
PURCHASES AND REDEMPTIONS: 8:30 to 5 PM, E.S.T. toll-free 800-441-7450
Monday through Friday
WORLD WIDE WEB:
Access general fund 24 Hours, 7 days a week http://www.blackrock.com
information and specific
fund performance. Request
mutual fund prospectuses
and literature. Forward
mutual fund inquiries.
E-MAIL:
Request prospectuses and 24 Hours, 7 days a week [email protected]
literature. Forward mutual
fund inquiries.
WRITTEN CORRESPONDENCE: POST OFFICE BOX ADDRESS STREET ADDRESS
BlackRock Funds BlackRock Funds
c/o PFPC Inc. c/o PFPC Inc.
P.O. Box 8907 400 Bellevue Parkway
Wilmington, DE 19899-8907 Wilmington, DE 19809
</TABLE>
27.
<PAGE>
BLACKROCK FUNDS
THE BLACKROCK FUNDS
BlackRock Funds is a leading mutual fund company currently managing in excess
of $14 billion in 35 portfolios designed to fit a broad range of investment
goals. Each portfolio is managed by recognized experts in equity, fixed income,
international, and tax-free investing who adhere to a pure investment style
/SM/.
STOCK PORTFOLIOS
- --------------------------------------------------------------------------------
Large Cap Growth Equity Select Equity
Large Cap Value Equity Micro-Cap Equity
Mid-Cap Growth Equity International Equity
Mid-Cap Value Equity International Emerging Markets
Small Cap Growth Equity International Small Cap Equity
Small Cap Value Equity Index Equity
STOCK & BOND PORTFOLIO
- --------------------------------------------------------------------------------
Balanced
BOND PORTFOLIOS
- --------------------------------------------------------------------------------
Low Duration Bond Government Income
Intermediate Government Bond Managed Income
Intermediate Bond International Bond
Core Bond GNMA
TAX-FREE BOND PORTFOLIOS
- --------------------------------------------------------------------------------
Tax-Free Income New Jersey Tax-Free Income
Delaware Tax-Free Income Ohio Tax-Free Income
Kentucky Tax-Free Income Pennsylvania Tax-Free Income
MONEY MARKET PORTFOLIOS
- --------------------------------------------------------------------------------
Money Market North Carolina Municipal Money Market
U.S. Treasury Money Market Ohio Municipal Money Market
Municipal Money Market Pennsylvania Municipal Money Market
New Jersey Municipal Money Market Virginia Municipal Money Market
<PAGE>
, 1998
- --------------------------------------------------------------------------------
THE GNMA PORTFOLIO INSTITUTIONAL SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PAGE
<S> <C>
What Are The Expenses Of The Portfolio?...................... 4
What Is The Portfolio?....................................... 5
What Types Of Securities Are In The Portfolio?............... 6
What Additional Investment Policies And Risks Apply?......... 7
What Are The Portfolio's Fundamental Investment
Limitations?................................................ 14
Who Manages The Fund?........................................ 15
How Are Shares Purchased And Redeemed?....................... 17
How Is Net Asset Value Calculated?........................... 19
How Frequently Are Dividends And Distributions Made To
Investors?.................................................. 19
How Are Fund Distributions Taxed?............................ 20
How Is The Fund Organized?................................... 21
How Is Performance Calculated?............................... 22
How Can I Get More Information?.............................. 23
</TABLE>
ASKING THE KEY
QUESTIONS
This Prospectus sets forth concisely information about the Black-
Rock GNMA Portfolio (the "Portfolio") that a prospective investor
needs to know before investing. Please keep it for future refer-
ence. A Statement of Additional Information dated , 1998
has been filed with the Securities and Exchange Commission (the
"SEC"). The Statement of Additional Information may be obtained
free of charge from the BlackRock Funds /SM/ (the "Fund") by call-
ing (800) 441-7764. The Statement of Additional Information, as
supplemented from time to time, is incorporated by reference into
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 infor-
mation regarding the Fund that has been filed with the SEC.
SHARES OF THE PORTFOLIO ARE NOT DEPOSITS OR OBLIGATIONS OF, OR
GUARANTEED OR ENDORSED BY, PNC BANK, NATIONAL ASSOCIATION OR ANY
OTHER BANK AND ARE NOT INSURED BY, GUARANTEED BY, OBLIGATIONS OF
OR OTHERWISE SUPPORTED BY THE U.S. GOVERNMENT, THE FEDERAL DE-
POSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY
OTHER GOVERNMENTAL AGENCY. INVESTMENTS IN THE PORTFOLIO INVOLVE
INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF PRINCIPAL AMOUNT IN-
VESTED.
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 AC-
CURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
2.
<PAGE>
- --------------------------------------------------------------------------------
THE GNMA PORTFOLIO OF BLACKROCK FUNDS
- --------------------------------------------------------------------------------
The BLACKROCK FUND Family consists of 35 portfolios and has
been structured to include many different investment styles
across the spectrum of fixed income investments so that invest-
ors may participate across multiple disciplines in order to
seek their long-term financial goals.
Effective January 31, 1998, the Fund has changed its name from
Compass Capital Funds /SM/ to BlackRock Funds /SM/.
The GNMA Portfolio of BLACKROCK FUNDS is one of fourteen in-
vestment portfolios that provide investors with a broad spec-
trum of investment alternatives within the fixed income sector.
Eight of these portfolios invest in taxable bonds, and six of
these portfolios invest in tax-exempt bonds. A detailed de-
scription of the GNMA Portfolio begins on page . To obtain a
prospectus describing the Fund's other fixed income portfolios,
call (800) 441-7762.
The Portfolio's performance benchmark is the Lehman GNMA Index
and its Lipper peer group is the GNMA Funds category. The Leh-
man GNMA Index is comprised of mortgage-backed pass-through se-
curities of the Government National Mortgage Association
(GNMA).
BlackRock, Inc. serves as investment adviser to the Portfolio.
BlackRock Financial Management, Inc. serves as sub-adviser to
the Portfolio.
UNDERSTANDING This Prospectus has been crafted to provide detailed, accurate
THE and comprehensive information on the BlackRock GNMA Portfolio.
BLACKROCK We intend this document to be an effective tool as you explore
GNMA different directions in fixed income investing.
PORTFOLIO
CONSIDERING There can be no assurance that any mutual fund will achieve its
THE RISKS IN investment objective. The Portfolio may purchase mortgage-re-
BOND lated, asset-backed and illiquid securities; enter into repur-
INVESTING chase and reverse repurchase agreements and engage in
leveraging, which is a speculative technique; lend portfolio
securities to third parties; and enter into futures contracts
and options. See "What Additional Investment Policies And Risks
Apply?"
INVESTING IN For information on how to purchase and redeem shares of the
THE Portfolio, see "How Are Shares Purchased And Redeemed?"
BLACKROCK
FUNDS
3.
<PAGE>
- -------------------------------------------------------------------------------
WHAT ARE THE EXPENSES OF THE PORTFOLIO?
- -------------------------------------------------------------------------------
Below is a summary of the annual operating expenses expected to be incurred by
Institutional Shares of the Portfolio for the current fiscal year as a per-
centage of average daily net assets. The figures shown under "Other expenses"
are estimated for the current fiscal year. An example based on the summary is
also shown.
<TABLE>
<CAPTION>
GNMA
PORTFOLIO
<S> <C> <C>
ANNUAL PORTFOLIO OPERATING EXPENSES
(AS A PERCENTAGE OF AVERAGE NET ASSETS)
Advisory fees (after fee waivers)(/1/) .35%
Other operating expenses .25
---
Administration fees (after fee waivers)(/1/) .17
Other expenses .08
---
Total Portfolio operating expenses (after fee waivers)(/1/) .60%
===
</TABLE>
(1) Without waivers, advisory fees would be .55% and administration fees would
be .23% for the Portfolio. BlackRock, Inc. and the Portfolio's administra-
tors are under no obligation to waive fees or reimburse expenses, but have
informed the Fund that they expect to waive fees and reimburse expenses
during the remainder of the current fiscal year as necessary to maintain
the Portfolio's total operating expenses at the levels set forth in the
table. Without waivers, "Other operating expenses" would be .31% and "To-
tal Portfolio operating expenses" would be .86%.
EXAMPLE
An investor in Institutional Shares would pay the following expenses on a
$1,000 investment assuming (1) a 5% annual return, and (2) redemption at the
end of each time period:
<TABLE>
<CAPTION>
ONE YEAR THREE YEARS
<S> <C> <C>
GNMA Portfolio $ 6 $19
</TABLE>
In addition to the compensation itemized in the expense table, institutions
that sell Portfolio shares and/or their salespersons may receive compensation
for the sale and distribution of shares or for services to the Portfolio. For
information regarding such compensation, see "Investment Advisory, Administra-
tion, Distribution and Servicing Arrangements" in the Statement of Additional
Information.
The foregoing Table and Example are intended to assist investors in under-
standing the costs and expenses that an investor in the Portfolio will bear
either directly or indirectly. They do not reflect any charges that may be im-
posed by brokers or other institutions directly on their customer accounts in
connection with investments in the Portfolio.
THE EXAMPLE SHOWN ABOVE SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE
INVESTMENT RETURN OR OPERATING EXPENSES. ACTUAL INVESTMENT RETURN AND OPERAT-
ING EXPENSES MAY BE MORE OR LESS THAN THOSE SHOWN.
4.
<PAGE>
- --------------------------------------------------------------------------------
WHAT IS THE PORTFOLIO?
- --------------------------------------------------------------------------------
The GNMA Portfolio of BLACKROCK FUNDS is one of fourteen Black-
Rock investment portfolios that provide investors with a broad
spectrum of investment alternatives within the fixed income
sector. Eight of these portfolios invest solely in taxable
bonds and six of these portfolios invest in tax-exempt bonds.
In certain investment cycles and over certain holding periods,
a fund that invests in any one of these styles may perform
above or below the market. An investment program that combines
these multiple disciplines allows investors to select from
among these various product options in the way that most
closely fits the investor's goals and sentiments.
<TABLE>
<C> <S>
Investment Objective The GNMA Portfolio seeks to provide current
income consistent with the preservation of
capital.
Investment Style The Portfolio generally pursues securities
issued by the Government National Mortgage
Association ("GNMAs"), as well as other U.S.
Government securities.
Portfolio Emphasis Portfolio assets are invested primarily in
GNMAs. GNMAs are securities issued by the
Government National Mortgage Association which
represent interests in pools of residential
mortgage loans originated by private lenders.
The dollar-weighted average maturity of the
Portfolio will range from approximately 5 to
10 years.*
</TABLE>
------
* The Portfolio's sub-adviser will normally attempt to struc-
ture the Portfolio to have comparable duration to its perfor-
mance benchmark. Duration, which measures price sensitivity
to interest rate changes, is not necessarily equal to average
maturity.
5.
<PAGE>
- --------------------------------------------------------------------------------
WHAT TYPES OF SECURITIES ARE IN THE PORTFOLIO?
- --------------------------------------------------------------------------------
The following table summarizes the types of securities found in the Portfolio,
according to the following designations:
Yes: The Portfolio will hold a significant concentration of these securities
at all times.
Elig.: Eligible; the Portfolio may purchase these securities, but they may or
may not be a significant holding at a given time.
Temp.: Temporary; the Portfolio may purchase these securities, but under nor-
mal market conditions is not expected to do so.
No:The Portfolio may not purchase these securities.
<TABLE>
<CAPTION>
NON FOREIGN
AGENCY/ SECURITIES/
AGENCY COMMERCIAL HIGH YIELD CURRENCY
TREASURIES AGENCIES MBS/1/ MBS/1/ CORP. ABS/2/ SECURITIES RISK MUNICIPALS
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Yes Yes Yes Elig. Yes Elig. No No Elig.
</TABLE>
/1/MBS = mortgage-backed securities
/2/ABS = asset-backed securities
6.
<PAGE>
- --------------------------------------------------------------------------------
WHAT ADDITIONAL INVESTMENT POLICIES AND RISKS APPLY?
- --------------------------------------------------------------------------------
The Portfolio will normally invest at least 80% of the value of its total as-
sets in debt securities. In addition, under normal market conditions the Port-
folio will invest at least 65% of its total assets in GNMAs. Securities ac-
quired by the Portfolio will be rated in the highest rating category at the
time of purchase (by Standard & Poor's Ratings Group ("S&P"), Moody's Investors
Service, Inc. ("Moody's"), Duff & Phelps Credit Co. or Fitch Investor Services,
Inc.) or, if unrated, of comparable quality as determined by the Portfolio's
sub-adviser. If a security's rating is reduced below the minimum rating that is
permitted for the Portfolio, the Portfolio's sub-adviser will consider whether
the Portfolio should continue to hold the security.
GNMAS AND OTHER MORTGAGE-RELATED AND ASSET-BACKED SECURITIES. The Portfolio
will invest primarily in GNMAs, and may make significant investments in other
residential and commercial mortgage-related and other asset-backed securities
(i.e., securities backed by home equity loans, installment sale contracts,
credit card receivables or other assets) issued by governmental entities and
private issuers.
The Portfolio may acquire several types of mortgage-related securities. GNMAs
are typically mortgage pass-through certificates, which provide the holder with
a pro rata interest in the underlying mortgages. The Portfolio may also acquire
adjustable rate mortgage-related securities ("ARMs") as well as collateralized
mortgage obligations ("CMOs"), which provide the holder with a specified inter-
est in the cash flow of a pool of underlying mortgages or other mortgage-backed
securities. Issuers of CMOs ordinarily elect to be taxed as pass-through enti-
ties known as real estate mortgage investment conduits ("REMICs"). CMOs are is-
sued in multiple classes, each with a specified fixed or floating interest rate
and a final distribution date. The relative payment rights of the various CMO
classes may be structured in a variety of ways. In most cases, however, pay-
ments of principal are applied to the CMO classes in the order of their respec-
tive stated maturities, so that no principal payments will be made on a CMO
class until all other classes having an earlier stated maturity date are paid
in full. The classes may include accrual certificates (also known as "Z-
Bonds"), which only accrue interest at a specified rate until other specified
classes have been retired and are converted thereafter to interest-paying secu-
rities. They may also include planned amortization classes ("PACs") which gen-
erally require, within certain limits, that specified amounts of principal be
applied on each payment date, and generally exhibit less yield and market vola-
tility than other classes.
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 may normally be prepaid at any
time because the underlying assets (i.e., loans) generally may be prepaid at
any time. In calculating the average weighted maturity of the Portfolio, the
maturity of mortgage-related and other asset-backed securities held by the
Portfolio will be based on estimates of average life which take prepayments
into account. 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. In general, the collateral supporting non-mortgage
asset-backed securities is of shorter maturity than mortgage loans and is less
likely to experience substantial prepayments.
The relationship between prepayments and interest rates may give some high-
yielding mortgage-related and asset-backed securities less potential for growth
in value than conventional bonds with comparable maturities. In addition, in
periods of falling interest rates, the rate of prepayments tends to increase.
During such periods, the reinvestment of prepayment proceeds by the Portfolio
will generally be at lower rates than the rates that were carried by the obli-
gations that have been prepaid. Because of these and other reasons, a mortgage-
related or asset-backed security's total return and maturity may be difficult
to predict precisely. To the extent
7.
<PAGE>
- -------------------------------------------------------------------------------
that the Portfolio purchases mortgage-related or asset-backed securities at a
premium, prepayments (which may be made without penalty) may result in loss of
the Portfolio's principal investment to the extent of premium paid.
Non-mortgage asset-backed securities involve risks that are not presented by
mortgage-related securities. Primarily, these securities do not have the bene-
fit of the same security interest in the underlying collateral. Credit card
receivables are generally unsecured, and the debtors are entitled to the pro-
tection of a number of state and Federal consumer credit laws many of which
give debtors the right to set off certain amounts owed on the credit cards,
thereby reducing the balance due. Most issuers of automobile receivables per-
mit the servicers to retain possession of the underlying obligations. If the
servicer were to sell these obligations to another party, there is a risk that
the purchaser would acquire an interest superior to that of the holders of the
related automobile receivables. In addition, because of the large number of
vehicles involved in a typical issuance and technical requirements under state
laws, the trustee for the holders of the automobile receivables may not have
an effective security interest in all of the obligations backing such receiv-
ables. Therefore, there is a possibility that recoveries on repossessed col-
lateral may not, in some cases, be able to support payments on these securi-
ties.
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. (or Sears Mortgage if PNC Mortgage Securities Corp. succeeded
to rights and duties of Sears Mortgage) or mortgage-related securities con-
taining loans or mortgages originated by PNC Bank, National Association ("PNC
Bank") or its affiliates. It is possible that under some circumstances, PNC
Mortgage Securities Corp. or its affiliates could have interests that are in
conflict with the holders of these mortgage-backed securities, and such hold-
ers could have rights against PNC Mortgage Securities Corp. or its affiliates.
STRIPPED AND ZERO COUPON OBLIGATIONS. To the extent consistent with its in-
vestment objective, the Portfolio 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 obliga-
tions. These participations, 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"). Stripped securities,
particularly SMBS, may exhibit greater price volatility than ordinary debt se-
curities because of the manner in which their principal and interest are re-
turned to investors.
SMBS are usually structured with two or more classes that receive different
proportions of the interest and principal distributions from a pool of mort-
gage-backed obligations. A common type of SMBS will have one class receiving
all of the interest, while the other class receives all of the principal. How-
ever, in some cases, one class will receive some of the interest and most of
the principal while the other class will receive most of the interest and the
remainder of the principal. If the underlying obligations experience greater
than anticipated prepayments of principal, the Portfolio may fail to fully re-
coup its initial investment. The market value of SMBS can be extremely vola-
tile in response to changes in interest rates. The yields on a class of SMBS
that receives all or most of the interest are generally higher than prevailing
market yields on other mortgage-related obligations because their cash flow
patterns are also volatile and there is a greater risk that the initial in-
vestment will not be fully recouped.
The Portfolio may invest in zero-coupon bonds, which are normally issued at a
significant discount from face value and do not provide for periodic interest
payments. Zero-coupon bonds may experience greater volatility in market value
than similar maturity debt obligations which provide for regular interest pay-
ments. Additionally, current federal tax law requires the holder of certain
zero coupon bonds to accrue income with respect to these securities prior to
the receipt of cash payments. To maintain its qualification as a regulated in-
vestment company and avoid liability for federal income and excise taxes, the
Portfolio may be required to distribute income accrued with respect to these
securities and may have to dispose of portfolio securities under
8.
<PAGE>
- --------------------------------------------------------------------------------
disadvantageous circumstances in order to generate cash to satisfy these dis-
tribution requirements. See "How Are Fund Distributions Taxed?"
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 Mort-
gage Association are supported by the United States' full faith and credit;
others such as those of the Federal National Mortgage Association and the Stu-
dent 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 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 instrumen-
talities if it is not obligated to do so by law.
CORPORATE AND BANK OBLIGATIONS. To the extent consistent with its investment
objective, the Portfolio may invest in debt obligations of domestic or foreign
corporations and banks, and may acquire commercial obligations issued by Cana-
dian corporations and Canadian counterparts of U.S. corporations, as well as
Europaper, which is U.S. dollar-denominated commercial paper of a foreign issu-
er. Bank obligations may include certificates of deposit, notes, bankers' ac-
ceptances 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 Portfolio 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 INVESTMENTS. The two principal classifications of Municipal Obliga-
tions are "general obligation" securities and "revenue" securities. General ob-
ligation securities are secured by the issuer's pledge of its full faith,
credit and taxing power for the payment of principal and interest. Revenue se-
curities 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 fi-
nanced. 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 in-
clude "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.
Also included within the general category of Municipal Obligations are partici-
pation certificates in a lease, an installment purchase contract, or a condi-
tional sales contract ("lease obligations") entered into by a state or politi-
cal subdivision to finance the acquisition or construction of equipment, land,
or facilities. Although lease obligations are not general obligations of the
issuer for which the state or other governmental body's unlimited taxing power
is pledged, certain lease obligations are backed by a covenant to appropriate
money to make the lease obligation payments. However, under certain lease obli-
gations, the state or governmental body has no obligation to make these pay-
ments in future years unless money is appropriated on a yearly basis. Although
"non-appropriation" lease obligations are secured by the leased property, dis-
position of the property in the event of foreclosure might prove difficult.
These securities represent a relatively new type of financing that is not yet
as marketable as more conventional securities.
To the extent the Portfolio's assets are invested in Municipal Obligations pay-
able from the revenues of similar projects or are invested in private activity
bonds, the Portfolio will be subject to the particular risks presented by the
laws and economic conditions relating to such projects and bonds to a greater
extent than it would be if its assets were not so invested.
The amount of information regarding the financial condition of issuers of Mu-
nicipal Obligations may be less extensive than the information for public cor-
porations, and the secondary market for Municipal Obligations
9.
<PAGE>
- --------------------------------------------------------------------------------
may be less liquid than that for taxable obligations. Accordingly, the ability
of the Portfolio to buy and sell Municipal Obligations may, at any particular
time and with respect to any particular securities, be limited. In addition,
Municipal Obligations purchased by the Portfolio include obligations backed by
letters of credit and other forms of credit enhancement issued by domestic and
foreign banks, as well as other financial institutions.
Opinions relating to the validity of Municipal Obligations and to the exemption
of interest thereon from Federal and state income tax are rendered by counsel
to the respective issuers and sponsors of the obligations at the time of issu-
ance. The Fund and its service providers will rely on such opinions and will
not review independently the underlying proceedings relating to the issuance of
Municipal Obligations, the creation of any tax-exempt derivative securities, or
the bases for such opinions.
INTEREST RATE TRANSACTIONS. The Portfolio may enter into interest rate swaps
and may purchase or sell interest rate caps and floors. The Portfolio may enter
into these transactions primarily to preserve a return or spread on a particu-
lar investment or portion of its holdings, as a duration management technique
or to protect against an increase in the price of securities the Portfolio an-
ticipates purchasing at a later date. The Portfolio intends to use these trans-
actions 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 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. 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 inter-
est on a notional principal amount from the party selling such interest rate
floor.
OPTIONS AND FUTURES CONTRACTS. To the extent consistent with its investment ob-
jective, the Portfolio may write (i.e., sell) covered call options, buy put op-
tions, buy call options and write secured put options for the purpose of hedg-
ing or earning additional income, which may be deemed speculative. For the pay-
ment 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, securities indices
or the yield differential between two securities. The Portfolio will not pur-
chase put and call options when the aggregate premiums on outstanding options
exceed 5% of its net assets at the time of purchase, and will not write options
on more than 25% of the value of its net assets (measured at the time an option
is written). 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.
To the extent consistent with its investment objective, the Portfolio may also
invest in futures contracts and options on futures contracts for hedging pur-
poses or to maintain liquidity. The value of the Portfolio's contracts may
equal or exceed 100% of its total assets, although the Portfolio will not pur-
chase 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 for related futures options entered into for other than bona fide
hedging purposes is 5% or less of its net assets.
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 quan-
tity of a foreign currency. The 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.
The 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 securi-
ties in the value of the securities to be sold. In addition, the Portfolio may
utilize futures contracts in anticipation of changes in the composition of its
holdings or in currency exchange rates.
10.
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The 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 ob-
ligated to sell or buy a futures contract if the option is exercised. In con-
nection with a portfolio's position in a futures contract or related option,
the Fund will create a segregated account of 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 instru-
ments 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 re-
sulting inability to close a futures contract when desired; (c) losses caused
by unanticipated market movements, which are potentially unlimited; (d) the
sub-adviser's inability to predict correctly the direction of securities pric-
es, 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 the Statement of Additional Information.
To maintain greater flexibility, the Portfolio may invest in instruments which
have the characteristics of futures contracts. These instruments may take a va-
riety of forms, such as debt securities with interest or principal payments de-
termined by reference to the value of a commodity at a future point in time.
The risks of such investments could reflect the risks of investing in futures
and securities, including volatility and illiquidity.
The Fund intends to comply with the regulations of the Commodity Futures Trad-
ing Commission exempting the Portfolio from registration as a "commodity pool
operator."
GUARANTEED INVESTMENT CONTRACTS. The Portfolio may make limited investments in
guaranteed investment contracts ("GICs") issued by highly rated U.S. insurance
companies. Under these contracts, a portfolio makes cash contributions to a de-
posit fund of the insurance company's general account. The insurance company
then credits to the portfolio, on a monthly basis, interest which is based on
an index (such as the Salomon Brothers CD Index), but is guaranteed not to be
less than a certain minimum rate. The Portfolio does not expect to invest more
than 5% of its net assets in GICs at any time during the current fiscal year.
SECURITIES LENDING. The Portfolio may seek additional income by lending securi-
ties 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 ir-
revocable bank letters of credit maintained on a current basis equal in value
to at least the market value of the loaned securities. The Portfolio may not
make such loans in excess of 33 1/3% of the value of its total assets. Securi-
ties loans involve risks of delay in receiving additional collateral or in re-
covering the loaned securities, or possibly loss of rights in the collateral if
the borrower of the securities becomes insolvent.
VARIABLE AND FLOATING RATE INSTRUMENTS. The Portfolio may purchase rated and
unrated variable and floating rate instruments. These 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 Portfolio may invest up to 10% of its total assets in leveraged inverse
floating rate debt instruments ("inverse floaters"). The interest rate of an
inverse floater resets in the opposite direction from the market rate of inter-
est to which it is indexed. An inverse floater may be considered to be
leveraged to the extent that its interest rate varies by a magnitude that ex-
ceeds the magnitude of the change in the index rate of interest. The higher de-
gree of leverage inherent in inverse floaters is associated with greater vola-
tility in their market values. Issuers of unrated variable and floating rate
instruments must satisfy the same criteria as set forth above for the Portfo-
lio. The absence of an active secondary market with respect to particular vari-
able and
11.
<PAGE>
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floating rate instruments, however, could make it difficult for the Portfolio
to dispose of a variable or floating rate instrument if the issuer defaulted on
its payment obligation or during periods when the Portfolio is not entitled to
exercise its demand rights.
REPURCHASE AGREEMENTS. The Portfolio may agree to purchase debt securities from
financial institutions subject to the seller's agreement to repurchase them 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. The Portfolio is authorized
to borrow money. If the securities held by the 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 de-
cline 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 Portfolio may use
the proceeds of reverse repurchase agreements to purchase other securities ei-
ther maturing, or under an agreement to resell, on a date simultaneous with or
prior to the expiration of the reverse repurchase agreement. The Portfolio may
use reverse repurchase agreements when it is anticipated that the interest in-
come 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 re-
purchase agreements may be 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 the 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 re-
purchase agreement is outstanding, the Portfolio will maintain a segregated ac-
count with the Fund's custodian containing cash, U.S. Government or other ap-
propriate liquid debt securities having a value at least equal to the repur-
chase price. The 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, the Portfolio may borrow up to an additional 5%
of its total assets for temporary purposes.
INVESTMENT COMPANIES. The Portfolio may invest in securities issued by other
investment companies within the limits prescribed by the 1940 Act. As a share-
holder of another investment company, the Portfolio would bear, along with
other shareholders, its pro rata portion of the other investment company's ex-
penses, including advisory fees. These expenses would be in addition to the ad-
visory and other expenses that the Portfolio bears directly in connection with
its own operations.
ILLIQUID SECURITIES. The Portfolio will not invest more than 15% of the value
of its net assets in securities that are illiquid. GICs, variable and floating
rate 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.
The Portfolio may purchase securities which are not registered under the Secu-
rities Act of 1933 (the "1933 Act") but which can be sold to "qualified insti-
tutional buyers" in accordance with Rule 144A under the 1933 Act. These securi-
ties will not be considered illiquid so long as it is determined by the Portfo-
lio's sub-adviser that an adequate trading market exists for the securities.
This investment practice could have the effect of increasing the level of illi-
quidity in the Portfolio during any period that qualified institutional buyers
become uninterested in purchasing these restricted securities.
WHEN-ISSUED PURCHASES AND FORWARD COMMITMENTS. The Portfolio may purchase secu-
rities on a "when-issued" basis and may purchase or sell securities on a "for-
ward 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 portfo-
lio to lock in a price or yield on a security that it owns or intends to pur-
chase, 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
12.
<PAGE>
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in a transaction may be less favorable than the price or yield available in the
market when the securities delivery takes place. The Portfolio's when-issued
purchases and forward commitments are not expected to exceed 25% of the value
of its total assets absent unusual market conditions.
DOLLAR ROLL TRANSACTIONS. To take advantage of attractive opportunities in the
mortgage market and to enhance current income, the 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. Dur-
ing the period between the sale and repurchase, the Portfolio will not be enti-
tled to receive interest and principal payments on the securities sold. Pro-
ceeds of the sale will be invested in additional instruments for the Portfolio,
and the income from these investments will generate income for the Portfolio.
If such income 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 the
Portfolio compared with what the performance would have been without the use of
dollar rolls. At the time the Portfolio enters into a dollar roll transaction,
it will place in a segregated account maintained with its custodian cash, U.S.
Government securities or other liquid securities having a value equal to the
repurchase price (including accrued interest) and will subsequently monitor the
account to ensure that its value is maintained. The 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 securi-
ties the Portfolio is required to purchase may decline below the agreed upon
repurchase price of those securities. If the broker/dealer to whom the Portfo-
lio sells securities becomes insolvent, the Portfolio's right to purchase or
repurchase securities may be restricted. Successful use of mortgage dollar
rolls may depend upon the sub-adviser's ability to correctly predict interest
rates and prepayments. There is no assurance that dollar rolls can be success-
fully employed.
SHORT SALES. The Portfolio may only make short sales of securities "against-
the-box." 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 de-
cline. The Portfolio 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 portfolio flexibility. In a short sale "against-the-box," at the time
of sale, the portfolio owns or has the immediate and unconditional right to ac-
quire the identical security at no additional cost. When selling short
"against-the-box," a portfolio forgoes an opportunity for capital appreciation
in the security.
PORTFOLIO TURNOVER RATES. Under normal market conditions, it is expected that
the annual portfolio turnover rate for the Portfolio will not exceed 450%. The
Portfolio's annual portfolio turnover rate will not be a factor preventing a
sale or purchase when the sub-adviser believes investment considerations war-
rant such sale or purchase. Portfolio turnover may vary greatly from year to
year as well as within a particular year. High portfolio turnover rates (i.e.,
100% or more) will generally result in higher transaction costs to the Portfo-
lio and may result in the realization of short-term capital gains that are tax-
able to shareholders as ordinary income.
INTEREST RATE AND EXTENSION RISK. The value of fixed income securities in the
Portfolio can 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 potentially greater capital appreciation and de-
preciation than securities with shorter maturities. The Portfolio is not re-
stricted to any maximum or minimum time to maturity in purchasing individual
portfolio securities, and the average maturity of the Portfolio's assets will
vary within the limits stated herein based upon its sub-adviser's assessment of
economic and market conditions. Although the Portfolio's sub-adviser will nor-
mally attempt to structure the Portfolio to have a comparable duration to its
benchmark as stated in that section, there can be no assurance that it will be
able to do so at all times.
13.
<PAGE>
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WHAT ARE THE PORTFOLIO'S FUNDAMENTAL INVESTMENT LIMITATIONS?
- --------------------------------------------------------------------------------
The Portfolio's investment objective and policies may be changed by the Fund's
Board of Trustees without shareholder approval. However, shareholders will be
given at least 30 days' notice before any change to the Portfolio's investment
objective. No assurance can be provided that the Portfolio will achieve its in-
vestment objective.
The Portfolio has also adopted certain fundamental investment limitations that
may be changed only with the approval of a "majority of the outstanding shares
of the Portfolio" (as defined in the Statement of Additional Information). Sev-
eral of the Portfolio's fundamental investment policies, which are set forth in
full in the Statement of Additional Information, are summarized below.
The Portfolio may not:
(1) purchase securities (except U.S. Government securities) if more than 5% of
its total assets will be invested in the securities of any one issuer, ex-
cept that up to 25% of the Portfolio's total assets may be invested without
regard to this 5% limitation; or
(2) invest 25% or more of its total assets in one or more issuers conducting
their principal business activities in the same industry.
The investment limitations stated above are applied at the time investment se-
curities are purchased.
14.
<PAGE>
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WHO MANAGES THE FUND?
- --------------------------------------------------------------------------------
BOARD OF The business and affairs of the Fund are managed under the di-
TRUSTEES rection of its Board of Trustees. The following persons cur-
rently serve on the Board:
William O. Albertini--Executive Vice President and Chief Finan-
cial 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 Institutional Center, The Wharton School, University
of Pennsylvania.
David R. Wilmerding, Jr.--Chairman, Gee, Wilmerding & Associ-
ates, Inc.
ADVISER AND The Adviser to the BlackRock Funds is BlackRock, Inc. Black-
SUB-ADVISER Rock, Inc. (formerly PNC Asset Management Group, Inc.) was or-
ganized in 1994 to perform advisory services for investment
companies, and has its principal offices at 1600 Market Street,
29th Floor, Philadelphia, Pennsylvania 19103. BlackRock, Inc.
is an indirect wholly-owned subsidiary of PNC Bank Corp., a
multi-bank holding company.
The sub-adviser to the Portfolio is BlackRock Financial Manage-
ment, Inc. ("BlackRock"), an affiliate of BlackRock, Inc., with
its primary offices at 345 Park Avenue, New York, New York
10154. BlackRock is a registered investment adviser, organized
in 1988. Robert S. Kapito, Scott Amero and Michael P. Lustig
serve as portfolio managers of the Portfolio. Mr. Kapito has
been Vice Chairman of the sub-adviser since 1988, Mr. Amero has
been Managing Director of the sub-adviser since 1990, and Mr.
Lustig has been a portfolio manager of the sub-adviser since
1995.
As adviser, BlackRock, Inc. is responsible for the overall in-
vestment management of the Portfolio. As sub-adviser, BlackRock
Financial Management is responsible for the day-to-day manage-
ment of the Portfolio, and generally makes all purchase and
sale investment decisions for the Portfolio. BlackRock Finan-
cial Management also provides research and credit analysis.
THE AFFILIATE SUB-ADVISERS OF BLACKROCK, INC. ARE:
. BlackRock Financial Management, Inc.: Domestic and non-dollar
fixed income.
. PNC Equity Advisors: Growth equity.
. Provident Capital Management: Value equity.
. CastleInternational Asset Management: International equity.
. PNC Institutional Management Corporation: Money market.
For their investment advisory and sub-advisory services, Black-
Rock, Inc. and the Portfolio's sub-adviser are entitled to
fees, computed daily and payable monthly, at the maximum annual
rates set forth below. As stated under "What Are The Expenses
Of The Portfolio?", BlackRock, Inc. and the sub-adviser intend
to waive a portion of their fees during the current fiscal
year. All sub-advisory fees are paid by BlackRock, Inc., and do
not represent an extra charge to the Portfolio.
MAXIMUM ANNUAL CONTRACTUAL FEE RATE (BEFORE WAIVERS)
<TABLE>
<CAPTION>
AVERAGE DAILY INVESTMENT SUB-ADVISORY
NET ASSETS ADVISORY FEE FEE
<S> <C> <C>
first $1 billion .550% .400%
$1 billion--$2 billion .500 .350
$2 billion--$3 billion .475 .325
greater than $3 billion .450 .300
</TABLE>
15.
<PAGE>
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The Portfolio's sub-adviser strives to achieve best execution
on all transactions. Infrequently, brokerage transactions for
the Portfolio may be directed through registered
broker/dealers who have entered into dealer agreements with
the Fund's distributor, subject to the requirements of best
execution.
ADMINISTRATORS BlackRock, Inc., PFPC Inc. ("PFPC") and BlackRock Distribu-
tors, Inc. ("BDI") (the "Administrators") serve as the Fund's
co-administrators. BlackRock, Inc. and PFPC are indirect
wholly-owned subsidiaries of PNC Bank Corp. BDI is a wholly-
owned subsidiary of Provident Distributors, Inc. ("PDI"). A
majority of the outstanding stock of PDI is owned by its of-
ficers.
The Administrators generally assist the Fund in all aspects
of its administration and operation, including matters relat-
ing to the maintenance of financial records and fund account-
ing. As compensation for these services, BlackRock, Inc. is
entitled to receive a fee, computed daily and payable month-
ly, at an annual rate of .03% of the Portfolio's average
daily net assets. PFPC and BDI are entitled to receive a com-
bined administration fee, computed daily and payable monthly,
at the aggregate annual rate of (i) .085% of the first $500
million of the Portfolio's average daily net assets, .075% of
the next $500 million of the Portfolio's average daily net
assets and .065% of the average daily net assets of the Port-
folio in excess of $1 billion and (ii) .115% of the first
$500 million of the average daily net assets allocated to In-
stitutional Shares of the Portfolio, .105% of the next $500
million of such average daily net assets and .095% of the av-
erage daily net assets allocated to Institutional Shares of
the Portfolio in excess of $1 billion. From time to time the
Administrators may waive some or all of their administration
fees from the Portfolio.
For information about the operating expenses the Portfolio
expects to incur in the current fiscal year, see "What Are
The Expenses Of The Portfolio?"
TRANSFER AGENT, PNC Bank, whose principal offices are located at 1600 Market
DIVIDEND Street, Philadelphia, Pennsylvania 19103, serves as the Port-
DISBURSING folio's custodian and PFPC, whose principal offices are lo-
AGENT AND cated at 400 Bellevue Parkway, Wilmington, Delaware 19809,
CUSTODIAN serves as their transfer agent and dividend disbursing agent.
EXPENSES Expenses are deducted from the total income of the Portfolio
before dividends and distributions are paid. Expenses in-
clude, but are not limited to, fees paid to BlackRock, Inc.
and the Administrators, transfer agency and custodian fees,
trustee fees, taxes, interest, professional fees, 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 pro-
spectuses and statements of additional information to exist-
ing shareholders, expenses relating to shareholder reports,
shareholder meetings and proxy solicitations, insurance pre-
miums, the expense of independent pricing services, and other
expenses which are not expressly assumed by BlackRock, Inc.
or the Fund's service providers under their agreements with
the Fund. 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.
16.
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HOW ARE SHARES PURCHASED AND REDEEMED?
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DISTRIBUTOR. Shares of the Portfolio are offered on a continuous basis by BDI
as distributor (the "Distributor"). BDI maintains its principal offices at Four
Falls Corporate Center, 6th Floor, West Conshohocken, PA 19428-2961.
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 Institutional Shares. However, the
Plan permits BDI, 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 sponsor-
ship 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 "In-
vestment Advisory, Administration, Distribution and Servicing Arrangements" in
the Statement of Additional Information.
PURCHASE OF SHARES. Institutional Shares are offered to institutional invest-
ors, including (a) registered investment advisers with a minimum investment of
$500,000 and (b) the trust departments of PNC Bank and its affiliates (collec-
tively, "PNC") on behalf of clients for whom PNC (i) acts in a fiduciary capac-
ity (excluding participant-directed employee benefit plans) or otherwise has
investment discretion or (ii) acts as custodian with respect to at least
$2,000,000 in assets, and individuals with a minimum investment of $2,000,000.
Institutional Shares are sold at their net asset value per share next computed
after an order is received by PFPC. Orders received by PFPC by 4:00 p.m. (East-
ern Time) on a Business Day are priced the same day. A "Business Day" is any
weekday that the New York Stock Exchange (the "NYSE") and the Federal Reserve
Bank of Philadelphia (the "FRB") are open for business.
Purchase orders may be placed by telephoning PFPC at (800) 441-7450. Orders re-
ceived by PFPC after 4:00 p.m. (Eastern Time) are priced on the following Busi-
ness Day.
Payment for Institutional Shares must normally be made in Federal funds or
other funds immediately available to the Fund's custodian. Payment may also, in
the discretion of the Fund, be made in the form of securities that are permis-
sible investments for the Portfolio. For further information, see the Statement
of Additional Information. The minimum initial investment for institutions is
$5,000. There is no minimum subsequent investment requirement. The Fund does
not accept third party checks for initial or subsequent investments.
The Fund may in its discretion waive or modify the minimum investment amount,
may reject any order for Institutional Shares and may suspend and resume the
sale of shares of any share class of the Portfolio at any time.
In the event that a shareholder acquiring Institutional Shares on or after May
1, 1998 ceases to meet the eligibility standards for purchasing Institutional
Shares (other than due to fluctuations in market value), then the shareholder's
Institutional Shares will, upon the direction of the Fund's distributor, auto-
matically be converted to shares of another class of the Portfolio having the
same aggregate net asset value as the shares converted. If, at the time of con-
version, an institution offering Service Shares of the Portfolio is acting on
the shareholder's behalf, then the shareholder's Institutional Shares will be
converted to Service Shares of the Portfolio. If not, then the shareholder's
Institutional Shares will be converted to Investor A Shares of the Portfolio.
Service Shares are currently authorized to bear additional service and process-
ing fees at the aggregate annual rate of .30% of average daily net assets,
while Investor A Shares are currently authorized to bear additional service,
processing and distribution fees at the aggregate annual rate of .50% of aver-
age daily net assets.
17.
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REDEMPTION OF SHARES. Redemption orders for Institutional Shares may be placed
by telephoning PFPC at (800) 441-7450. Institutional Shares are redeemed at
their net asset value per share next determined after PFPC's receipt of the re-
demption order. 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.
Payment for redeemed shares for which a redemption order is received by PFPC
before 4:00 p.m. (Eastern Time) on a Business Day is normally made in Federal
funds wired to the redeeming Institution on the next Business Day, provided
that the Fund's custodian is also open for business. Payment for redemption or-
ders received after 4:00 p.m. (Eastern Time) or on a day when the Fund's custo-
dian is closed is normally wired in Federal funds on the next Business Day fol-
lowing redemption on which the Fund's custodian is open for business. The Fund
reserves the right to wire redemption proceeds within seven days after receiv-
ing a redemption order if, in the judgment of BlackRock, Inc., an earlier pay-
ment could adversely affect the Portfolio. No charge for wiring redemption pay-
ments is imposed by the Fund.
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 Fund may redeem Institutional Shares in any shareholder's account if the
account balance drops below $5,000 as the result of redemption requests and the
shareholder does not increase the balance to at least $5,000 on thirty days'
written notice.
The Fund may also suspend the right of redemption or postpone the date of pay-
ment 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 Fund's responsibili-
ties under the 1940 Act. See "Purchase and Redemption Information" in the
Statement of Additional Information for examples of when such redemption might
be appropriate.
Shares of the Portfolio may be purchased by customers of broker-dealers and
agents which have established a servicing relationship with the Fund on behalf
of their customers. These broker-dealers and agents may impose additional or
different conditions on the purchase or redemption of Portfolio shares by their
customers and may charge their customers transaction, account or other fees on
the purchase and redemption of Portfolio shares. Each broker-dealer or agent is
responsible for transmitting to its customers a schedule of any such fees and
information regarding any additional or different conditions regarding pur-
chases and redemptions. Shareholders who are customers of such broker-dealers
or agents should consult them for information regarding these fees and condi-
tions.
18.
<PAGE>
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HOW IS NET ASSET VALUE CALCULATED?
- --------------------------------------------------------------------------------
Net asset value is calculated separately for Institutional Shares of the Port-
folio as of the close of regular trading hours on the NYSE (currently 4:00 p.m.
Eastern Time) on each Business Day by dividing the value of all securities and
other assets owned by the Portfolio that are allocated to its Institutional
Shares, less the liabilities charged to its Institutional Shares, by the number
of its Institutional Shares that are outstanding.
Most securities held by the Portfolio are priced based on their market value as
determined by reported sales prices, or the mean between bid and asked prices,
that are provided by securities dealers or pricing services. Portfolio securi-
ties which are primarily traded on foreign securities exchanges are normally
valued at the preceding closing values of such securities on their respective
exchanges. Securities for which market quotations are not readily available are
valued at fair market value as determined in good faith by or under the direc-
tion 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 Portfolio's sub-adviser under the supervision of the Board
of Trustees determines such method does not represent fair value.
HOW FREQUENTLY ARE DIVIDENDS AND DISTRIBUTIONS MADE TO INVESTORS?
- --------------------------------------------------------------------------------
The Portfolio will distribute substantially all of its net investment income
and net realized capital gains, if any, to shareholders. All distributions are
reinvested at net asset value in the form of additional full and fractional
shares of Institutional Shares of the Portfolio unless a shareholder 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 re-
ceipt by PFPC. The Portfolio declares a dividend each day on "settled" shares
(i.e. shares for which the Portfolio has received payment in Federal funds) on
the first Business day after a purchase order is placed with the Fund. Payments
by check are normally converted to Federal funds within two Business Days of
receipt. Over the course of a year, substantially all of the Portfolio's net
investment income will be declared as dividends. the amount of the daily divi-
dend for the Portfolio will be based on periodic projections of its net invest-
ment income. All dividends are paid within ten days after the end of each
month. Net realized capital gains (including net short-term capital gains), if
any, will be distributed by the Portfolio at least annually.
19.
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HOW ARE FUND DISTRIBUTIONS TAXED?
- --------------------------------------------------------------------------------
The Portfolio intends to qualify as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). If
the Portfolio qualifies, 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 distributions (except distributions
that are "exempt interest dividends" or are treated as a return of capital),
whether the distributions are paid in cash or reinvested in additional shares.
Distributions paid out of the Portfolio's "net capital gain" (the excess of 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 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 the Portfolio. Dividends declared in October,
November or December of any year payable to shareholders of record on a speci-
fied date in those months will be deemed to have been received by the share-
holders on December 31 of such year, if the dividends are paid during the fol-
lowing January.
An investor considering buying shares on or just before a dividend record date
should be aware that the amount of the forthcoming dividend payment, although
in effect a return of capital, will be taxable.
A taxable gain or loss may be realized by a shareholder upon the redemption,
transfer or exchange of shares depending upon their tax basis and their price
at the time of redemption, transfer or exchange. Any loss upon the sale or ex-
change of shares held for six months or less will be disallowed for Federal in-
come tax purposes to the extent of any exempt interest dividends received by
the shareholder.
TAX TREATMENT OF CERTAIN SECURITIES. The Portfolio may make investments that
produce income that is not matched by a corresponding cash distribution to the
Portfolio, such as investments in pay-in-kind bonds or in obligations such as
zero coupon securities having original issue discount (i.e., an amount equal to
the excess of the stated redemption price of the security at maturity over its
issue price), or market discount (i.e., an amount equal to the excess of the
stated redemption price of the security over the basis of such bond immediately
after it was acquired) if the Portfolio elects to accrue market discount on a
current basis. In addition, income may continue to accrue for federal income
tax purposes with respect to a non-performing investment. Any such income would
be treated as income earned by the Portfolio and therefore would be subject to
the distribution requirements of the Code. Because such income may not be
matched by a corresponding cash distribution to the Portfolio, the Portfolio
may be required to borrow money or dispose of other securities to be able to
make distributions to its investors. In addition, if an election is not made to
currently accrue market discount with respect to a market discount bond, all or
a portion of any deduction or any interest expenses incurred to purchase or
hold such bond may be deferred until such bond is sold or otherwise disposed.
This is not an exhaustive discussion of applicable tax consequences, and in-
vestors may wish to contact their tax advisers concerning investments in the
Portfolio. Except as discussed below, dividends paid by the 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,shareholders who are non-resident alien individuals, foreign trusts or
estates, foreign corporations or foreign partnerships may be subject to differ-
ent Federal income tax treatment. Future legislative or administrative changes
or court decisions may materially affect the tax consequences of investing in
the Portfolio. For additional information concerning the tax treatment of divi-
dends and distributions by the states listed below, including certain restric-
tions applicable to such treatment, see "Taxes" in the Statement of Additional
Information.
20.
<PAGE>
- --------------------------------------------------------------------------------
HOW IS THE FUND ORGANIZED?
- --------------------------------------------------------------------------------
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 com-
pany. 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 num-
ber of shares in thirty-eight investment portfolios. The Portfolio offers five
separate classes of shares--Institutional Shares, Service Shares, Investor A
Shares, Investor B Shares and Investor C Shares. This prospectus relates only
to Institutional Shares of the Portfolio.
Shares of each class bear their pro rata portion of all operating expenses paid
by the Portfolio, except transfer agency fees, certain administrative/servicing
fees and amounts payable under the Fund's Distribution and Service Plan. Be-
cause of these "class expenses" and sales charges, the performance of the Port-
folio's Institutional Shares is expected to be higher than the performance of
the Portfolio's Service Shares, and the performance of each of the Institu-
tional Shares and Service Shares of the Portfolio is expected to be higher than
the performance of the Portfolio's classes of Investor Shares. The performance
of each class of Investor Shares may be different. The Fund offers various
services and privileges in connection with its Investor Shares that are not
generally offered in connection with its Institutional and Service Shares, in-
cluding an automatic investment plan and an automatic withdrawal plan. For fur-
ther information regarding the Fund's Service or Investor Share classes, con-
tact PFPC at (800) 441-7764 (Service Shares) or (800) 441-7762 (Investor
Shares).
Each share of the Portfolio has a par value of $.001, represents an interest in
the Portfolio and is entitled to the dividends and distributions earned on the
Portfolio's assets that are declared in the discretion of the Board of Trust-
ees. 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 re-
quired 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 February 4, 1998, PNC Bank held of record approximately 78% of the Fund's
outstanding shares, as trustee on behalf of individual and institutional in-
vestors, 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.
21.
<PAGE>
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HOW IS PERFORMANCE CALCULATED?
- -------------------------------------------------------------------------------
Performance information for Institutional Shares of the Portfolio may be
quoted in advertisements and communications to shareholders. Total return will
be calculated on an average annual total return basis for various periods. Av-
erage annual total return reflects the average annual percentage change in
value of an investment in Institutional Shares of the Portfolio over the mea-
suring period. Total return may also be calculated on an aggregate total re-
turn basis. Aggregate total return reflects the total percentage change in
value over the measuring period. Both methods of calculating total return as-
sume that dividend and capital gain distributions made by the Portfolio with
respect to its Institutional Shares are reinvested in Institutional Shares.
The yield of Institutional Shares is computed by dividing the Portfolio's net
income per share allocated to its Institutional 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.
The performance of the Portfolio's Institutional Shares may be compared to the
performance of other mutual funds with similar investment objectives and to
relevant indices, as well as to ratings or rankings prepared by independent
services or other financial or industry publications that monitor the perfor-
mance of mutual funds. For example, the performance of the Portfolio's Insti-
tutional Shares may be compared to data prepared by Lipper Analytical Servic-
es, Inc., CDA Investment Technologies, Inc. and Weisenberger Investment Com-
pany Service, and with the performance of the Lehman GNMA Index, the T-Bill
Index, the "stocks, bonds and inflation index" published annually by Ibbotson
Associates and the Lehman Government Corporate Bond Index, as well as any
other benchmarks discussed in this Prospectus. Performance information may
also include evaluations of the Portfolio and its Institutional Shares pub-
lished by nationally recognized ranking services, and information as reported
in financial publications such as Business Week, Fortune, Institutional In-
vestor, 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 return of Institutional Shares of the Portfolio, the Portfolio may
provide other information demonstrating hypothetical investment returns. This
information may include, but is not limited to, illustrating the compounding
effects of dividends in a dividend reinvestment plan or the impact of tax-de-
ferred investing.
Performance quotations for shares of the Portfolio represent past performance
and should not be considered representative of future results.
The investment return and principal value of an investment in the Portfolio
will fluctuate so that an investor's Institutional Shares, when redeemed, may
be worth more or less than their original cost. Since performance will fluctu-
ate, performance data for Institutional Shares of the Portfolio cannot neces-
sarily 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. Performance is
generally a function of the kind and quality of the instruments held in a
portfolio, portfolio maturity, operating expenses and market conditions. Any
fees charged by brokers or other institutions directly to their customer ac-
counts in connection with investments in Institutional Shares will not be in-
cluded in the Portfolio performance calculations.
22.
<PAGE>
- --------------------------------------------------------------------------------
HOW CAN I GET MORE INFORMATION?
- --------------------------------------------------------------------------------
CONVENIENT WAYS TO ACCESS FUND INFORMATION
Below is a brief description of how investors can easily access information
about the BlackRock Funds.
<TABLE>
<CAPTION>
FUND INFORMATION HOURS AVAILABLE PHONE INFORMATION
<S> <C> <C>
INTERNAL 9 AM to 6 PM, E.S.T. toll-free 888-8BLACKROCK
WHOLESALERS/BROKER-DEALER Monday through Friday toll-free 888-825-2257
SUPPORT:
PORTFOLIO MANAGERS 24 Hours, 7 days a week toll-free 800-FUTURE4
COMMENTARY: toll-free 800-388-8734
(Audio recording updated
periodically)
SHAREHOLDER SERVICES
TELEPHONE ACCESS: 24 Hours, 7 days a week toll-free 800-441-7764
ACCOUNT SERVICE 8:30 to 5 PM, E.S.T. toll-free 800-441-7764
REPRESENTATIVES: Monday through Friday
Available to discuss
account balance
information, mutual fund
prospectus, literature and
discuss programs and
services available.
PURCHASES AND REDEMPTIONS: 8:30 to 5 PM, E.S.T. toll-free 800-441-7450
Monday through Friday
WORLD WIDE WEB:
Access general fund 24 Hours, 7 days a week http://www.blackrock.com
information and specific
fund performance. Request
mutual fund prospectuses
and literature. Forward
mutual fund inquiries.
E-MAIL:
Request prospectuses and 24 Hours, 7 days a week [email protected]
literature. Forward mutual
fund inquiries.
WRITTEN CORRESPONDENCE: POST OFFICE BOX ADDRESS STREET ADDRESS
BlackRock Funds BlackRock Funds
c/o PFPC Inc. c/o PFPC Inc.
P.O. Box 8907 400 Bellevue Parkway
Wilmington, DE 19899-8907 Wilmington, DE 19809
</TABLE>
23.
<PAGE>
BLACKROCK FUNDS
THE BLACKROCK FUNDS
BlackRock Funds is a leading mutual fund company currently managing in excess
of $14 billion in 35 portfolios designed to fit a broad range of investment
goals. Each portfolio is managed by recognized experts in equity, fixed income,
international, and tax-free investing who adhere to a pure investment
style./SM/
STOCK PORTFOLIOS
- --------------------------------------------------------------------------------
Large Cap Growth Equity Select Equity
Large Cap Value Equity Micro-Cap Equity
Mid-Cap Growth Equity International Equity
Mid-Cap Value Equity International Emerging Markets
Small Cap Growth Equity International Small Cap Equity
Small Cap Value Equity Index Equity
STOCK & BOND PORTFOLIO
- --------------------------------------------------------------------------------
Balanced
BOND PORTFOLIOS
- --------------------------------------------------------------------------------
Low Duration Bond Government Income
Intermediate Government Bond Managed Income
Intermediate Bond International Bond
Core Bond GNMA
TAX-FREE BOND PORTFOLIOS
- --------------------------------------------------------------------------------
Tax-Free Income New Jersey Tax-Free Income
Delaware Tax-Free Income Ohio Tax-Free Income
Kentucky Tax-Free Income Pennsylvania Tax-Free Income
MONEY MARKET PORTFOLIOS
- --------------------------------------------------------------------------------
Money Market North Carolina Municipal Money Market
U.S. Treasury Money Market Ohio Municipal Money Market
Municipal Money Market Pennsylvania Municipal Money Market
New Jersey Municipal Money Market Virginia Municipal Money Market
<PAGE>
BLACKROCK FUNDS/SM/
(FORMERLY, COMPASS CAPITAL FUNDS/SM/)
STATEMENT OF ADDITIONAL INFORMATION
This Statement of Additional Information provides supplementary information
pertaining to shares representing interests in the Money Market, Municipal Money
Market, U.S. Treasury Money Market (formerly, the Government Money Market
Portfolio), 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 (formerly, the Value
Equity Portfolio), Large Cap Growth Equity (formerly, the Growth Equity
Portfolio), Index Equity, Small Cap Value Equity, Mid-Cap Value Equity, Micro-
Cap Equity, International Equity, International Emerging Markets, International
Small Cap Equity, Balanced, Small Cap Growth Equity, Mid-Cap Growth Equity,
Select Equity (formerly, the Core Equity Portfolio), Managed Income, Tax-Free
Income, Intermediate Government Bond (formerly, the Intermediate Government
Portfolio), Delaware Tax-Free Income, Kentucky Tax-Free Income, Ohio Tax-Free
Income, Pennsylvania Tax-Free Income, Low Duration Bond (formerly, the Short
Government Bond Portfolio), Intermediate Bond (formerly, the Intermediate-Term
Bond Portfolio), Government Income, International Bond (formerly, the
International Fixed Income Portfolio), New Jersey Tax-Free Income, Core Bond and
GNMA Portfolios (collectively, the "Portfolios") of BlackRock Funds (the
"Fund"). The 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 and New Jersey Municipal
Money Market Portfolios are called "Money Market Portfolios," and the other
Portfolios are called "Non-Money Market Portfolios." This Statement of
Additional Information is not a prospectus, and should be read only in
conjunction with the Prospectuses of the Fund relating to the Portfolios dated
___________ __, 1998, as amended from time to time (the "Prospectuses").
Prospectuses may be obtained from the Fund's distributor by calling toll-free
(800) 441-7379. This Statement of Additional Information is dated __________
__, 1998. Capitalized terms used herein and not otherwise defined have the same
meanings as are given to them in the Prospectuses.
<PAGE>
CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Investment Policies............................. 3
Special Considerations for State-Specific
Portfolios..................................... 24
Trustees and Officers........................... 68
Shareholder and Trustee Liability of the Fund... 79
Investment Advisory, Administration,
Distribution and Servicing Arrangements........ 80
Expenses........................................ 107
Portfolio Transactions.......................... 108
Purchase and Redemption Information............. 113
Valuation of Portfolio Securities............... 120
Performance Information......................... 124
Taxes........................................... 157
Additional Information Concerning Shares........ 167
Miscellaneous................................... 169
Financial Statements............................ 173
Appendix A (Description of Securities Ratings).. A-1
Appendix B (Description of Futures)............. 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
PROSPECTUSES IN CONNECTION WITH THE OFFERING MADE BY THE PROSPECTUSES 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 PROSPECTUSES DO 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.
-2-
<PAGE>
INVESTMENT POLICIES
The following supplements information contained in the Prospectuses
concerning the Portfolios' investment policies. Except as indicated, the
information below relates only to those Portfolios that are authorized to invest
in the instruments or securities described below.
The Index Equity Portfolio invests all of its investable assets in The U.S.
Large Company Series (the "Index Master Portfolio") of The DFA Investment Trust
Company (the "Trust"). Accordingly, the following discussion relates to: (i)
the investment policies of all the Portfolios including the Index Equity
Portfolio; and (ii) where indicated the investment policies of the Index Master
Portfolio.
ADDITIONAL INFORMATION ON INVESTMENT STRATEGY
The Large Cap Value Equity, Large Cap Growth Equity, Mid-Cap Value Equity
and Mid-Cap Growth Equity Portfolios will invest primarily in securities of
established companies. For this purpose, an established company is one which,
together with its predecessors, has at least three years of continuous operating
history.
The Low Duration Bond Portfolio will seek to maintain a duration for its
portfolio in a range of +/-20% of the current duration of the Merrill Lynch 1-3
Year Treasury Index. The Government Income Portfolio will seek to maintain an
interest rate sensitivity within a range comparable to that of 7 to 10 year U.S.
Treasury bonds.
ADDITIONAL INFORMATION ON PORTFOLIO INVESTMENTS.
REVERSE REPURCHASE AGREEMENTS. Each Portfolio (including the Index Master
Portfolio) other than the Municipal Money Market, Ohio Municipal Money Market,
Pennsylvania Municipal Money Market, North Carolina Municipal Money Market,
Virginia Municipal Money Market and New Jersey Municipal Money Market Portfolios
(the "Municipal Money Market Portfolios") may invest in reverse repurchase
agreements. Reverse repurchase agreements involve the sale of securities held
by a Portfolio pursuant to a 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 maintain
in a segregated account 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 or sub-adviser will consider
the earning power, cash flows and
-3-
<PAGE>
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. In determining average-weighted portfolio maturity, an
instrument will be deemed to have a maturity equal to either the period
remaining until the next interest rate adjustment or the time the Portfolio
involved can recover payment of principal as specified in the instrument,
depending on the type of instrument involved. Each of the Equity Portfolios of
the Fund does not intend to invest more than 5% of its net assets in variable
and floating rate 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. Each of the Equity Portfolios of the Fund
does not intend to invest more than 5% of its net assets in bank obligations.
The Index Master Portfolio may purchase obligations of U.S. banks and
savings and loan associations and dollar-denominated obligations of U.S.
subsidiaries and branches of foreign banks, such as certificates of deposit
(including marketable variable rate certificates of deposit) and bankers'
acceptances. Bank certificates of deposit will only be acquired by the Index
Master Portfolio if the bank has assets in excess of $1 billion.
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
-4-
<PAGE>
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 "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 Managed Income, Intermediate Government, Low Duration Bond,
Intermediate Bond, Government Income, International Bond, Core Bond, GNMA, Tax-
Free Income, Pennsylvania Tax-Free Income, New Jersey Tax-Free Income, Ohio Tax-
Free Income, Delaware Tax-Free Income and Kentucky Tax-Free Income Portfolios
(the "Bond Portfolios") and the Balanced Portfolio 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.
-5-
<PAGE>
Investors may purchase beneficial interests in CMOs and REMICs, which are known
as "regular" interests or "residual" interests. The residual in a CMO or REMIC
structure generally represents the interest in any excess cash flow remaining
after making required payments of principal of and interest on the CMOs or
REMICs, as well as the related administrative expenses of the issuer. Residual
interests generally are junior to, and may be significantly more volatile than,
"regular" CMO and REMIC interests. The Portfolios do not currently 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 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
-6-
<PAGE>
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 principal as payments are
required to be made on the underlying mortgage participation certificates
("Pcs"). Pcs represent undivided interests in specified level payment,
residential mortgages or participations 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."
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
-7-
<PAGE>
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
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. Each of the Equity Portfolios of the Fund does
not intend to invest more than 5% of its net assets in U.S. Government
obligations.
The Index Master Portfolio may purchase (i) debt securities issued by the
U.S. Treasury which are direct obligations of the U.S. Government, including
bills, notes and bonds, and (ii) obligations issued or guaranteed by U.S.
Government-sponsored instrumentalities and federal agencies, including FNMA,
Federal Home Loan Bank and the Federal Housing Administration.
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
chartered to promote economic development. Each of the Equity Portfolios of the
Fund does not intend to invest more than 5% of its net assets in supranational
organization obligations.
LEASE OBLIGATIONS. The Portfolios may hold participation certificates in a
lease, an installment purchase contract, or a conditional sales contract ("lease
obligations").
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The Sub-Adviser will monitor the credit standing of each municipal borrower
and each entity providing credit support and/or a put option relating to lease
obligations. In determining whether a lease obligation is liquid, the Sub-
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 are imposed on the lease obligor's ability to
utilize substitute property or services other than those covered by the lease
obligation.
The 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 will
only invest in lease obligations with puts that (i) may be exercised at par on
not more than seven days notice, and (ii) are issued by institutions deemed by
the sub-adviser to present minimal credit risks. Such obligations will be
considered liquid. However, a number of puts are not exercisable at the time
the put would otherwise be exercised if the municipal borrower is not
contractually obligated to make payments (e.g., an event of nonappropriation
with a "nonappropriation" lease obligation). Under such circumstances, the
lease obligation while previously considered liquid would become illiquid, and a
Portfolio might lose its entire investment in such 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 a 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, the Fund might take possession of and
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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 a Portfolio. When the lease contains a non-appropriation clause,
however, the failure to pay would not be a default and a Portfolio would not
have the right to take possession of the assets. Any income derived from a
Portfolio's ownership or operation of such assets may not be tax-exempt. 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 Money Market Portfolios may purchase commercial
paper rated in one of the two highest rating categories of a nationally
recognized statistical rating organization ("NRSRO"). The Non-Money Market
Portfolios, except the Index Master Portfolio, may purchase commercial paper
rated (at the time of purchase) "A-1" by S&P or "Prime-1" by Moody's or, when
deemed advisable by a Portfolio's adviser or sub-adviser, "high quality" issues
rated "A-2" or "Prime-2" by S&P or Moody's, respectively. The Index Master
Portfolio may purchase commercial paper rated (at the time of purchase) "A-1" or
better by S&P or "Prime-1" by Moody's, or, if not rated, issued by a corporation
having an outstanding unsecured debt issue rated "Aaa" by Moody's or "AAA" by
S&P, and having a maximum maturity of nine months. 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 Fund 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. Each of the Equity Portfolios of the Fund does not intend to invest more
than 5% of its net assets in commercial paper.
REPURCHASE AGREEMENTS. Each Portfolio may invest in repurchase agreements.
The repurchase price under the repurchase agreements described in the
Prospectuses generally equals the price 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).
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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 Portfolio's
adviser or sub-adviser. A Portfolio's adviser or sub-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 Portfolio's adviser or sub-
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 or sub-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 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, a 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.
The Index Master Portfolio may enter into repurchase agreements, but will
not enter into a repurchase agreement with a duration of more than seven days
if, as a result, more than 10% of the value of its total assets would be so
invested. The Index Master Portfolio will also only invest in repurchase
agreements with a bank if the bank has at least $1 billion in assets and is
approved by the Investment Committee of DFA. DFA will monitor
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the market value of transferred securities plus any accrued interest thereon so
that the value of such securities will at least equal the repurchase price. The
securities underlying the repurchase agreements will be limited to U.S.
Government and agency obligations described under "U.S. Government Obligations"
above.
INVESTMENT GRADE DEBT OBLIGATIONS. Each of the Money Market Portfolios may
invest in securities in the two highest rating categories of NRSROs. The Non-
Money Market Portfolios, except the Index Master Portfolio and the Low Duration
Bond, Intermediate Government Bond, Government Income and GNMA Portfolios, may
invest in "investment grade securities," which are securities rated in the four
highest rating categories of an NRSRO. The Intermediate Government Bond,
Government Income and GNMA Portfolios may invest in debt securities rated Aaa by
Moody's or AAA by S&P. 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.
The Index Master Portfolio may invest in non-convertible corporate debt
securities which are issued by companies whose commercial paper is rated "Prime-
1" by Moody's or "A-1" by S&P and dollar-denominated obligations of foreign
issuers issued in the U.S. If the issuer's commercial paper is unrated, then
the debt security would have to be rated at least "AA" by S&P or "Aa2" by
Moody's. If there is neither a commercial paper rating nor a rating of the debt
security, then the Index Master Portfolio's investment adviser must determine
that the debt security is of comparable quality to equivalent issues of the same
issuer rated at least "AA" or "Aa2."
See Appendix A to this Statement of Additional Information for a
description of applicable securities ratings.
NON-INVESTMENT GRADE SECURITIES. The Low Duration Bond Portfolio may
invest in non-investment grade or "high yield" fixed income or convertible
securities commonly known to investors as "junk bonds" when the Portfolio's sub-
adviser believes that the investment characteristics of such securities make
them desirable in light of the Portfolio's investment objective and current
portfolio mix, so long as under normal market conditions, no more than 20% of
its total assets are invested in non-investment grade debt securities, and such
securities are rated "B" or higher at the time of purchase by at least one major
rating agency.
High yield securities are bonds that are issued by a company whose credit
rating (based on rating agencies' evaluation of the likelihood of repayment)
necessitates offering a higher coupon
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and yield on its issues when selling them to investors who may otherwise be
hesitant in purchasing the debt of such a company. While generally providing
greater income and opportunity for gain, non-investment grade debt securities
may be subject to greater risks than securities which have higher credit
ratings, including a high risk of default, and their yields will fluctuate over
time. High yield securities will generally be in the lower rating categories of
recognized rating agencies (rated "Ba" or lower by Moody's or "BB" or lower by
Standard & Poor's) or will be non-rated. The credit rating of a high yield
security does not necessarily address its market value risk, and ratings may
from time to time change, positively or negatively, to reflect developments
regarding the issuer's financial condition. High yield securities are
considered to be speculative with respect to the capacity of the issuer to
timely repay principal and pay interest or dividends in accordance with the
terms of the obligation and may have more credit risk than higher rated
securities.
While the market values of high yield securities tend to react less to
fluctuations in interest rates than do those of higher rated securities, the
values of high yield securities often reflect individual corporate developments
and have a high sensitivity to economic changes to a greater extent than do
higher rated securities. Issuers of high yield 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
high yield 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. Thus, investors in high yield securities have a lower degree of
protection with respect to principal and interest payments then do investors in
higher rated securities.
During an economic downturn, a substantial period of rising interest rates
or a recession, highly leveraged issuers of high yield securities may experience
financial distress possibly resulting in insufficient revenues to meet their
principal and interest payment obligations, to meet projected business goals and
to obtain additional financing. An economic downturn could also disrupt the
market for lower-rated securities and adversely affect the value of outstanding
securities, the Portfolio's net asset value and the ability of the issuers to
repay principal and interest. If the issuer of a security held by a Portfolio
defaulted, the Portfolio may not receive full interest and principal payments
due to it and could incur additional expenses if it chose to seek recovery of
its investment.
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The secondary markets for high yield securities are not as liquid as the
secondary markets for higher rated securities. The secondary markets for high
yield 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 high yield 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, a Portfolio may have difficulty disposing of certain high
yield 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 high yield 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 high yield 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 high yield markets 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 high yield
securities may be affected by legislative and regulatory developments. These
developments could adversely affect a Portfolio's net asset value and investment
practices, the secondary market for high yield securities, the financial
condition of issuers of these securities and the value and liquidity of
outstanding high yield 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 high yield bonds and
limiting the deductibility of interest by certain corporate issuers of high
yield bonds adversely affected the market in recent years.
When the secondary market for high yield securities becomes more illiquid,
or in the absence of readily available market quotations for such securities,
the relative lack of reliable objective data makes it more difficult to value a
Portfolio's securities, and judgment plays a more important role in determining
such valuations. Increased illiquidity in the junk bond market, in combination
with the relative youth and growth of the market for such securities, also may
affect the ability of a Portfolio to dispose of such securities at a desirable
price. Additionally, if the secondary markets for high yield securities
contract due to adverse economic conditions or for other reasons, certain of a
Portfolio's liquid securities may become illiquid
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and the proportion of the Portfolio's assets invested in illiquid securities may
significantly increase.
The Low Duration Bond Portfolio may invest in securities rated "B" and
above or determined by the sub-adviser to be of comparable quality. Such
securities are considered to have the current capacity to meet interest and
principal payments, but have a greater vulnerability to default than higher
rated securities. Adverse business, financial or economic conditions will
likely impair capacity or willingness to pay interest and principal.
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. 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 sub-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 sub-adviser's own
credit analysis than in the case of mutual funds investing in higher-rated
securities. For a description of these ratings, see Appendix A.
In selecting non-investment grade securities, the sub-adviser considers
factors such as those relating to the creditworthiness of issuers, the ratings
and performance of the securities, the protections afforded the securities and
the diversity of the Portfolio. The sub-adviser continuously monitors the
issuers of non-investment grade securities held by the Portfolio for their
ability to make required principal and interest payments, as well as in an
effort to control the liquidity of the Portfolio so that it can meet redemption
requests. If a security's rating is reduced below the minimum credit rating
that is permitted for a Portfolio, the Portfolio's sub-adviser will consider
whether the Portfolio should continue to hold the security.
In the event that a Portfolio investing in high yield securities
experiences an unexpected level of net redemptions, the Portfolio could be
forced to sell its holdings without regard to the investment merits, thereby
decreasing the assets upon which the Portfolio's rate of return is based.
The costs attributable to investing in the high yield markets are usually
higher for several reasons, such as higher investment research costs and higher
commission costs.
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
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future date. When a Portfolio agrees to purchase securities on this 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's commitments. It may be expected that the market value of a
Portfolio's net assets will fluctuate to a greater degree when it sets aside
portfolio securities to cover such purchase commitments than when it sets aside
cash. Because a 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, each Portfolio expects that its forward commitments and
commitments to purchase when-issued or TBA securities will not exceed 25% of the
value of its total assets absent unusual market conditions.
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 or 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 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.
RIGHTS OFFERINGS AND WARRANTS TO PURCHASE. Each equity Portfolio (except
the Index Master Portfolio) and the Balanced Portfolio may participate in rights
offerings and may purchase warrants, which are privileges issued by corporations
enabling the owners to subscribe to and purchase a specified number of shares of
the corporation at a specified price during a specified period of time.
Subscription rights normally have a short life span to expiration. The purchase
of rights or warrants involves the risk that a Portfolio could lose the purchase
value of a right or warrant if the right to subscribe to additional shares is
not exercised prior to the rights' and warrants' expiration. Also, the purchase
of rights and/or warrants involves the risk that the effective price paid for
the right and/or warrant added
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to the subscription price of the related security may exceed the value of the
subscribed security's market price such as when there is no movement in the
level of the underlying security. A Portfolio will not invest more than 5% of
its net assets, taken at market value, in warrants, or more than 2% of its net
assets, taken at market value, in warrants not listed on the New York or
American Stock Exchanges. Warrants acquired by a Portfolio in units or attached
to other securities are not subject to this restriction.
FOREIGN CURRENCY TRANSACTIONS. Forward foreign currency exchange contracts
involve an obligation to purchase or sell a specified currency at a future date
at a price set at the time of the contract. Forward currency contracts do not
eliminate fluctuations in the values of portfolio securities but rather allow a
Portfolio to establish a rate of exchange for a future point in time. A
Portfolio may use forward foreign currency exchange contracts to hedge against
movements in the value of foreign currencies (including the "ECU" used in the
European Community) relative to the U.S. dollar in connection with specific
portfolio transactions or with respect to portfolio positions. A Portfolio may
enter into forward foreign currency exchange contracts when deemed advisable by
its adviser or sub-adviser under two circumstances. First, when entering into a
contract for the purchase or sale of a security, a Portfolio may enter into a
forward foreign currency exchange contract for the amount of the purchase or
sale price to protect against variations, between the date the security is
purchased or sold and the date on which payment is made or received, in the
value of the foreign currency relative to the U.S. dollar or other foreign
currency.
Second, when a Portfolio's adviser or sub-adviser anticipates that a
particular foreign currency may decline relative to the U.S. dollar or other
leading currencies, in order to reduce risk, the Portfolio may enter into a
forward contract to sell, for a fixed amount, the amount of foreign currency
approximating the value of some or all of the Portfolio's securities denominated
in such foreign currency. With respect to any forward foreign currency
contract, it will not generally be possible to match precisely the amount
covered by that contract and the value of the securities involved due to the
changes in the values of such securities resulting from market movements between
the date the forward contract is entered into and the date it matures. In
addition, while forward contracts may offer protection from losses resulting
from declines in the value of a particular foreign currency, they also limit
potential gains which might result from increases in the value of such currency.
A Portfolio will also incur costs in connection with forward foreign currency
exchange contracts and conversions of foreign currencies and U.S. dollars.
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A Portfolio may also engage in proxy hedging transactions to reduce the
effect of currency fluctuations on the value of existing or anticipated holdings
of portfolio securities. 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 some or all 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. In addition, 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. A 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. For example, a Portfolio may hold both French government
bonds and German government bonds, and the Adviser or Sub-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.
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.
A separate account of a Portfolio consisting of liquid assets equal to the
amount of the Portfolio's assets that could be required to consummate forward
contracts entered into under the second circumstance, as set forth above, will
be established with the Fund's custodian. For the purpose of determining the
adequacy of the securities in the account, the deposited securities will be
valued at market or fair value. If the market or fair value of such securities
declines, additional cash or securities will be placed in the account daily so
that the value of the account will equal the amount of such commitments by the
Portfolio.
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
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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 as are held in a segregated account 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 difference is maintained by the Portfolio in liquid assets
in a segregated account with its custodian.
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 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
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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 Non-Money Market Portfolio
(including the Index Master Portfolio) may invest in futures contracts and
options thereon (interest rate futures contracts or index futures contracts, as
applicable). These instruments are described in Appendix B to this Statement of
Additional Information.
STAND-BY COMMITMENTS. Under a stand-by commitment for a Municipal
Obligation, a dealer agrees to purchase at the Portfolio's option a specified
Municipal Obligation at a specified price. Stand-by commitments for Municipal
Obligations may be exercisable by a Portfolio at any time before the maturity of
the underlying Municipal Obligations and may be sold, transferred or assigned
only with the instruments involved. It is expected that such stand-by
commitments will generally be available without the payment of any direct or
indirect consideration. However, if necessary or advisable, a Portfolio may pay
for such a stand-by commitment either separately in cash or by paying a higher
price for Municipal Obligations which are acquired subject to the commitment for
Municipal Obligations (thus reducing the yield to maturity otherwise available
for the same securities). The total amount paid in either manner for
outstanding stand-by commitments for Municipal Obligations held by a Portfolio
will not exceed 1/2 of 1% of the value of such Portfolio's total assets
calculated immediately after each stand-by commitment is acquired.
Stand-by commitments will only be entered into with dealers, banks and
broker-dealers which, in a sub-adviser's opinion, present minimal credit risks.
A Portfolio will acquire stand-by commitments solely to facilitate portfolio
liquidity and not to exercise its rights thereunder for trading purposes.
Stand-by commitments will be valued at zero in determining net asset
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value. Accordingly, where a Portfolio pays directly or indirectly for a stand-
by commitment, its cost will be reflected as an unrealized loss for the period
during which the commitment is held by such Portfolio and will be reflected as a
realized gain or loss when the commitment is exercised or expires.
TAX-EXEMPT DERIVATIVES. The Municipal Money Market Portfolios and the Tax-
Free Income, Ohio Tax-Free Income, Pennsylvania Tax-Free Income, New Jersey Tax-
Free Income, Delaware Tax-Free Income and Kentucky Tax-Free Income Portfolios
(collectively, the "Money and Non-Money Market Municipal Portfolios") may hold
tax-exempt derivatives which may be in the form of tender option bonds,
participations, beneficial interests in a trust, partnership interests or other
forms. A number of different structures have been used. For example, interests
in long-term fixed-rate municipal debt obligations, held by a bank as trustee or
custodian, are coupled with tender option, demand and other features when the
tax-exempt derivatives are created. Together, these features entitle the holder
of the interest to tender (or put) the underlying municipal debt obligation to a
third party at periodic intervals and to receive the principal amount thereof.
In some cases, municipal debt obligations are represented by custodial receipts
evidencing rights to receive specific future interest payments, principal
payments, or both, on the underlying securities held by the custodian. Under
such arrangements, the holder of the custodial receipt has the option to tender
the underlying securities at their face value to the sponsor (usually a bank or
broker dealer or other financial institution), which is paid periodic fees equal
to the difference between the securities' fixed coupon rate and the rate that
would cause the securities, coupled with the tender option, to trade at par on
the date of a rate adjustment. The Money and Non-Money Market Municipal
Portfolios may hold tax-exempt derivatives, such as participation interests and
custodial receipts, for municipal debt obligations which give the holder the
right to receive payment of principal subject to the conditions described above.
The Internal Revenue Service has not ruled on whether the interest received on
tax-exempt derivatives in the form of participation interests or custodial
receipts is tax-exempt, and accordingly, purchases of any such interests or
receipts are based on the opinions of counsel to the sponsors of such derivative
securities. Neither the Fund nor its investment adviser or sub-advisers will
review the proceedings related to the creation of any tax-exempt derivatives or
the basis for such opinions.
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
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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.
While the Index Master Portfolio may earn additional income from lending
securities, such activity is incidental to the investment objective of the Index
Master Portfolio. The value of securities loaned may not exceed 33 1/3% of the
value of the Index Master Portfolio's total assets. In connection with such
loans, the Index Master Portfolio will receive collateral consisting of cash or
U.S. Government securities, which will be maintained at all times in an amount
equal to at least 100% of the current market value of the loaned securities. In
addition, the Index Master Portfolio will be able to terminate the loan at any
time, will receive reasonable interest on the loan, as well as amounts equal to
any dividends, interest or other distributions on the loaned securities. In the
event of the bankruptcy of the borrower, the Trust could experience delay in
recovering the loaned securities. Management of the Trust believes that this
risk can be controlled through careful monitoring procedures.
YIELDS AND RATINGS. The yields on certain obligations are dependent on a
variety of factors, including general market 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. A Portfolio's adviser or sub-adviser will consider such an
event in determining whether the Portfolio should continue to hold the security.
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INTEREST RATE TRANSACTIONS AND CURRENCY SWAPS. The Bond 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. The International Bond Portfolio may also enter into currency swaps,
which involve the exchange of the rights of a Portfolio and another party to
make or receive payments in specified currencies.
A Portfolio 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. In
contrast, currency swaps usually involve the delivery of the entire principal
value of one designated currency in exchange for the other designated currency.
A Portfolio will accrue the net amount of the excess, if any, of its
obligations over its entitlements with respect to each interest rate or currency
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. 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 will not enter into any interest rate or currency swap
unless the unsecured commercial paper, senior debt or claims paying ability of
the other party is rated either "A" or "A-1" or better by S&P, Duff & Phelps or
Fitch, or "A" or "P-1" or better by Moody's.
A Portfolio will enter into currency or interest rate swap, cap and floor
transactions only with institutions deemed the creditworthy by the Portfolio's
adviser or sub-adviser. If there is a default by the other party to such a
transaction, a Portfolio will have contractual remedies pursuant to the
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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, other than the Index Equity
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.
SPECIAL CONSIDERATION REGARDING THE OHIO TAX-FREE INCOME PORTFOLIO. The
Ohio Tax-Free Income Portfolio will not trade its securities for the purpose of
seeking profits. For purposes of this policy, the Portfolio may vary its
portfolio securities if (i) there has been an adverse change in a security's
credit rating or in that of its issuer or in the adviser's or sub-adviser's
credit analysis of the security or its issuer; (ii) there has been, in the
opinion of the adviser and sub-adviser, a deterioration or anticipated
deterioration in general economic or market conditions affecting issuers of Ohio
Municipal Obligations, or a change or anticipated change in interest rates;
(iii) adverse changes or anticipated changes in market conditions or economic or
other factors temporarily affecting the issuers of one or more portfolio
securities make necessary or desirable the sale of such security or securities
in anticipation of the Portfolio's repurchase of the same or comparable
securities at a later date; or (iv) the adviser or sub-adviser engages in
temporary defensive strategies.
SPECIAL CONSIDERATIONS FOR STATE-SPECIFIC PORTFOLIOS
The following information regarding the State-Specific Portfolios is
derived from official statements of certain issuers published in connection with
their issuance of securities and from other publicly available information, and
is believed to be accurate. No independent verification has been made of any of
the following information.
SPECIAL CONSIDERATIONS REGARDING INVESTMENTS IN OHIO STATE-SPECIFIC
OBLIGATIONS. The Ohio Tax-Free Money Market and Ohio Tax-Free Income Portfolios
(the "Ohio Portfolios") will each invest most of its net assets in securities
issued by or on behalf of (or in certificates of participation in lease-purchase
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obligations of) the State of Ohio, political subdivisions of the State, or
agencies or instrumentalities of the State or its political subdivisions ("Ohio
State-Specific Obligations"). The Ohio Portfolios are therefore susceptible to
general or particular economic, political or regulatory factors that may affect
issuers of Ohio State-Specific Obligations. The following information
constitutes only a brief summary of some of the many complex factors that may
have an effect. The information does not apply to "conduit" obligations on
which the public issuer itself has no financial responsibility.
Generally, the creditworthiness of Ohio State-Specific Obligations of local
issuers is unrelated to that of obligations of the State itself, and the State
has no responsibility to make payments on those local obligations.
There may be specific factors that at particular times apply in connection
with investment in particular Ohio State-Specific Obligations or in those
obligations of particular Ohio issuers. It is possible that the investment may
be in particular Ohio State-Specific Obligations, or in those of particular
issuers, as to which those factors apply. However, the information below is
intended only as a general summary, and is not intended as a discussion of any
specific factors that may affect any particular obligation or issuer.
Ohio is the seventh most populous state. The 1990 Census count of
10,847,000 indicated a 0.5% population increase from 1980. The Census estimate
for 1996 is 11,173,000.
While diversifying more into the service and other non-manufacturing areas,
the Ohio economy continues to rely in part on durable goods manufacturing
largely concentrated in motor vehicles and equipment, steel, rubber products and
household appliances. As a result, general economic activity, as in many other
industrially-developed states, tends to be more cyclical than in some other
states and in the nation as a whole. Agriculture is an important segment of the
economy, with over half the State's area devoted to farming and approximately
16% of total employment in agribusiness.
In prior years, the State's overall unemployment rate was commonly somewhat
higher than the national figure. For example, the reported 1990 average monthly
State rate was 5.7%, compared to the 5.5% national figure. However, for the last
six years the State rates were below the national rates (4.9% versus 5.4% in
1996). The unemployment rate and its effects vary among geographic areas of the
State.
There can be no assurance that future national, regional or state-wide
economic difficulties, and the resulting impact on State or local government
finances generally, will not adversely
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affect the market value of Ohio State-Specific Obligations held in the Ohio
Portfolios or the ability of particular obligors to make timely payments of debt
service on (or lease payments relating to) those Obligations.
The State operates on the basis of a fiscal biennium for its appropriations
and expenditures, and is precluded by law from ending its July 1 to June 30
fiscal year (FY) or fiscal biennium in a deficit position. Most State
operations are financed through the General Revenue Fund (GRF), for which the
personal income and sales-use taxes are the major sources. Growth and depletion
of GRF ending fund balances show a consistent pattern related to national
economic conditions, with the ending FY balance reduced during less favorable
and increased during more favorable economic periods. The State has well-
established procedures for, and has timely taken, necessary actions to ensure
resource/expenditure balances during less favorable economic periods. Those
procedures included general and selected reductions in appropriations spending.
The 1992-93 biennium presented significant challenges to State finances.
To allow time to resolve certain budget differences, an interim appropriations
act was enacted effective July 1, 1991; it included GRF debt service and lease
rental appropriations for the entire 1992-93 biennium, while continuing most
other appropriations for a month. Pursuant to the general appropriations act
for the entire biennium, passed on July 11, 1991, $200 million was transferred
from the Budget Stabilization Fund ("BSF", a cash and budgetary management fund)
to the GRF in FY 1992.
Based on updated results and forecasts in the course of that FY, both in
light of a continuing uncertain nationwide economic situation, there was
projected, and then timely addressed a FY 1992 imbalance in GRF resources and
expenditures. In response, the Governor ordered most State agencies to reduce
GRF spending in the last six months of FY 1992 by a total of approximately $184
million; the $100.4 million BSF balance and additional amounts from certain
other funds were transferred late in the FY to the GRF; and adjustments were
made in the timing of certain tax payments.
A significant GRF shortfall (approximately $520 million) was then projected
for FY 1993. It was addressed by appropriate legislative and administrative
actions, including the Governor's ordering $300 million in selected GRF spending
reductions and subsequent executive and legislative action (a combination of tax
revisions and additional spending reductions). The June 30, 1993 ending GRF
fund balance was approximately $111 million, of which, as a first step to BSF
replenishment, $21 million was deposited in the BSF.
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None of the spending reductions were applied to appropriations needed for
debt service on or lease rentals relating to any State obligations.
The 1994-95 biennium presented a more affirmative financial picture. Based
on June 30, 1994 balances, an additional $260 million was deposited in the BSF.
The biennium ended June 30, 1995 with a GRF ending fund balance of $928 million,
of which $535.2 million was transferred into the BSF. The significant GRF fund
balance, after leaving in the GRF an unreserved and undesignated balance of $70
million, was transferred to the BSF and other funds including school assistance
funds and, in anticipation of possible federal program changes, a human services
stabilization fund.
From a higher than forecast 1996-97 mid-biennium GRF fund balance, $100
million was transferred for elementary and secondary school computer network
purposes and $30 million to a new State transportation infrastructure fund.
Approximately $400.8 million served as a basis for temporary 1996 personal
income tax reductions aggregating that amount. The 1996-97 biennium-ending GRF
fund balance was $834.9 million. Of that, $250 million goes to school building
construction and renovation, $94 million to the school computer network, $44.2
million for school textbooks and instructional materials and a distance learning
program, and $34 million to the BSF (which had a December 30, 1997 balance of
$862.7 million), with the $263 million balance to a State income tax reduction
fund.
The GRF appropriations act for the current 1997-98 biennium was passed on
June 25, 1997 and promptly signed (after selective vetoes) by the Governor. All
necessary GRF appropriations for State debt service and lease rental payments
then projected for the biennium were included in that act.
The State's incurrence or assumption of debt without a vote of the people
is, with limited exceptions, prohibited by current State constitutional
provisions. The State may incur debt, limited in amount to $750,000, to cover
casual deficits or failures in revenues or to meet expenses not otherwise
provided for. The Constitution expressly precludes the State from assuming the
debts of any local government or corporation. (An exception is made in both
cases for any debt incurred to repel invasion, suppress insurrection or defend
the State in war.)
By 14 constitutional amendments approved from 1921 to date (the latest
adopted in 1995), Ohio voters authorized the incurrence of State debt and the
pledge of taxes or excises to its payment. At December 30, 1997, $948 million
(excluding certain highway bonds payable primarily from highway use receipts) of
this debt was outstanding. The only such State debt at that date still
authorized to be incurred were portions of the
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highway bonds, and the following: (a) up to $100 million of obligations for coal
research and development may be outstanding at any one time ($30.9 million
outstanding); (b) $240 million of obligations authorized for local
infrastructure improvements, no more than $120 million of which may be issued in
any calendar year ($826.8 million outstanding); and (c) up to $200 million in
general obligation bonds for parks, recreation and natural resources purposes
which may be outstanding at any one time ($90.9 million outstanding, with no
more than $50 million to be issued in any one year).
The electors in 1995 approved a constitutional amendment extending the
local infrastructure bond program (authorizing an additional $1.2 billion of
State full faith and credit obligations to be issued over 10 years for the
purpose), and authorizing additional highway bonds (expected to be payable
primarily from highway use receipts). The latter supersedes the prior $500
million outstanding authorization, and authorizes not more than $1.2 billion to
be outstanding at any time and not more than $220 million to be issued in a
fiscal year.
The Constitution also authorizes the issuance of State obligations for
certain purposes, the owners of which do not have the right to have excises or
taxes levied to pay debt service. Those special obligations include obligations
issued by the Ohio Public Facilities Commission and the Ohio Building Authority,
and certain obligations issued by the State Treasurer, over $4.8 billion of
which were outstanding or sold and awaiting delivery at December 30, 1997.
A 1990 constitutional amendment authorizes greater State and political
subdivision participation (including financing) in the provision of housing.
The General Assembly may for that purpose authorize the issuance of State
obligations secured by a pledge of all or such portion as it authorizes of State
revenues or receipts (but not by a pledge of the State's full faith and credit).
A 1994 constitutional amendment pledges the full faith and credit and
taxing power of the State to meeting certain guarantees under the State's
tuition credit program which provides for purchase of tuition credits, for the
benefit of State residents, guaranteed to cover a specified amount when applied
to the cost of higher education tuition. (A 1965 constitutional provision that
authorized student loan guarantees payable from available State moneys has never
been implemented, apart from a "guarantee fund" approach funded essentially
from program revenues.)
State and local agencies issue obligations that are payable from revenues
from or relating to certain facilities (but not from taxes). By judicial
interpretation, these obligations are
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not "debt" within constitutional provisions. In general, payment obligations
under lease-purchase agreements of Ohio public agencies (in which certificates
of participation may be issued) are limited in duration to the agency's fiscal
period, and are renewable only upon appropriations being made available for the
subsequent fiscal period.
Local school districts in Ohio receive a major portion (state-wide
aggregate approximately 44% in recent years) of their operating moneys from
State subsidies, but are dependent on local property taxes, and in 119 districts
from voter-authorized income taxes, for significant portions of their budgets.
Litigation, similar to that in other states, is pending questioning the
constitutionality of Ohio's system of school funding. The Ohio Supreme Court
has recently concluded that aspects of the system (including basic operating
assistance and the loan program referred to below) are unconstitutional, and
ordered the State to provide for and fund a system complying with the Ohio
Constitution, staying its order for a year (to March 1998) to permit time for
responsive corrective actions. A small number of the State's 612 local school
districts have in any year required special assistance to avoid year-end
deficits. A program has provided for school district cash need borrowing
directly from commercial lenders, with diversion of State subsidy distributions
to repayment if needed. Recent borrowings under this program totalled $41.1
million for 28 districts in FY 1994, and $71.1 million for 29 districts in FY
1995 (including $29.5 million for one), $87.2 million for 20 districts in fiscal
year 1996 (including $42.1 million for one), and $113.2 million for 12 districts
in 1997 (including $90 million to one for restructuring its prior loans).
Ohio's 943 incorporated cities and villages rely primarily on property and
municipal income taxes for their operations. With other subdivisions, they also
receive local government support and property tax relief moneys distributed by
the State.
For those few municipalities and school districts that on occasion have
faced significant financial problems, there are statutory procedures for a joint
State/local commission to monitor the fiscal affairs and for development of a
financial plan to eliminate deficits and cure any defaults. (Similar procedures
have recently been extended to counties and townships.) Since inception for
municipalities in 1979, these "fiscal emergency" procedures have been applied to
24 cities and villages; for 18 of them the fiscal situation was resolved and the
procedures terminated (one village is in preliminary "fiscal watch" status). As
of January 5, 1998, the 1996 school district "fiscal emergency" provision had
been applied to five districts, and ten were on preliminary "fiscal watch"
status.
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At present the State itself does not levy ad valorem taxes on real or
tangible personal property. Those taxes are levied by political subdivisions
and other local taxing districts. The Constitution has since 1934 limited to 1%
of true value in money the amount of the aggregate levy (including a levy for
unvoted general obligations) of property taxes by all overlapping subdivisions,
without a vote of the electors or a municipal charter provision, and statutes
limit the amount of that aggregate levy to 10 mills per $1 of assessed valuation
(commonly referred to as the "ten-mill limitation"). Voted general obligations
of subdivisions are payable from property taxes that are unlimited as to amount
or rate.
SPECIAL CONSIDERATIONS REGARDING INVESTMENT IN PENNSYLVANIA STATE-SPECIFIC
OBLIGATIONS. The concentration of investments in Pennsylvania State-Specific
Obligations by the Pennsylvania Municipal Money Market and Pennsylvania Tax-Free
Income Portfolios raises special investment considerations. In particular,
changes in the economic condition and governmental policies of the Commonwealth
of Pennsylvania and its municipalities could adversely affect the value of those
Portfolios and their portfolio securities. This section briefly describes
current economic trends in Pennsylvania.
Pennsylvania has historically been dependent on heavy industry, although
recent declines in the coal, steel and railroad industries have led to
diversification of the Commonwealth's economy. Recent sources of economic
growth in Pennsylvania are in the service sector, including trade, medical and
health services, education and financial institutions. Agriculture continues to
be an important component of the Commonwealth's economic structure, with nearly
one-third of the Commonwealth's total land area devoted to cropland, pasture and
farm woodlands.
The population of Pennsylvania experienced a slight increase in the period
1987 through 1996, and has a high proportion of persons 65 or older. The
Commonwealth is highly urbanized, with almost 79% of the 1990 census population
residing in metropolitan statistical areas. The two largest metropolitan
statistical areas, those containing the Cities of Philadelphia and Pittsburgh,
together comprise approximately 44% of the Commonwealth's total population.
The Commonwealth utilizes the fund method of accounting and over 150 funds
have been established for purposes of recording receipts and disbursements of
the Commonwealth, of which the General Fund is the largest. Most of the
Commonwealth's operating and administrative expenses are payable from the
General Fund. The major tax sources for the General Fund are the sales tax, the
personal income tax and the corporate net income
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tax. Major expenditures of the Commonwealth include funding for education,
public health and welfare and transportation.
The constitution of the Commonwealth provides that operating budget
appropriations of the Commonwealth may not exceed the estimated revenues and
available surplus in the fiscal year for which funds are appropriated. Annual
budgets are enacted for the General Fund (the principal operating fund of the
Commonwealth) and for certain special revenue funds which together represent the
majority of expenditures of the Commonwealth. Although a negative balance was
experienced applying generally accepted accounting principles ("GAAP") in the
General Fund for fiscal 1990 and 1991, tax increases and spending decreases have
resulted in surpluses in subsequent years; and as of June 30, 1996, the General
Fund had a surplus of $635.2 million. The deficit in the Commonwealth's
unreserved/undesignated funds also had been eliminated.
Certain litigation is pending against the Commonwealth that could adversely
affect the ability of the Commonwealth to pay debt service on its obligations
including suits relating to the following matters: (a) the ACLU has filed suit
in Federal court demanding additional funding for child welfare services; the
Commonwealth settled a similar suit in the Commonwealth Court of Pennsylvania
and is seeking the dismissal of the federal suit, inter alia, because of that
----- ----
settlement. After its earlier denial was reversed by the Third Circuit Court of
Appeals, the district court granted class certification to the ACLU, and the
parties are proceeding with discovery; (b) in 1987, the Supreme Court of
Pennsylvania held the statutory scheme for county funding of the judicial system
to be in conflict with the constitution of the Commonwealth, but stayed judgment
pending enactment by the legislature of funding consistent with the opinion, and
the legislature has yet to consider legislation implementing the judgment. In
1992, a new action in mandamus was filed seeking to compel the Commonwealth to
comply with the original decision; (c) litigation has been filed in both state
and Federal court by an association of rural and small schools and several
individual school districts and parents challenging the constitutionality of the
Commonwealth's system for funding local school districts --the Federal case has
been stayed pending resolution of the state case. Trial of the state case was
completed in September 1997 and a decision is pending; and (d) both the
Commonwealth and the City of Philadelphia are involved in cases currently before
the Pennsylvania Supreme Court that may result in their being required to fund
remedies for the unintentional racial segregation in the Philadelphia public
schools.
The City of Philadelphia (the "City") experienced severe financial
difficulties during the early 1990's which impaired its access to public credit
markets. The City experienced a series of General Fund deficits for fiscal
years 1988 through 1992.
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Legislation was enacted in 1991 to create an Intergovernmental Cooperation
Authority (the "Authority") to provide deficit reduction financing and fiscal
oversight for Philadelphia. In order for the Authority to issue bonds on behalf
of the City, the City and the Authority entered into an intergovernmental
cooperation agreement providing the Authority with certain oversight powers with
respect to the fiscal affairs of the City. Philadelphia currently is operating
under a five year plan approved by the Authority on May 20, 1997. The unaudited
balance of the City's General Fund as of June 30, 1997 was approximately $120.0
million.
The Authority's power to issue further bonds to finance capital projects or
deficit expired on December 31, 1994, and its power to issue debt to finance a
cash flow deficit expired December 31, 1996. Its ability to refund outstanding
bonds is unrestricted. The Authority had $1,102.4 million in special revenue
bonds outstanding as of June 30, 1997.
Most recently, Moody's has rated the long-term general obligation bonds of
the Commonwealth "Aa3," Standard & Poor's has rated such bonds "AA-" and Fitch
has rated such bonds "AA." There can be no assurance that the economic
conditions on which these ratings are based will continue or that particular
bond issues may not be adversely affected by changes in economic or political
conditions.
SPECIAL CONSIDERATIONS REGARDING INVESTMENT IN NORTH CAROLINA STATE-
SPECIFIC OBLIGATIONS. The concentration of investments in North Carolina State-
Specific Obligations by the North Carolina Municipal Money Market Portfolio
raises special investment considerations. In particular, changes in the
economic condition and governmental policies of North Carolina and its political
subdivisions, agencies, instrumentalities, and authorities could adversely
affect the value of the Portfolio and its portfolio securities. This section
briefly describes current economic trends in North Carolina.
The State of North Carolina has three major operating funds: the General
Fund, the Highway Fund and the Highway Trust Fund. North Carolina derives most
of its revenue from taxes, including individual income tax, corporation income
tax, sales and use taxes, corporation franchise tax, alcoholic beverage tax,
insurance tax, inheritance tax, tobacco products tax and soft drink tax
(currently being phased out). North Carolina receives other non-tax revenues
which are also deposited in the General Fund. The most important are Federal
funds collected by North Carolina agencies, university fees and tuition,
interest earned by the North Carolina Treasurer on investments of General Fund
moneys and revenues from the judicial branch. The proceeds from the motor fuel
tax, highway use tax and motor vehicle license tax are deposited in the Highway
Fund and the Highway Trust Fund.
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Fiscal year 1996 ended with a positive General Fund balance of
approximately $573.4 million. An additional $153.1 million was available from a
reserved fund balance. Of this aggregate amount, $77.3 million was reserved in
the Savings Reserve (bringing the total reserve to $500.9 million) and $130.0
million was reserved in the Reserve for Repair and Renovation of State
Facilities (bringing the total reserve to $151.3 million after prior
withdrawals). An additional $47.1 million was transferred to a newly-created
Clean Water Management Trust Fund, $39.5 million was reserved in a Capital
Improvement Reserve, and $26.2 million was transferred to newly-created Federal
Retiree Refund and Administration Accounts, leaving an unreserved General Fund
balance at June 30, 1996 of approximately $406.1 million.
Fiscal year 1997 ended with a positive General Fund balance of
approximately $874.8 million. Along with additional reserves, $135 million was
reserved in the Reserve for Repair and Renovation of State Facilities, in
addition to a supplemental reserve of $39.3 million for repairs and renovations
(bringing the total reserve to $221.2 million after prior withdrawals). An
additional $49.4 million was transferred to the Clean Water Management Trust
Fund (bringing the total reserve to $49.4 million after prior withdrawals) and
$115 million and $156 million were reserved in newly-created Disaster Relief and
Intangible Tax Refund Reserves, respectively. The Disaster Relief Reserve was
used to cover disaster relief funds spent during fiscal year 1997. An
additional $61 million was reserved for the State to acquire the shares of the
North Carolina Railroad Company not held by the State. No additional amounts
were transferred to the Savings Reserve for the year (the existing balance of
$500.9 million having met the statutory reserve requirements). After additional
reserves, the unreserved General Fund balance at the end of fiscal year 1997 was
approximately $318.7 million.
The foregoing results are presented on a budgetary basis. Accounting
principles applied to develop data on a budgetary basis differ significantly
from those principles used to present financial statements in conformity with
generally accepted accounting principles (GAAP). Based on a modified accrual
basis (GAAP), the General Fund balance at June 30, 1996 and 1997 was $1,422.1
million and $1,703.9 million, respectively.
On August 28, 1997, the North Carolina General Assembly adopted the
biennium budget for 1997 to 1999. The $11.4 billion budget for fiscal year 1998
included a 7.6% increase in spending over the fiscal year 1997 budget.
Highlights of the new budget included increased spending for education, with
$181 million in funding for teacher pay raises averaging 6.5% and $92 million to
implement the newly-enacted Excellent Schools Act, which raises teacher salaries
to the national average over four years and requires teachers at low-performing
schools to pass competency
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tests. Money was also reserved for schools that achieve or surpass academic
goals, school technology funds, new school buses, staff development programs,
community college job training programs, and other education purposes. The
General Assembly also passed a welfare reform program, adopted a streamlined
process for cleaning up brownfields for reuse as industrial and commercial
sites, and cut the North Carolina sales tax on food by 1% beginning in 1998.
The General Assembly adjusted downward the General Fund appropriation
support for the continuation budgets by $425.4 million and $242.2 million in
fiscal years 1998 and 1998, respectively, and authorized continuation funding of
$10,439.4 million for fiscal year 1998 and $10,957.5 million for fiscal year
1999. The adjustments included reductions of expenditures resulting from
supporting revenues sources being reclassified from tax and nontax revenues to
departmental receipts, increases in departmental receipts and federal receipts,
reductions of projected operating costs, and other efficiencies and savings.
Increases of $798.7 million for fiscal year 1998 and $574.5 million for fiscal
year 1999 were approved for operating budgets.
The North Carolina budget is based upon a number of existing and assumed
State and non-State factors, including State and national economic conditions,
international activity, Federal government policies and legislation and the
activities of the State's General Assembly. Such factors are subject to change
which may be material and affect the budget. The Congress of the United States
is considering a number of matters affecting the federal government's
relationship with State governments that, if enacted into law, could affect
fiscal and economic policies of the states, including North Carolina.
During recent years North Carolina has moved from an agricultural to a
service and goods producing economy. According to the North Carolina Employment
Security Commission (the "Commission"), in July 1997, North Carolina ranked
tenth among the states in non-agricultural employment and eighth in
manufacturing employment. The Commission estimated North Carolina's seasonally
adjusted unemployment rate in November 1997 to be 3.5% of the labor force, as
compared with an unemployment rate of 4.6% nationwide.
The following are certain cases pending in which the State of North
Carolina faces the risk of either a loss of revenue or an unanticipated
expenditure which, in the opinion of the North Carolina Department of State
Treasurer, would not materially adversely affect the State's ability to meet its
financial obligations:
1. Swanson v. State of North Carolina and Patton v. State of North
Carolina -- State Tax Refunds - Federal Retirees. In
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Davis v. Michigan (1989), the United States Supreme Court ruled that a Michigan
- -----------------
income tax statute which taxed federal retirement benefits while exempting those
paid by state and local governments violated the constitutional doctrine of
intergovernmental tax immunity. At the time of the Davis decision, North
-----
Carolina law contained similar exemptions in favor of state and local retirees.
Those exemptions were repealed prospectively, beginning with the 1989 tax year.
All public pension and retirement benefits are now entitled to a $4,000 annual
exclusion.
Following Davis, federal retirees filed a class action suit in federal
-----
court in 1989 seeking damages equal to the North Carolina income tax paid on
federal retirement income by the class members (Swanson). A companion suit was
-------
filed in state court in 1990. The complaints alleged that the amount in
controversy exceeded $140 million. The North Carolina Department of Revenue
estimate of refunds and interest liability is $280.89 million as of June 30,
1994. In 1991, the North Carolina Supreme Court ruled in favor of the State in
the state court action, concluding that Davis could only be applied
-----
prospectively and that the taxes collected from the federal retirees were thus
not improperly collected. In 1993, the United States Supreme Court vacated that
decision and remanded the case back to the North Carolina Supreme Court. The
North Carolina Supreme Court then ruled in favor of the State on the grounds
that the federal retirees had failed to comply with state procedures for
challenging unconstitutional taxes. Plaintiffs petitioned the United States
Supreme Court for review of that decision, which petition was denied. The
United States District Court ruled in favor of the defendants in the companion
federal case, and a petition for reconsideration was denied. Plaintiffs
appealed to the United States Court of Appeals, which concurred with the lower
court's ruling. The United States Supreme Court rejected an appeal, ruling that
the lawsuit was a state matter, leaving the North Carolina Supreme Court's
ruling in force. Despite these victories in court, the General Assembly in its
1996 Special Session adopted legislation allowing for a refund of taxes for
federal retirees. Effective for tax years beginning on or after January 1,
1996, federal retirees are entitled to a North Carolina income tax credit for
taxes paid on their pension benefits during tax years 1985 through 1988. In the
alternative, a partial refund may be claimed in lieu of a credit for eligible
taxpayers.
An additional lawsuit was filed in 1995 in State Court by federal
pensioners to recover State income taxes paid on federal retirement benefits
(Patton). This case grew out of a claim by federal pensioners in the original
- -------
federal court case in Swanson. In the new lawsuit, the plaintiffs allege that
-------
when the State granted an increase in retirement benefits to State retirees in
the same legislation that equalized tax treatment between state
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and federal retirees, the increased benefits to State retirees constituted an
indirect violation of Davis. The lawsuit seeks a refund of taxes paid by
-----
federal retirees on federal retirement benefits received in the years 1989
through 1993 and refunds or monetary relief sufficient to equalize the alleged
on-going discriminatory treatment for those years. Potential refunds exceed
$300 million. This case has been suspended pending final judgment in Bailey
------
(discussed below), and no court date has been set. Should plaintiffs prevail in
Bailey, such a result, the Federal retirees allege, would reestablish the
- ------
disparity of treatment between State and Federal pension income that was held
unconstitutional in Davis. The North Carolina Attorney General believes that
-----
sound legal authority and arguments support the denial of this claim. Potential
refunds and interest are estimated to be $585.09 million for the period through
fiscal year 1997. Until this matter is resolved, any additional potential
refunds and interest will continue to accrue.
2. Bailey v. State of North Carolina -- State Tax Refunds - State
Retirees. State and local governmental retirees filed a class action suit in
1990 as a result of the repeal of the income tax exemptions for state and local
government retirement benefits. The original suit was dismissed after the North
Carolina Supreme Court ruled in 1991 that the plaintiffs had failed to comply
with state law requirements for challenging unconstitutional taxes and the
United States Supreme Court denied review. In 1992, many of the same plaintiffs
filed a new lawsuit alleging essentially the same claims, including breach of
contract, unconstitutional impairment of contract rights by the State in taxing
benefits that were allegedly promised to be tax-exempt and violation of several
state constitutional provisions.
On May 31, 1995 the Superior Court issued an order ruling in favor of the
plaintiffs. Under the terms of the order, the Superior Court found that the act
of the General Assembly that repealed the tax exemption on State and local
government retirement benefits is null, void, and unenforceable and that
retirement benefits which were vested before August 1989 are exempt from
taxation. The North Carolina Attorney General has appealed this order, which
appeal is pending in the North Carolina Supreme Court.
Potential refunds and interest are estimated to be $287.56 million for the
period through fiscal year 1997. Until this matter is resolved, any additional
potential refunds and interest will continue to accrue. Furthermore, if the
order of the Superior Court is upheld, its provisions would apply prospectively
to prevent future taxation of State and local government retirement benefits
that were vested before August 1989. The North Carolina Attorney General's
Office believes that sound legal arguments support the State's position on the
merits.
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In its 1996 Short Session, the North Carolina General Assembly approved
additional North Carolina general obligation bonds in the amount of $950 million
for highways and $1.8 billion for schools. These bonds were approved by the
voters of the State in November, 1996. In March 1997, North Carolina issued
$450 million of the authorized school bonds (Public School Building Bonds). In
November 1997, North Carolina issued $250 million of the authorized highway
bonds (Highway Bonds). The offering of the remaining $2.05 billion of these
authorized bonds is anticipated to occur over the next two-five years.
Currently, Moody's, S&P and Fitch rate North Carolina general obligation
bonds "Aaa," "AAA," and "AAA," respectively. See Appendix A.
SPECIAL CONSIDERATIONS REGARDING INVESTMENT IN VIRGINIA STATE-SPECIFIC
OBLIGATIONS. The Virginia State-Specific Money Market Portfolio will invest
primarily in Virginia State-Specific Obligations. For this reason, the
Portfolio is affected by political, economic, regulatory or other developments
that constrain the taxing, revenue-collecting and spending authority of Virginia
issuers or otherwise affect the ability of Virginia issuers to pay interest,
principal or any premium. The following information constitutes only a brief
summary of certain of these developments and does not purport to be a complete
description of them. The information has been obtained from recent official
statements prepared by the Commonwealth of Virginia relating to its securities,
and no independent investigation has been undertaken to verify its accuracy.
Moreover, the information relates only to the state itself and not to the
numerous special purpose or local government units whose issues may also be held
by the Portfolio. The credits represented by such issues may be affected by a
wide variety of local factors or structuring concerns, and no disclosure is made
here relating to such matters.
The rate of economic growth in the Commonwealth of Virginia has increased
steadily over the past decade. Per capita income in Virginia has been
consistently above national levels during that time. The services sector in
Virginia generates the largest number of jobs, followed by wholesale and retail
trade, state and local government and manufacturing. Because of Northern
Virginia, with its proximity to Washington, D.C. and Hampton Roads, which has
the nation's largest concentration of military installations, the Federal
government has a greater economic impact on Virginia relative to its size than
any state other than Alaska and Hawaii.
According to statistics published by the U.S. Department of Labor, Virginia
typically has one of the lowest unemployment rates in the nation. This is
generally attributed to the balance among the various sectors represented in the
economy. Virginia
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is one of twenty states with a right-to-work law and is generally regarded as
having a favorable business climate marked by few strikes or work stoppages.
Virginia is also one of the least unionized among the industrialized states.
Virginia's state government operates on a two-year budget. The
Constitution vests the ultimate responsibility and authority for levying taxes
and appropriating revenue in the General Assembly, but the Governor has broad
authority to manage the budgetary process. Once an appropriation act becomes
law, revenue collections and expenditures are constantly monitored by the
Governor, assisted by the Secretary of Finance and the Department of Planning
and Budget, to ensure that a balanced budget is maintained. If projected
revenue collections fall below amounts appropriated at any time, the Governor
must reduce expenditures and withhold allotments of appropriations (other than
for debt service and other specified purposes) to restore balance. An amendment
to the Constitution, effective January 1, 1993, established a Revenue
Stabilization Fund. This Fund is used to offset a portion of anticipated
shortfalls in revenues in years when appropriations based on previous forecasts
exceed expected revenues in subsequent forecasts. The Revenue Stabilization
Fund consists of an amount not to exceed 10 percent of Virginia's average annual
tax revenues derived from taxes on income and retail sales for the three
preceding fiscal years.
General Fund revenues are principally comprised of direct taxes. In recent
fiscal years, most of the total tax revenues have been derived from five major
taxes imposed by Virginia on individual and fiduciary income, sales and use,
corporate income, public service corporations and premiums of insurance
companies.
In September 1991, the Debt Capacity Advisory Committee was created by the
Governor through an executive order. The committee is charged with annually
estimating the amount of tax-supported debt that may prudently be authorized,
consistent with the financial goals, capital needs and policies of Virginia.
The committee annually reviews the outstanding debt of all agencies,
institutions, boards and authorities of Virginia for which Virginia has either a
direct or indirect pledge of tax revenues or moral obligation. The Committee
provides its recommendations on the prudent use of such obligations to the
Governor and the General Assembly.
The Constitution of Virginia prohibits the creation of debt by or on behalf
of Virginia that is backed by Virginia's full faith and credit, except as
provided in Section 9 of Article X. Section 9 of Article X contains several
different provisions for the issuance of general obligation and other debt, and
Virginia is well within its limit for each:
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<PAGE>
Section 9(a)(2) provides that the General Assembly may incur general
obligation debt to meet certain types of emergencies, subject to limitations on
amount and duration; to meet casual deficits in the revenue or in anticipation
of the collection of revenues of Virginia; and to redeem a previous debt
obligation of Virginia. Total indebtedness issued pursuant to this Section may
not exceed 30 percent of an amount equal to 1.15 times the annual tax revenues
derived from taxes on income and retail sales, as certified by the Auditor of
Public Accounts for the preceding fiscal year.
Section 9(b) provides that the General Assembly may authorize the creation
of general obligation debt for capital projects. Such debt is required to be
authorized by an affirmative vote of a majority of each house of the General
Assembly and approved in a statewide election. The outstanding amount of such
debt is limited to an amount equal to 1.15 times the average annual tax revenues
derived from taxes on income and retail sales, as certified by the Auditor of
Public Accounts for the three preceding fiscal years less the total amount of
bonds outstanding. The amount of 9(b) debt that may be authorized in any single
fiscal year is limited to 25 percent of the limit on all 9(b) debt less the
amount of 9(b) debt authorized in the current and prior three fiscal years.
Section 9(c) provides that the General Assembly may authorize the creation
of general obligation debt for revenue-producing capital projects (so-called
"double-barrel" debt). Such debt is required to be authorized by an affirmative
vote of two-thirds of each house of the General Assembly and approved by the
Governor. The Governor must certify before the enactment of the authorizing
legislation and again before the issuance of the debt that the net revenues
pledged are expected to be sufficient to pay principal of and interest on the
debt. The outstanding amount of 9(c) debt is limited to an amount equal to 1.15
times the average annual tax revenues derived from taxes on income and retail
sales, as certified by the Auditor of Public Accounts for the three preceding
fiscal years. While the debt limits under Sections 9(b) and 9(c) are each
calculated as the same percentage of the same average tax revenues, these debt
limits are separately computed and apply separately to each type of debt.
Section 9(d) provides that the restrictions of Section 9 are not applicable
to any obligation incurred by Virginia or any of its institutions, agencies or
authorities if the full faith and credit of Virginia is not pledged or committed
to the payment of such obligation. There are currently outstanding various
types of such 9(d) revenue bonds. Certain of these bonds, however, are paid in
part or in whole from revenues received as appropriations by the General
Assembly from general tax revenues, while others are paid solely from revenues
of the applicable project. The
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<PAGE>
repayment of debt issued by the Virginia Public Building Authority, the Virginia
Port Authority, the Virginia College Building Authority Equipment Leasing
Program and the Innovative Technology Authority is supported in large part by
General Fund appropriations.
The Commonwealth Transportation Board is a substantial issuer of bonds for
highway projects. These bonds are secured by and are payable from funds
appropriated by the General Assembly from the Transportation Trust Fund for such
purpose. The Transportation Trust Fund was established by the General Assembly
in 1986 as a special non-reverting fund administered and allocated by the
Transportation Board to provide increased funding for construction, capital and
other needs of state highways, airports, mass transportation and ports. The
Virginia Port Authority has also issued bonds that are secured by a portion of
the Transportation Trust Fund.
Virginia is involved in numerous leases that are subject to appropriation
of funding by the General Assembly. Virginia also finances the acquisition of
certain personal property and equipment through installment purchase agreements.
Bonds issued by the Virginia Housing Development Authority, the Virginia
Resources Authority and the Virginia Public School Authority are designed to be
self-supporting from their individual loan programs. A portion of the Virginia
Housing Development Authority and Virginia Public School Authority bonds and all
of the Virginia Resources Authority bonds are secured in part by a moral
obligation pledge of Virginia. Should the need arise, Virginia may consider
funding deficiencies in the respective debt service reserves for such moral
obligation debt. To date, none of these authorities has advised Virginia that
any such deficiencies exist.
Local government in Virginia is comprised of 95 counties, 40 incorporated
cities, and 190 incorporated towns. Virginia is unique among the several states
in that cities and counties are independent, and their land areas do not
overlap. The largest expenditures by local governments in Virginia are for
education, but local governments also provide other services such as water and
sewer, police and fire protection and recreational facilities. The Virginia
Constitution imposes numerous restrictions on local indebtedness, affecting both
its incurrence and amount.
In Davis v. Michigan (decided March 28, 1989), the United States Supreme
Court ruled unconstitutional states' exempting from state income tax the
retirement benefits paid by the state or local governments without exempting
retirement benefits paid by the Federal government. At that time, Virginia
exempted state and local retirement benefits but not Federal retirement
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<PAGE>
benefits. At a Special Session held in April 1989, the General Assembly repealed
the exemption of state and local retirement benefits. Following Davis, at least
five suits, some with multiple plaintiffs, for refunds of Virginia income taxes,
were filed by Federal retirees. These suits were consolidated under the name of
Harper v. Virginia Department of Taxation.
In a Special Session, the Virginia General Assembly on July 9, 1994, passed
emergency legislation to provide payments in five annual installments to Federal
retirees in a settlement of the retirees' claims as a result of Davis. In 1995
and 1996, the General Assembly passed legislation allowing more retirees to
participate in the settlement. As of April 15, 1996, the estimated total cost
to Virginia for the settlement was approximately $316.2 million.
On September 15, 1995, the Supreme Court of Virginia rendered its decision
in Harper, reversing the judgment of the trial court, entering final judgment in
------
favor of the taxpayers, and directing that the amounts unlawfully collected be
refunded with statutory interest. Virginia issued refund checks on November 9,
1995, and interest stopped accruing as of November 3, 1995. The cost of
refunding all Virginia income taxes paid on Federal government pensions for
taxable years 1985, 1986, 1987 and 1988 to Federal government pensioners who
opted out of the settlement was approximately $78.7 million, including interest
earnings.
The total cost of refunding all Virginia income taxes paid on Federal
pensions on account of the settlement (approximately $316.2 million) and the
judgment ($78.7 million) is approximately $394.9 million, of which $266.4
million ($124.5 million in respect of the settlement and the entire $78.7
million in respect of the judgment and $63.2 million in fiscal year 1997) has
been paid, leaving $128.5 million payable in respect of the settlement --
approximately $62.5 million on March 31, 1998 and (subject to appropriation) $66
million on March 31, 1999.
Most recently, Moody's has rated the long-term general obligation bonds of
Virginia Aaa, and Standard & Poor's has rated such bonds AAA. There can be no
assurance that the economic conditions on which these ratings are based will
continue or that particular bond issues may not be adversely affected by changes
in economic or political conditions.
SPECIAL CONSIDERATIONS REGARDING INVESTMENT IN NEW JERSEY STATE-SPECIFIC
OBLIGATIONS. The following information constitutes only a brief summary, does
not purport to be a complete description and is largely based on information
drawn from official statements relating to securities offerings of New Jersey
municipal obligations available as of the date of this Statement of Additional
Information. The accuracy and
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<PAGE>
completeness of the information contained in such offering statements has not
been independently verified.
State Finance/Economic Information. New Jersey is the ninth largest
----------------------------------
state in population and the fifth smallest in land area. With an average of
1,077 people per square mile, it is the most densely populated of all the
states. New Jersey's economic base is diversified, consisting of a variety of
manufacturing, construction and service industries, supplemented by rural areas
with selective commercial agriculture. Historically, New Jersey's average per
capita income has been well above the national average, and in 1996 New Jersey
ranked second among the states in per capita personal income ($31,053).
By the beginning of the national recession (which officially started
in July 1990 according to the National Bureau of Economic Research),
construction activity had already been declining in New Jersey for nearly two
years. The onset of recession caused an acceleration of New Jersey's job losses
in construction and manufacturing, as well as an employment downturn in such
previously growing sectors as wholesale trade, retail trade, finance, utilities,
trucking and warehousing.
Reflecting the economic downturn, the rate of unemployment in New
Jersey rose from 3.6% during the first quarter of 1989 to a recessionary peak of
8.5% during 1992. Since then, the unemployment rate fell to an average of 6.2%
in 1996 and 5.5% for the six month period from January 1997.
For the recovery period as a whole, May 1992 to June 1997, service-
producing employment in New Jersey has expanded by 283,500 jobs. In the
manufacturing sector, employment losses slowed between 1992 and 1994. During
1995 and 1996, however, manufacturing job losses increased slightly to 10,100
and 13,900 respectively, reflecting a slowdown in national manufacturing
production activity. Conditions have slowly improved in the construction
industry, where employment has risen by 18,600 since its low in May 1992.
New Jersey's Budget and Appropriation System. New Jersey operates on
--------------------------------------------
a fiscal year ending on June 30. The General Fund is the fund into which all
New Jersey revenues not otherwise restricted by statute are deposited and from
which appropriations are made. The largest part of the total financial
operations of New Jersey is accounted for in the General Fund, which includes
revenues received from taxes and unrestricted by statute, most federal revenues,
and certain miscellaneous revenue items. The Appropriation Acts enacted by the
New Jersey Legislature and approved by the Governor provide the basic framework
for the operation of the General Fund. The undesignated General Fund balance at
year end for fiscal year 1994 was $1,264.6 million, for fiscal year 1995 was
$950.2 million and for fiscal year 1996
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was $882.2 million. For fiscal year 1997, the undesignated balance in the
General Fund was $1,078.3 million, subject to change upon completion of the
year-end audit. The estimated undesignated balance for fiscal year 1998 is
$553.5 million, based on the amounts contained in the fiscal year 1998
Appropriations Acts. The fund balances are available for appropriation in
succeeding fiscal years.
During the course of the fiscal year, the Governor may take steps to
reduce State expenditures if it appears that revenues have fallen below those
originally anticipated. There are additional means by which the Governor may
ensure that the State does not incur a deficit. Under the State Constitution,
no supplemental appropriation may be enacted after adoption of an appropriations
act except where there are sufficient revenues on hand or anticipated, as
certified by the Governor, to meet such appropriation.
General Obligation Bonds. New Jersey finances capital projects
------------------------
primarily through the sale of its general obligation bonds. These bonds are
backed by the full faith and credit of New Jersey. Tax revenues and certain
other fees are pledged to meet the principal and interest payments required to
pay the debt fully.
The aggregate outstanding general obligation bonded indebtedness of
New Jersey as of June 30, 1997 was $3.437 billion. The appropriation for the
debt service obligation on outstanding indebtedness is $483.7 million for fiscal
year 1998.
In addition to payment from bond proceeds, capital construction can
also be funded by appropriation of current revenues on a pay-as-you-go basis.
For fiscal year 1998, the amount appropriated to this purpose is $516.0 million.
Tax and Revenue Anticipation Notes. In fiscal year 1992 New Jersey
----------------------------------
initiated a program under which it issued tax and revenue anticipation notes to
aid in providing effective cash flow management to fund balances which occur in
the collection and disbursement of the General Fund and Property Tax Relief Fund
revenues. There are presently $800 million of tax and revenue anticipation
notes outstanding. These notes mature on June 15, 1998. Such notes constitute
special obligations of New Jersey payable solely from moneys on deposit in the
General Fund and Property Tax Relief Fund and legally available for such
payment.
Lease Financing. New Jersey has entered into a number of leases
---------------
relating to the financing of certain real property and equipment. New Jersey
leases the Richard J. Hughes Justice Complex in Trenton from the Mercer County
Improvement Authority (the "MCIA"). Under the lease agreements with the New
Jersey Economic Development Authority (the "EDA"), New Jersey leases (i)
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office buildings that house the New Jersey Division of Motor Vehicles, New
Jersey Network, a branch of the United States Postal Service and a parking
facility, (ii) approximately 13 acres of real property and certain
infrastructure improvements thereon located in the city of Newark, (iii) certain
energy saving equipment which shall be installed in various buildings around New
Jersey and (iv) the New Jersey Performing Arts Center Facility in the City of
Newark. New Jersey also leases several office buildings, facilities and
improvements from the New Jersey Building Authority (the "NJBA"). Rental
payments under each of the foregoing leases are sufficient to pay debt service
on the related bonds issued by MCIA, EDA and NJBA, and in each case are subject
to annual appropriation by the New Jersey Legislature.
Beginning in April 1984, New Jersey, acting through the Director of
the Division of Purchase and Property, entered into a series of lease purchase
agreements which provide for the acquisition of equipment, services and real
property to be used by various departments and agencies of New Jersey. To date,
New Jersey has completed eleven lease purchase agreements which have resulted in
the issuance of Certificates of Participation totaling $749,350,000. The
agreements relating to these transactions provide for semi-annual rental
payments. New Jersey's obligation to pay rentals due under these leases is
subject to annual appropriations being made by the New Jersey Legislature.
State Supported School and County College Bonds. Legislation provides
-----------------------------------------------
for future appropriations for New Jersey aid to local school districts equal to
debt service on a maximum principal amount of $280,000,000 of bonds issued by
such local school districts for construction and renovation of school facilities
and for New Jersey aid to counties equal to debt service on up to $80,000,000 of
bonds issued by counties for construction of county college facilities. The New
Jersey Legislature is not legally bound to make such future appropriations, but
has done so to date on all outstanding obligations issued under these laws.
"Moral Obligation" Financing. The authorizing legislation for certain
----------------------------
New Jersey entities provides for specific budgetary procedures with respect to
certain obligations issued by such entities. Pursuant to such legislation, a
designated official is required to certify any deficiency in a debt service
reserve fund maintained to meet payments of principal of and interest on the
obligations, and a New Jersey appropriation in the amount of the deficiency is
to be made. However, the New Jersey Legislature is not legally bound to make
such an appropriation. Bonds issued pursuant to authorizing legislation of this
type are sometimes referred to as "moral obligation" bonds. There is no
statutory limitation on the amount of "moral obligation" bonds which may be
issued by eligible New Jersey
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entities. As of June 30, 1997, outstanding "moral obligation" bonded
indebtedness issued by New Jersey entities totaled $614,324,305 and maximum
annual debt service subject to "moral obligation" is $67,502,366.04.
Higher Education Assistance Authority. The Higher Education
-------------------------------------
Assistance Authority ("HEAA") has issued $149,996,064 aggregate principal amount
of revenue bonds. It is anticipated that the HEAA's revenues will be sufficient
to cover debt service on its bonds.
New Jersey Housing and Mortgage Finance Agency. Neither the New
----------------------------------------------
Jersey Housing and Mortgage Finance Agency nor its predecessors, the New Jersey
Housing Finance Agency and the New Jersey Mortgage Finance Agency, have had a
deficiency in a debt service reserve fund which required New Jersey to
appropriate funds to meet its "moral obligation". It is anticipated that this
agency's revenues will continue to be sufficient to cover debt service on its
bonds.
South Jersey Port Corporation. New Jersey has periodically provided
-----------------------------
the South Jersey Port Corporation (the "Port Corporation") with funds to cover
all debt service and property tax requirements, when earned revenues are
anticipated to be insufficient to cover these obligations. For calendar years
1986 through 1997, New Jersey has made appropriations totaling $49,560,536.25
which covered deficiencies in revenues of the Port Corporation, for debt service
and property tax payments.
New Jersey Sports and Exposition Authority. On March 2, 1992, the New
------------------------------------------
Jersey Sports and Exposition Authority (the "Sports Authority") issued
$147,490,000 in New Jersey guaranteed bonds and defeased all previously
outstanding New Jersey guaranteed bonds of the Sports Authority. New Jersey
officials have stated the belief that the revenue of the Sports Authority will
be sufficient to provide for the payment of debt service on these obligations
without recourse to New Jersey's guarantee.
Legislation enacted in 1992 authorizes the Sports Authority to issue bonds
for various purposes payable from New Jersey appropriations. Pursuant to this
legislation, the Sports Authority and the New Jersey Treasurer have entered into
an agreement (the "State Contract") pursuant to which the Sports Authority will
undertake certain projects, including the refunding of certain outstanding bonds
of the Sports Authority, and the New Jersey Treasurer will credit to the Sports
Authority Fund amounts from the General Fund sufficient to pay debt service and
other costs related to the bonds. The payment of all amounts under the State
Contract is subject to and dependent upon appropriations being made by the New
Jersey Legislature. As of
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<PAGE>
June 30, 1997 there are approximately $458,890,000 aggregate principal amount of
Sports Authority bonds outstanding, the debt service on which is payable from
amounts credited to the Sports Authority Fund pursuant to the State Contract.
New Jersey Transportation Trust Fund Authority. In July 1984, New Jersey
created the New Jersey Transportation Trust Fund Authority (the "TTFA"), an
instrumentality of New Jersey organized and existing under the New Jersey
Transportation Trust Fund Authority Act of 1984, as amended (the "TTFA Act") for
the purpose of funding a portion of New Jersey's share of the cost of
improvements to New Jersey's transportation system. Pursuant to the TTFA Act,
the TTFA, the New Jersey Treasurer and the Commissioner of Transportation
executed a contract (the "TTFA Contract") which provides for the payment of
these revenues to the TTFA. The payment of all such amounts is subject to and
dependent upon appropriations being made by the New Jersey Legislature and there
is no requirement that the Legislature make such appropriation. On May 30, 1995,
the New Jersey Legislature amended the TTFA Act to provide, among other things,
for (i) the issuance of debt in an aggregate principal amount in excess of the
statutory debt limitation in effect prior to the enactment of the 1995
amendments, (ii) an increase in the amount of revenues available to the TTFA and
(iii) broadening the scope of transportation projects.
Pursuant to the Act, the aggregate principal amount of TTFA's bonds, notes
or other obligations outstanding at any one time may not exceed $700 million
plus amounts carried over from prior fiscal years. These bonds are special
obligations of the TTFA payable from payments made by New Jersey pursuant to the
TTFA Contract.
Economic Recovery Fund Bonds. Legislation enacted during 1992 by New
----------------------------
Jersey authorizes the EDA to issue bonds for various economic development
purposes. Pursuant to that legislation, EDA and the New Jersey Treasurer have
entered into an agreement (the "ERF Contract") through which EDA has agreed to
undertake the financing of certain projects and the New Jersey Treasurer has
agreed to credit to the Economic Recovery Fund from the General Fund amounts
equivalent to payments due to New Jersey under an agreement with the Port
Authority of New York and New Jersey. The payment of all amounts under the ERF
Contract is subject to and dependent upon appropriations being made by the New
Jersey Legislature.
Counties and Municipalities. New Jersey law also regulates the issuance of
---------------------------
debt by local units. The Local Budget Law limits the amount of tax anticipation
notes that may be issued by local units and requires the repayment of such notes
within 120 days of the end of the fiscal year (six months in the case of the
counties) in which issued. The Local Bond Law
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(N.J.S.A. 4OA:2-1 I.) governs the issuance of bonds and notes by the local
--------
units. No local unit is permitted to issue bonds for the payment of current
expenses (other than Fiscal Year Adjustment Bonds described more fully below).
Local units may not issue bonds to pay outstanding bonds, except for refunding
purposes, and then only with the approval of the Local Finance Board. Local
units may issue bond anticipation notes for temporary periods not exceeding in
the aggregate approximately ten years from the date of first issue. The debt
that any local unit may authorize is limited to a percentage of its equalized
valuation basis, which is the average of the equalized value of all taxable real
property and improvements within the geographic boundaries of the local unit, as
annually determined by the Director of the Division of Taxation, for each of the
three most recent years. In the calculation of debt capacity, the Local Bond
Law and certain other statutes permit the deduction of certain classes of debt
("statutory deductions") from all authorized debt of the local unit ("gross
capital debt") in computing whether a local unit has exceeded its statutory debt
limit. Statutory deductions from gross capital debt consist of bonds or notes
(i) authorized for school purposes by a regional school district or by a
municipality or a school district with boundaries coextensive with such
municipality to the extent permitted under certain percentage limitations set
forth in the School Bond Law (as hereinafter defined); (ii) authorized for
purposes which are self-liquidating, but only to the extent permitted by the
Local Bond Law; (iii) authorized by a public body other than a local unit the
principal of and interest on which is guaranteed by the local unit, but only to
the extent permitted by law; (iv) that are bond anticipation notes; (v) for
which provision for payment has been made; or (vi) authorized for any other
purpose for which a deduction is permitted by law. Authorized net capital debt
(gross capital debt minus statutory deductions) is limited to 3.5 percent of the
equalized valuation basis in the case of municipalities and 2 percent of the
equalized valuation basis in the case of counties. The debt limit of a county
or municipality, with certain exceptions, may be exceeded only with the approval
of the Local Finance Board.
State Pension Funding Bonds. Legislation enacted in June 1997 authorizes
---------------------------
the EDA to issue bonds to pay a portion of New Jersey's unfunded accrued pension
liability for New Jersey's retirement systems (the "Unfunded Accrued Pension
Liability"), which, together with amounts derived from the revaluation of the
pension assets pursuant to companion legislation enacted at the same time, will
be sufficient to fully fund the Unfunded Accrued Pension Liability. On June 30,
1997 the EDA issued $2,803,042,498.56 aggregate principal amount of State
Pension Funding Bonds, Series 1997A-1997C. The EDA and the New Jersey Treasurer
have entered into an agreement which provides for the payment to the EDA of
monies sufficient to pay debt service on
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the bonds. Such payments are subject to and dependent upon appropriations being
made by the New Jersey Legislature.
School District Bonds. School district bonds and temporary notes are issued
in conformity with N.J.S.A. 18A:24-1 et seq. (the "School Bond Law"). Although
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school districts are exempted from the 5 percent down payment provision
generally applied to bonds issued by municipalities and counties, they are
subject to debt limits (which vary depending on the type of school system
provided) and to New Jersey regulation of their borrowing. The debt limitation
on school district bonds depends upon the classification of the school district,
but may be as high as 4 percent of the average equalized valuation basis of the
constituent municipality. In certain cases involving school districts in cities
with populations exceeding 100,000, the debt limit is 8 percent of the average
equalized valuation basis of the constituent municipality, and in cities with
populations in excess of 80,000 the debt limit is 6 percent of the aforesaid
average equalized valuation.
School District Lease Purchase Financings. In 1982, school districts
-----------------------------------------
were given an alternative to the traditional method of bond financing capital
improvements pursuant to N.J.S.A. 18A:20-4.2(f) (the "Lease Purchase Law"). The
--------
Lease Purchase Law permits school districts to acquire a site and school
building through a lease purchase agreement with a private lessor corporation.
The lease purchase agreement does not require voter approval. The rent payments
attributable to the lease purchase agreement are subject to annual appropriation
by the school district and are required, pursuant to N.J.A.C. 6:22A-1.2(h), to
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be included in the annual current expense budget of the school district.
Furthermore, the rent payments attributable to the lease purchase agreement do
not constitute debt of the school district and therefore do not impact on the
school district's debt limitation. Lease purchase agreements in excess of five
years require the approval of the Commissioner and the Local Finance Board.
Qualified Bonds. In 1976, legislation was enacted (P.L. 1976, c.38
---------------
and c.39) which provides for the issuance by municipalities and school districts
of "qualified bonds". Whenever a local board of education or the governing body
of a municipality determines to issue bonds, it may file an application with the
Local Finance Board and, in the case of a local board of education, the
Commissioner, to qualify bonds pursuant to P.L. 1976, c.38 or c.39. Upon
approval of such an application and after receipt of a certificate stating the
name and address of the paying agent for such bonds, the maturity schedule,
interest rates and payment dates, the New Jersey Treasurer shall, in the case of
qualified bonds for school districts, withhold from the school aid payable to
such municipality or school district and, in the case of qualified
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bonds for municipalities, withhold from the amount of business personal property
tax replacement revenues, gross receipts tax revenues, municipal purposes tax
assistance fund distributions, New Jersey urban aid, New Jersey revenue sharing,
and any other funds appropriated as New Jersey aid and not otherwise dedicated
to specific municipal programs, payable to such municipalities, an amount
sufficient to cover debt service on such bonds. These "qualified bonds" are not
direct, guaranteed or moral obligations of New Jersey, and debt service on such
bonds will be provided by New Jersey only if the above-mentioned appropriations
are made by New Jersey. Total outstanding indebtedness for "qualified bonds"
consisted of $224,492,700 by various school districts as of June 30, 1995 and
$903,760,316 by various municipalities as of June 30, 1995.
New Jersey School Bond Reserve Act. The New Jersey School Bond
----------------------------------
Reserve Act (N.J.S.A. 18A:56-17 et seq.) establishes a school bond reserve
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within the constitutionally dedicated Fund for the Support of Free Public
Schools. Under this law the reserve is maintained at an amount equal to 1.5
percent of the aggregate outstanding bonded indebtedness of counties,
municipalities or school districts for school purposes (exclusive of bonds whose
debt service is provided by New Jersey appropriations), but not in excess of
monies available in such fund. If a municipality, county or school district is
unable to meet payment of the principal of or interest on any of its school
bonds, the trustee of the school bond reserve will purchase such bonds at the
face amount thereof or pay the holders thereof the interest due or to become
due. At June 30, 1995, the book value of the Fund's assets aggregated
$88,736,798 and the reserve, computed as of June 30, 1995, amounted to
$38,811,015. There has never been an occasion to call upon this fund. New
Jersey provides support of certain bonds of counties, municipalities and school
districts through various statutes.
Local Financing Authorities. The Local Authorities Fiscal Control Law
---------------------------
(N.J.S.A. 40A:5A-1 et seq.) provides for state supervision of the fiscal
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operations and debt issuance practices of independent local authorities and
special taxing districts by the New Jersey Department of Community Affairs. The
Local Authorities Fiscal Control Law applies to all autonomous public bodies
created by counties or municipalities, which are empowered to issue bonds, to
impose facility or service charges, or to levy taxes in their districts. This
encompasses most autonomous local authorities (sewerage, municipal utilities,
parking, pollution control, improvement, etc.) and special taxing districts
(fire, water, etc.). Authorities which are subject to differing New Jersey or
federal financial restrictions are exempted, but only to the extent of that
difference.
Financial control responsibilities over local authorities and special
districts are assigned to the Local
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Finance Board and the Director of the Division of Local Government Services.
The Local Finance Board exercises approval power over the creation of new
authorities and special districts as well as their dissolution. The Local
Finance Board also reviews, conducts public hearings and issues findings and
recommendations on any proposed project financing of an authority or district,
and on any proposed financing agreement between an municipality or county and an
authority or special district. The Local Finance Board prescribes minimum audit
requirements to be followed by authorities and special districts in the conduct
of their annual audits. The Director reviews and approves annual budgets of
authorities and special districts.
LITIGATION. At any given time, there are various numbers of claims and
cases pending against the State of New Jersey, New Jersey agencies and
employees, seeking recovery of monetary damages that are primarily paid out of
the fund created pursuant to the New Jersey Tort Claims Act (N.J.S.A. 59:1-1 et
seq). New Jersey does not formally estimate its reserve representing potential
exposure for these claims and cases. New Jersey is unable to estimate its
exposure for these claims and cases.
New Jersey routinely receives notices of claim seeking substantial sums of
money. The majority of those claims have historically proven to be of
substantially less value than the amount originally claimed. Under the New
Jersey Tort Claims Act, any tort litigation against New Jersey must be preceded
by a notice of claim, which affords New Jersey the opportunity for a six-month
investigation prior to the filing of any suit against it. At any given time,
there are various numbers of claims and cases pending against the University of
Medicine and Dentistry and its employees, seeking recovery of monetary damages
that are primarily paid out of the Self Insurance Reserve Fund created pursuant
to the New Jersey Tort Claims Act. An independent study estimated an aggregate
potential exposure of $90,800,000 for tort and medical malpractice claims
pending as of June 30, 1997. In addition, at any given time, there are various
numbers of contract and other claims against the University of Medicine and
Dentistry, seeking recovery of monetary damages or other relief which, if
granted, would require the expenditure of funds. New Jersey is unable to
estimate its exposure for these claims.
Other lawsuits presently pending or threatened in which New Jersey has the
potential for either a significant loss of revenue or a significant
unanticipated expenditures include the following:
New Jersey Education Association v. State of New Jersey challenging
amendments enacted in 1994 affecting the funding of the Teachers Pension and
Annuity Fund, the Public Employees' Retirement System, the Police and Fireman's
Retirement System, the State Police Retirement System and the Judicial
Retirement
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System. The matter was stayed pending the adoption of the Appropriations Act
for Fiscal Year 1998 and has been closed on a stipulation of dismissal entered
by the court upon consent of all the parties with no payment made by any of the
parties.
County of Passaic v. State of New Jersey the County of Passaic, Passaic
County Utilities Authority and Passaic County Pollution Control Financing
Authority alleged tort and contract claims against New Jersey and the New Jersey
Department of Environmental Protection associated with a resource recovery
facility which the plaintiffs had once planned to build. The complaint alleged
$30 million in damages for an alleged violation of a 1984 consent order
concerning the construction of the resource recovery facility. The court
granted New Jersey's motion for summary judgment and the appellate division
affirmed on October 17, 1997. The time for filing of a petition for
recertification has elapsed.
Interfaith Community Organization v. Shinn, a suit filed by a coalition of
churches and church leaders in Hudson County against the Governor, the
Commissioners of the Department of Environmental Protection and the Department
of Health, concerning chromium contamination in Liberty State Park in Jersey
City.
American Trucking Associations, Inc. and Tri-State Motor Transit Co. v.
State of New Jersey challenging the constitutionality of annual hazardous and
solid waste licensure fees collected by the Department of Environmental
Protection, seeking permanent injunction enjoining future collection of fees and
refund of all renewal fees, fines and penalties collected.
Abbott v. Burke, a decision by the New Jersey Supreme Court on July 12,
1994 requires that a funding formula be enacted by December 31, 1996 which would
close the spending gap between poor urban school districts and wealthy suburban
school districts by fiscal year 1998. On December 20, 1996, the Comprehensive
Education Improvement and Financing Act ("CEIFA") was enacted. On January 6,
1997 the Education Law Center filed a motion in aid of litigant's rights with
the New Jersey Supreme Court requesting, in part, relief in the form of 100%
spending parity or state aid in the amount of approximately $200 million to be
redistributed to the special needs school districts. On May 14, 1997, the
Supreme Court held the CEIFA unconstitutional as applied to 28 districts and
ordered New Jersey to appropriate additional funds beginning with the 1997-98
school year so that each district would be able to spend at the average of the
wealthy suburban districts and remanded to the Superior Court to oversee a study
and report of the Commission of Education on the special education needs and
facilities of those districts.
Affiliated FM Insurance Company v. State of New Jersey, an action by
certain members of the New Jersey Property-Liability
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Insurance Guaranty Association challenging the constitutionality of assessments
used for the Market Transition Fund and seeking repayment of assessments paid
since 1990.
In the Matter of the 1997 Assessment Made by the New Jersey Property
Liability Insurance Guaranty Association Pursuant to N.J.S.A. 17:30A-4, in a
case related to the case above, the American Insurance Association and the
Alliance of American Insurers filed an appeal of an administrative action
seeking an emergent stay of their obligation to pay assessments to the New
Jersey Property-Liability Insurance Guaranty Association. The plaintiffs allege
that the assessment of $160 million per calendar year is without statutory
authority. On July 28, 1997, the court denied the plaintiffs' application for
emergent relief and denied New Jersey's motion for summary disposition.
C.F. v. Fauver, a class action in federal district court by prisoners with
serious mental disorders who are confined within the facilities of the New
Jersey Department of Corrections seeking injunctive relief in the form of
changes to the manner in which the mental health services are provided to
inmates.
Cleary v. Waldman, the plaintiffs claim that the Medicare Catastrophic
Coverage Act, providing funds to spouses of institutionalized individuals
sufficient funds to live in the community, requires that a certain system be
used to provide the funds and another system is being used instead. Estimate of
exposure if the court were to find for the plaintiffs are in the area of $50
million per year from both New Jersey and Federal sources combined. Plaintiffs
motion for a preliminary injunction was denied and is being appealed.
United Hospitals v. State of New Jersey, 18 New Jersey hospitals are
challenging the Medicaid reimbursements made since February 1995 claiming that
New Jersey failed to comply with certain federal requirements, the reimbursement
regulations are arbitrary, capricious and unreasonable, rates were incorrectly
calculated, the hospitals were denied due process, the Medicaid reimbursement
provisions violate the New Jersey Constitution, and Medicaid State Plan was
violated by the New Jersey Department of Human Services implementation of
hospital rates in 1995 and 1996.
Trump Hotels & Casino Resorts, Inc. v. Mirage Resorts Incorporated, the
plaintiff is suing Mirage Resorts and New Jersey in an attempt to enjoin their
efforts to build a highway and tunnel funded by Mirage Resorts and $55 million
in bonds collateralized by future casino obligations, claiming that the project
violates the New Jersey Constitution provision that requires all revenues the
state receives from gaming operations to benefit the elderly and disabled. The
plaintiff also claims (i) the failure to disclose this constitutional infirmity
is a material omission within the meaning of Rule 10b-5 of the
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Securities and Exchange Act of 1934, (ii) the defendants have sought to avoid
the requirements of the Clean Water Act, Clean Air Act, Federal Highway Act and
the New Jersey Coastal Area Facility Review Act. On May 1, 1997, the federal
district court granted the defendants' motion to dismiss and appeal is pending
in the Third Circuit. In a related action, State of New Jersey v. Trump Hotels
& Casino Resorts, Inc., New Jersey filed a declaratory judgment action seeking a
declaration that the use of certain funds New Jersey statutory provisions
existed that permitted use of certain funds to be used for other purposes than
the elderly or disabled. Declaratory judgment was entered in favor of New
Jersey on May 14, 1997 and the matter is now in the Appellate Division.
United Alliance v. State of New Jersey, plaintiffs allege that the Casino
Reinvestment Development Authority funding mechanisms are illegal including the
gross receipts tax, the parking tax, and the Atlantic City fund. This matter
has been placed on the inactive list. Five additional cases have been filed in
opposition to the road and tunnel project which also contain related challenges:
Bryant v. New Jersey Department of Transportation, Merolla and Brady v. Casino
Reinvestment Development Authority, Middlesex County v. Casino Reinvestment
Development Authority, Gallagher v. Casino Reinvestment Development Authority
and George Harms v. State of New Jersey. Summary judgment has been granted in
favor of the New Jersey or its agencies in Merolla, Middlesex and Gallagher but
the plaintiffs have filed an appeal.
Blecker v. State of New Jersey, a class action filed on behalf of providers
of Medicare Part B services to Qualified Medicare Beneficiaries seeking
reimbursement for Medicare co-insurance and deductibles not paid by the New
Jersey Medicaid program from 1988 to February 10, 1995. Plaintiffs claim a
breach of contract and violation of federal civil rights laws. Arguments on the
State's motions to dismiss and for summary judgment are expected to take place
in late November or in December 1997.
Spadoro v. New Jersey Economic Development Authority, the plaintiff
challenges the funding of New Jersey's accrued unfunded liability on the State's
pension funds through $2,803,042,498.56 in bonds issued by the New Jersey
Economic Development Authority and authorized by the Pension Bond Financing Act
of 1997. This suit is a second attempt by the plaintiff who claims that
resolution authorizing the issuance of bonds was invalid because (i) the State
Treasurer and other ex officio members of the Authority had a conflict of
interest, (ii) the actions of the Authority violated the public policy of the
State, and (iii) there were various procedural defects in the conduct of the
meeting. Oral argument on the defendants' motion for summary judgment is
scheduled for January 8, 1998.
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Camden County Energy Recovery Associates v. New Jersey Department of
Environmental Protection, the plaintiff owns and operates a resource facility in
Camden County and has filed suit seeking to have the solid waste reprocurement
process halted to clarify bid specification. The court did not halt the bid
process but did require clarifications. Co-defendant Pollution Control
Financing Authority of Camden County counterclaimed, seeking reformation of the
contract between it and the plaintiff and cross-claimed against New Jersey for
contribution and indemnification.
SPECIAL CONSIDERATIONS REGARDING INVESTMENT IN DELAWARE STATE-SPECIFIC
OBLIGATIONS. The concentration of investments in Delaware State-Specific
Obligations by the Delaware Tax-Free Income Portfolio raises special investment
considerations. In particular, changes in the economic condition and
governmental policies of Delaware and its political subdivisions, agencies,
instrumentalities and authorities could adversely affect the value of the
Delaware Tax-Free Income Portfolio. This section briefly describes current
economic trends in Delaware. The information set forth in this section relates
only to the State itself and not to the special purpose or local government
units whose issues may also be held by the Delaware Tax-Free Income Portfolio.
The credits represented by such issuers may be affected by a wide variety of
local factors or structuring concerns, and no disclosure is made herein relating
to such matters.
Delaware has enjoyed expansion throughout most sectors of its economy
during the 1990's. Much of Delaware's success in maintaining a healthy economy
over this time period can be attributed to efforts to diversify its economic
base. Delaware's employment base has expanded beyond its historical emphasis in
chemical and automobile manufacturing to include strong banking and service
sectors. According to recent Dun & Bradstreet figures, Delaware has the lowest
business failure rate in the United States.
Delaware has experienced above-average population growth through the
1990's. Net in-migration accounts for a significant share of the growth.
Delaware's total personal income grew 7.1% in 1996, compared with 4.9% for the
Mid-Atlantic region and 5.6% for the nation. Delaware's non-agricultural
employment accounts for approximately 98% of the workforce. In 1997, a 3.2%
increase in non-agricultural employment occurred (greater than the 1.7% increase
for the mid-Atlantic region and the 2.3% increase for the nation). The State's
unemployment rate for 1997 was 4% lower than both the Mid-Atlantic region rate
and the national rate.
The State's general obligation debt outstanding was $626.7 million on
December 31, 1997, with approximately 80% scheduled to mature within ten years
and approximately 95% scheduled to mature
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within fifteen years. Delaware's debt burden reflects the centralized role of
the State government in undertaking capital projects typically funded at local
government levels elsewhere, such as highways, correctional facilities and
schools. There is no state Constitutional debt limit applicable to Delaware.
However, Delaware has instituted several measures designed to manage and reduce
its indebtedness. In 1991, the State enacted legislation putting a three-part
debt limit in place, one part of which restricts new debt authorization to 5% of
the budgetary General Fund revenue as projected on June 30 for the next fiscal
year. Delaware voluntarily retires its general obligation debt. Delaware has
implemented and maintained a "pay-as-you-go" financing program for capital
projects. In fiscal 1986, 1989 and 1996, available cash was used to defease an
aggregate of $69.4 million of high coupon general obligation debt. In fiscal
1997, $10 million of previously authorized general obligation bonds were
deauthorized. Delaware has also undertaken a series of bond refundings to lower
the overall debt service on its obligations.
Delaware budgets and controls its financial activities on the cash basis of
accounting. State law requires Delaware to record its financial transactions in
either of two major categories -- the budgetary General Fund or the budgetary
Special Funds. The General Fund provides for the cost of the State's general
operations and is credited with all tax and other revenue of Delaware not
dedicated to Special Funds. All disbursements from the General Fund must be
authorized by appropriations of the Delaware General Assembly. The Special
Funds are designated for specific purposes, and the appropriate fund is credited
with the tax or other revenue allocated to such fund and is charged with the
related disbursements. The principal receipts credited to the appropriate
Special Fund are unemployment insurance taxes, transportation-related taxes for
the Transportation Trust Fund, certain taxes on insurance companies and property
taxes levied by local school districts.
The Delaware Constitution limits annual appropriations by majority vote of
both houses of the General Assembly to 98% of estimated budgetary General Fund
revenue plus the unencumbered budgetary General Fund balance, if any, from the
previous year. The State Constitution also provides for the deposit of the
excess of any unencumbered budgetary General Funds at the end of the fiscal year
into a reserve account (the "Budget Reserve Account"), provided that the amount
of the Budget Reserve Account does not exceed 5% of the estimated appropriations
used to determine the appropriation limit for that fiscal year. Transfers of
$100.9 million were made to fund the Budget Reserve Account for fiscal 1998.
The Budget Reserve Account provides a cushion and money from the account can be
accessed only with the approval of a three-fifths vote of each house of the
General Assembly and only to fund an unanticipated budgetary General Fund
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deficit or to provide funds required as a result of the enactment of legislation
causing a reduction in revenue.
Delaware concluded fiscal year 1997 with a cumulative cash balance of
$392.8 million. The Budget Reserve Account was fully funded and an additional
$183.7 million was set aside for continuing and encumbered appropriations
resulting in an unencumbered cash balance on June 30, 1997 of $116.2 million.
These results are presented on a budgetary basis. Accounting principles applied
to develop data on a budgetary basis differ from those principles used to
present financial statements in conformity with generally accepted accounting
principles (GAAP).
The principal source of Delaware revenue is personal income tax. Delaware
does not levy ad valorem taxes on real or personal property and does not impose
a general sales or use tax. In May 1980, the Delaware Constitution was amended
to limit tax and license fee increases and the imposition of new taxes or fees.
Any tax or license fee increase or new tax or license fee must be passed by a
three-fifths vote of each house of the General Assembly, rather than by a simple
majority vote.
Certain litigation is pending against the State. The State is a
potentially responsible party with respect to two sites which are subject to
remediation under the Federal Superfund Act. The State has taken the position
that a number of other parties are jointly and severally liable for the
remediation costs, but Delaware's share of the cost may exceed $1.0 million.
Delaware is also a defendant in various suits alleging wrongful discharge, use
of excessive force by State police officers, sexual assault, civil rights
violations and discrimination claims. The State believes that it has valid
defenses to all of these actions; however, the State has a potential aggregate
liability exposure that could exceed $3 million.
Delaware is exposed to risks and losses related to employee health and
accident, worker's compensation, environmental and a portion of property and
casualty claims. Delaware does not purchase commercial insurance to cover these
risks because of prohibitive costs. The State covers all claim settlements or
judgments from its budgetary General Fund. It continues to carry commercial
insurance for all other risks.
SPECIAL CONSIDERATIONS REGARDING INVESTMENTS IN KENTUCKY STATE-SPECIFIC
OBLIGATIONS. The Kentucky Tax-Free Income Portfolio will invest primarily in
Kentucky State-Specific Obligations. Such obligations generally include tax-
free securities issued by the Commonwealth of Kentucky ("Kentucky" or the
"Commonwealth"), its counties and various other local authorities to finance
such long-term public purpose projects as schools, universities, housing,
transportation, utilities,
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hospitals and water and sewer facilities throughout the Commonwealth.
According to statistics furnished by the Office of Financial Management and
Economic Analysis of the Kentucky Finance and Administration Cabinet, dated as
of October 30, 1997, Kentucky has 1.5% of the total U.S. population, 1.2% of
total U.S. personal income, and 1.4% of total U.S. nonagricultural employment.
During 1996, the Kentucky unemployment rate averaged 5.5% compared with the
national average of 5.4%. During the first half of 1997, the Kentucky
unemployment rate averaged 5.6% as compared to 5.1% nationally. During 1996,
nonagricultural employment in Kentucky grew by 1.7% compared to 5.6% nationally.
Nonagricultural employment has grown by 16.8% compared to the national average
of 11.6% during the period from 1990 to mid-1997.
Kentucky is a leader among the states in the production of coal. Tobacco
is the dominant agricultural product, and Kentucky ranks second among the U.S.
in the total cash value of tobacco raised. Potential federal regulation of the
tobacco industry, including action by Congress on a settlement agreement with
the tobacco industry to resolve multiple pending lawsuits may impact the tobacco
industry, though the degree of the impact cannot be predicted with any
certainty.
There is significant diversification in the manufacturing mix in the
Commonwealth, including tobacco processing plants, distilleries and durable
goods production consisting of, among other things, automobiles, heavy
machinery, consumer appliances and office equipment. Kentucky now ranks fourth
among all U.S. auto-producing states and four of the current top-selling
vehicles manufactured in the U.S. are manufactured in Kentucky. The horse
breeding and racing industry plays an important role both as a significant
industry as well as encouraging tourist business in the Commonwealth.
No single segment of the economy of Kentucky accounts for as much as one
fourth of the overall Commonwealth domestic product. The economy is diversified
to the extent that an economic decline in a single segment would not necessarily
lead to the non-payment of debt service on Kentucky State-Specific Obligations.
A national economic decline, however, could impact the ability of issuers to pay
debt service, if the decline impacted various segments within the
Commonwealth.
Economic problems include a continuing high unemployment rate in the non-
urbanized ares of the Commonwealth. The Coal Severance Tax is a significant
revenue producer for the Commonwealth and its political subdivisions, and any
substantial decrease in the amount of coal or other minerals produced could
result in revenue shortfalls. Additionally, any Federal
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legislation adversely affecting the tobacco industry would have a negative
impact on Kentucky's economy. Although revenue obligations of the Commonwealth
or its political subdivisions may be payable from a specific project, there can
be no assurances that further economic difficulties and the resulting impact on
state and local government finances will not adversely affect the market value
of the obligations issued by the Commonwealth and its political subdivisions or
the ability of the respective entities to pay debt service on their
obligations.
The Commonwealth relies heavily upon sales and use taxes, individual income
taxes, property taxes, corporate income taxes, insurance premium taxes,
alcoholic beverage taxes, corporate license taxes, cigarette taxes, mineral
soverance taxes, motor fuel taxes, motor vehicle usage taxes and horse racing
taxes for its revenue. The cities, counties and other local governments are
essentially limited to property taxes, occupational license taxes, utility
taxes, transit and restaurant meals taxes and various license fees for their
revenue. Kentucky State-Specific Obligations are subject to the risks of
general economic and other factors as well.
There are several general types of Kentucky State-Specific Obligations.
General obligation securities are secured by the issuer's pledge of its full
faith, credit and/or taxing power for the payment of principal and interest.
General obligation securities are rare since they must be authorized by a two-
thirds vote of the electorate of the issuer. Revenue obligations are payable
from and secured by a particular revenue stream, such as lease rentals, utility
usage and connection charges, student registration or housing fees, bridge or
highway tolls, parking fees and sports event gate receipts. Although industrial
building revenue obligations are issued by municipal authorities, they are
secured by revenue derived from some form of contractual arrangement with a non-
governmental user. Some revenue obligations, including industrial building
revenue obligations, are secured by a mortgage on the real property.
Improvement assessment obligations are obligations secured by a special
assessment (e.g., a sewer charge) that the governmental issuer imposes on each
owner of property benefited by the improvement (e.g., a sanitary sewer project).
The assessments are similar to taxes and have a priority which is similar to a
tax lien. Refunded or defeased bonds are secured by an escrow fund, which
usually is invested in United States government securities and occasionally in
bank certificates of deposit or similar instruments. Housing obligations are
usually secured by mortgages pledged for the payment of the obligations. Local
housing authorities sometimes issue obligations that are secured by rentals from
the operation of a housing project. Housing obligations may also have
additional security in the form of federal guarantees of the mortgages or
rentals constituting the primary security.
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<PAGE>
There are variations in the security of Kentucky State-Specific
Obligations, both within a particular classification and between
classifications, depending on numerous factors.
Because of constitutional limitations, the Commonwealth cannot enter into a
financial obligation of more than two years' duration, and no other municipal
issuer within the Commonwealth can enter into a financial obligation of more
than one year's duration. As a consequence, the payment and security
arrangements applicable to Kentucky State-Specific Obligations differ
significantly from those generally applicable to revenue obligations in other
states. For example, most local school construction is financed from
obligations nominally issued by a larger city or county government, which holds
legal title to the school, subject to a year-to-year renewable leaseback
arrangement with the local school district. However, there is no reported
instance in which a Kentucky school bond has gone into default. Similar
arrangements are used to finance many city and county construction projects but
in these cases, the obligations are nominally issued in the name of a public
corporation, which holds title to the project and leases the project back to the
city or county on a year-to-year renewable basis. In such situations, the rent
that the nominal issuer receives from the actual user of the property financed
by the obligations is the only source of any security for the payment of the
obligations.
Overview of the Commonwealth's Debt Authorities. The Commonwealth's
-----------------------------------------------
indebtedness is comprised of obligations which are either direct obligations of
the Commonwealth or obligations of one of the debt-issuing entities created by
the legislature to finance various projects or programs. Direct debt is general
obligation debt that pledges the full faith, credit, and taxing powers of the
Commonwealth as security for the repayment of the debt. The Kentucky
Constitution requires voter approval by general referendum prior to the issuance
of general obligations in amounts exceeding $500,000. There are currently no
general obligations outstanding.
The second type of debt incurred by the Commonwealth is project revenue
debt. Project revenue debt pledges as security for repayment of the debt only
the revenues produced by the projects funded from the debt. Project revenue
obligations are not a direct obligation of the Commonwealth. Project revenues
are, in some cases, derived partially, or solely, from legislative
appropriations which are subject to biennial renewal. In other cases, revenues
generated from the project financed by the debt are used to make the debt
service payments in full.
The third type of debt incurred by the Commonwealth is moral obligation
debt. These obligations are not direct obligations of the Commonwealth and no
appropriations of the Commonwealth are pledged to pay the debt service. Rather
these entities covenant
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<PAGE>
to request funds from the Governor and the legislature in the event of a
shortfall in the debt service. The entities which utilize this process are
discussed in the following section.
Debt Issuing Entities of the Commonwealth. Project revenue debt has been
-----------------------------------------
incurred by seventeen of the commissions, corporations, authorities, or boards
created by the Commonwealth. Seven of the debt issuing authorities issue
obligations to finance projects that are not repaid by Commonwealth revenues.
These are the Kentucky Housing Corporation, the Kentucky Infrastructure
Authority, the Kentucky Higher Education Student Loan Corporation, the School
Facilities Construction Commission, the Kentucky Economic Development Finance
Authority, the Kentucky Local Correctional Facilities Construction Authority and
the Kentucky Agricultural Finance Corporation. None of these entities, except
for some of the obligations of the School Facilities Construction Commission and
the Kentucky Infrastructure Authority, receive appropriations for the payment of
debt service. Project revenues are used to repay debt service for these debt
authorities. The legislature has placed specific debt limitations on the
principal debt outstanding of the Kentucky Housing Corporation ($1.125 billion),
the Kentucky Higher Education Student Loan Corporation ($553 million) and the
Kentucky Agricultural Finance Corporation ($500 million). The debt of the
Kentucky Local Correctional Facilities Construction Authority is limited to the
level of debt service supported by a fee collected from certain cases in the
District Courts of the Commonwealth. Currently, no debt limitation exists for
the Kentucky Economic Development Finance Authority.
The remaining debt issuing entities of the Commonwealth receive a
appropriations biennially for the payment of debt service. The appropriation to
the School Facilities Construction Commission is used to subsidize the debt
service payments, in whole or in part, made by local school districts on local
school construction projects. The subsidy has varied by project. Two financing
programs of the Kentucky Infrastructure Authority, the Governmental Agencies
Program and the Multiple Projects Construction Loan Program, receive no
appropriations and have a debt ceiling. The three other financing programs of
the Kentucky Infrastructure Authority, the Federally Assisted Wastewater
Program, the Infrastructure Revolving Fund Program and the Solid Waste Revolving
Loan and Grant Program, have been appropriated monies. The State Property and
Buildings Commission, the Turnpike Authority of Kentucky and the State
Universities cannot incur debt for any project without prior approval of the
projects and appropriation of debt service by the legislature.
In 1997, the Commonwealth created the Kentucky Asset/Liability Commission
to develop and implement programs to assist in the management of the
Commonwealth's net interest
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<PAGE>
margin, and it may issue tax and revenue anticipation notes project notes, and
funding notes to achieve its purpose.
Default Record. Neither the Commonwealth nor any of its agencies have ever
--------------
defaulted in the payment of principal or interest on general obligation
indebtedness or project revenue obligations.
ADDITIONAL INVESTMENT LIMITATIONS.
Each Portfolio is subject to the investment limitations enumerated in this
subsection which may be changed with respect to a particular Portfolio only by a
vote of the holders of a majority of such Portfolio's outstanding shares (as
defined below under "Miscellaneous"). The Index Master Portfolio's fundamental
investment limitations are described separately.
MONEY MARKET PORTFOLIOS:
1) Each of the Money Market, Municipal Money Market and U.S. Treasury
Money Market Portfolios may not purchase securities of any one issuer (other
than securities issued or guaranteed by the U.S. Government, its agencies or
instrumentalities or certificates of deposit for any such securities) if more
than 5% of the value of the Portfolio's total assets (taken at current value)
would be invested in the securities of such issuer, or more than 10% of the
issuer's outstanding voting securities would be owned by the Portfolio or the
Fund, except that up to 25% of the value of the Portfolio's total assets (taken
at current value) may be invested without regard to these limitations. For
purposes of this limitation, a security is considered to be issued by the entity
(or entities) whose assets and revenues back the security. A guarantee of a
security is not deemed to be a security issued by the guarantor when the value
of all securities issued and guaranteed by the guarantor, and owned by the
Portfolio, does not exceed 10% of the value of the Portfolio's total
assets.
2) No Portfolio may borrow money or issue senior securities, except that
each Portfolio may borrow from banks and (other than a Municipal Money Market
Portfolio) enter into reverse repurchase agreements for temporary purposes in
amounts up to one-third of the value of its total assets at the time of such
borrowing; or mortgage, pledge or hypothecate any assets, except in connection
with any such borrowing and then in amounts not in excess of one-third of the
value of the Portfolio's total assets at the time of such borrowing. No
Portfolio will purchase securities while its aggregate borrowings (including
reverse repurchase agreements and borrowings from banks) in excess of 5% of its
total assets are outstanding. Securities held in escrow or separate accounts in
connection with a Portfolio's investment
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<PAGE>
practices are not deemed to be pledged for purposes of this limitation.
3) Each of the 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 and New Jersey Municipal
Money Market Portfolios may not purchase securities which would cause 25% or
more of the value of its 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. The Money Market Portfolio, on the other hand,
may not purchase any securities which would cause, at the time of purchase, less
than 25% of the value of its total assets to be invested in the obligations of
issuers in the banking industry, or in obligations, such as repurchase
agreements, secured by such obligations (unless the Portfolio is in a temporary
defensive position) or which would cause, at the time of purchase, more than 25%
of the value of its total assets to be invested in the obligations of issuers in
any other industry. In applying the investment limitations stated in this
paragraph, (i) there is no limitation with respect to the purchase of (a)
instruments issued (as defined in Investment Limitation number 1 above) 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, (b) instruments issued by domestic
banks (which may include U.S. branches of foreign banks) and (c) repurchase
agreements secured by the instruments described in clauses (a) and (b); (ii)
wholly-owned finance companies will be considered to be in the industries of
their parents if their activities are primarily related to financing the
activities of the parents; and (iii) utilities will be divided according to
their services, for example, gas, gas transmission, electric and gas, electric
and telephone will be each considered a separate industry.
4) Each 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 will invest at least 80% of its
net assets in AMT Paper and instruments the interest on which is exempt from
regular Federal income tax, except during defensive periods or during periods of
unusual market conditions.
5) The Municipal Money Market Portfolio will invest at least 80% of its
net assets in instruments the interest on which is exempt from regular Federal
income tax and is not an item of tax preference for purposes of Federal
alternative minimum tax, except during defensive periods or during periods of
unusual market conditions.
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<PAGE>
NON-MONEY MARKET PORTFOLIOS:
Each of the Non-Money Market Portfolios (other than the Ohio Tax-Free
Income, Pennsylvania Tax-Free Income, New Jersey Tax-Free Income, Delaware Tax
Free Income and Kentucky Tax-Free Income Portfolios) may not:
1) Purchase securities of any one issuer (other than securities issued or
guaranteed by the U.S. Government, its agencies or instrumentalities or
certificates of deposit for any such securities) if more than 5% of the value of
the Portfolio's total assets would (taken at current value) be invested in the
securities of such issuer, or more than 10% of the issuer's outstanding voting
securities would be owned by the Portfolio or the Fund, except that up to 25% of
the value of the Portfolio's total assets may (taken at current value) be
invested without regard to these limitations. For purposes of this limitation,
a security is considered to be issued by the entity (or entities) whose assets
and revenues back the security. A guarantee of a security shall not be deemed
to be a security issued by the guarantors when the value of all securities
issued and guaranteed by the guarantor, and owned by the Portfolio, does not
exceed 10% of the value of the Portfolio's total assets.
Each of the Non-Money Market Portfolios may not:
2) 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 (as defined in Investment Limitation No. 1 above) 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; and
(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.
Each Non-Money Market Portfolio (other than the Managed Income,
Intermediate Government Bond, Low Duration Bond, Intermediate Bond, Government
Income, International Bond, Core Bond and Balanced and GNMA Portfolios) may
not:
3) Borrow money or issue senior securities, except that each Portfolio
may borrow from banks and enter into reverse repurchase agreements for temporary
purposes in amounts up to
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<PAGE>
one-third of the value of its total assets at the time of such borrowing; or
mortgage, pledge or hypothecate any assets, except in connection with any such
borrowing and then in amounts not in excess of one-third of the value of the
Portfolio's total assets at the time of such borrowing. No Portfolio will
purchase securities while its aggregate borrowings (including reverse repurchase
agreements and borrowings from banks) in excess of 5% of its total assets are
outstanding. Securities held in escrow or separate accounts in connection with
a Portfolio's investment practices are not deemed to be pledged for purposes of
this limitation.
None of the Managed Income, Intermediate Government Bond, Low Duration
Bond, Intermediate Bond, Government Income, Core Bond, International Bond and
Balanced and GNMA Portfolios may:
4) Issue senior securities, borrow money or pledge its assets, except
that a Portfolio may borrow from banks or enter into reverse repurchase
agreements or dollar rolls in amounts aggregating not more than 33 1/3% of the
value of its total assets (calculated when the loan is made) to take advantage
of investment opportunities and may pledge up to 33 1/3% of the value of its
total assets to secure such borrowings. Each Portfolio is also authorized to
borrow an additional 5% of its total assets without regard to the foregoing
limitations for temporary purposes such as clearance of portfolio transactions
and share redemptions. For purposes of these restrictions, the purchase or sale
of securities on a "when-issued," delayed delivery or forward commitment basis,
the purchase and sale of options and futures contracts and collateral
arrangements with respect thereto are not deemed to be the issuance of a senior
security, a borrowing or a pledge of assets.
ALL PORTFOLIOS:
No Portfolio may:
1. 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.
2. Acquire any other investment company or investment company
security except in connection with a merger, consolidation, reorganization or
acquisition of assets or where otherwise permitted by the 1940 Act.
3. 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
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<PAGE>
investment objective, policies and limitations may be deemed to be underwriting.
4. Write or sell put options, call options, straddles, spreads, or
any combination thereof, except for transactions in options on securities,
securities indices, futures contracts and options on futures contracts and, in
the case of the International Bond Portfolio, currencies.
5. Purchase securities of companies for the purpose of exercising
control.
6. Purchase securities on margin, make short sales of securities or
maintain a short position, except that (a) this investment limitation shall not
apply to a Portfolio's transactions in futures contracts and related options or
a Portfolio's sale of securities short against the box, and (b) a Portfolio may
obtain short-term credit as may be necessary for the clearance of purchases and
sales of portfolio securities.
7. Purchase or sell commodity contracts, or invest in oil, gas or
mineral exploration or development programs, except that each Portfolio may, to
the extent appropriate to its investment policies, purchase securities (publicly
traded securities in the case of each Money Market Portfolio) of companies
engaging in whole or in part in such activities and may enter into futures
contracts and related options.
8. Make 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.
9. 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.
10. Notwithstanding the investment limitations of the Index Equity
Portfolio, the Index Equity Portfolio may invest all of its assets in shares of
an open-end management investment company with substantially the same investment
objective, policies and limitations as the Portfolio.
Although the foregoing investment limitations would permit the Money Market
Portfolios to invest in options, futures contracts and options on futures
contracts, and to sell securities short against the box, those Portfolios do not
currently intend to trade in such instruments or engage in such transactions
during the next twelve months (except to the extent a portfolio security may be
subject to a "demand feature" or
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<PAGE>
"put" as permitted under SEC regulations for money market funds). Prior to
making any such investments, a Money Market Portfolio would notify its
shareholders and add appropriate descriptions concerning the instruments and
transactions to its Prospectus.
INDEX MASTER PORTFOLIO:
The investment limitations of the Index Master Portfolio, the Portfolio in
which the Index Equity Portfolio invests all of its investable assets, are
separate from those of the Index Equity Portfolio. The Index Master Portfolio
may not:
1. Invest in commodities or real estate, including limited partnership
interests therein, although it may purchase and sell securities of companies
which deal in real estate and securities which are secured by interests in real
estate, and may purchase or sell financial futures contracts and options
thereon;
2. Make loans of cash, except through the acquisition of repurchase
agreements and obligations customarily purchased by institutional investors;
3. As to 75% of the total assets of the Index Master Portfolio, invest in
the securities of any issuer (except obligations of the U.S. Government and its
instrumentalities) if, as a result, more than 5% of the Index Master Portfolio's
total assets, at market, would be invested in the securities of such issuer;
4. Purchase or retain securities of an issuer if those officers and
trustees of the Trust or officers and directors of the Trust's investment
adviser owning more than 1/2 of 1% of such securities together own more than 5%
of such securities;
5. Borrow, except from banks and as a temporary measure for extraordinary
or emergency purposes and then, in no event, in excess of 5% of the Index Master
Portfolio's gross assets valued at the lower of market or cost; provided that it
may borrow amounts not exceeding 33% of its net assets from banks and pledge not
more than 33% of such assets to secure such loans;
6. Pledge, mortgage, or hypothecate any of its assets to an extent
greater than 10% of its total assets at fair market value, except as described
in (5) above;
7. Invest more than 10% of the value of its total assets in illiquid
securities which include certain restricted securities, repurchase agreements
with maturities of greater than seven days, and other illiquid investments;
8. Engage in the business of underwriting securities issued by others;
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<PAGE>
9. Invest for the purpose of exercising control over management of any
company;
10. Invest its assets in securities of any investment company, except in
connection with a merger, acquisition of assets, consolidation or
reorganization;
11. Invest more than 5% of its total assets in securities of companies
which have (with predecessors) a record of less than three years' continuous
operation;
12. Acquire any securities of companies within one industry if, as a
result of such acquisition, more than 25% of the value of its total assets would
be invested in securities of companies within such industry;
13. Write or acquire options (except as described in (1) above) or
interests in oil, gas or other mineral exploration, leases or development
programs;
14. Purchase warrants; however, it may acquire warrants as a result of
corporate actions involving its holdings of other equity securities;
15. Purchase securities on margin or sell short; or
16. Acquire more than 10% of the voting securities of any issuer.
Although (2) above prohibits cash loans, the Index Master Portfolio is
authorized to lend portfolio securities. With respect to (7) above, pursuant to
Rule 144A under the 1993 Act, the Index Master Portfolio may purchase certain
unregistered (i.e. restricted) securities upon a determination that a liquid
institutional market exists for the securities. If it is decided that a liquid
market does exist, the securities will not be subject to the 10% limitation on
holdings of illiquid securities stated in (7) above. While maintaining
oversight, the Board of Trustees of the Trust has delegated the day-to-day
function of making liquidity determinations to DFA, the Index Master Portfolio's
adviser. For Rule 144A securities to be considered liquid, there must be at
least two dealers making a market in such securities. After purchase, the Board
of Trustees of the Trust and DFA will continue to monitor the liquidity of Rule
144A securities.
For purposes of (12) above, utility companies will be divided
according to their services; e.g., gas, gas transmission, electric and gas,
electric, water and telephone will each be considered a separate industry.
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<PAGE>
Because the structure of the Index Master Portfolio is based on the
relative market capitalizations of eligible holdings, it is possible that the
Index Master Portfolio might include at least 5% of the outstanding voting
securities of one or more issuers. In such circumstances, the Trust and the
issuer would be deemed "affiliated persons" under the Investment Company Act of
1940, and certain requirements of the Act regulating dealings between affiliates
might become applicable.
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>
PRINCIPAL OCCUPATION
NAME AND ADDRESS POSITION WITH FUND DURING PAST FIVE YEARS
- ---------------- ------------------ ----------------------
<S> <C> <C>
William O. Albertini Trustee Executive Vice President
Bell Atlantic Global and Chief Financial
Wireless Officer since August,
1717 Arch Street 1997, Bell Atlantic
29th Floor East Global Wireless (global
Philadelphia, PA 19103 wireless communications);
Age: 55 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); Chairman,
President and Chief
Executive Officer from
August 1989 - January
1991, Bell Atlantic
Enterprises
International, Inc.;
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
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION
NAME AND ADDRESS POSITION WITH FUND DURING PAST FIVE YEARS
- ---------------- ------------------ ----------------------
<S> <C> <C>
Foundation since October
1991.
Raymond J. Clark/1/ Trustee, Treasurer of Princeton
Office of the Treasurer President and University since 1987;
Princeton University Treasurer Trustee, The Compass
3 New South Building Capital Group of Funds
P.O. Box 35 from 1987 to 1996;
Princeton, New Jersey 08540 Trustee, United-Way
Age: 62 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;
Trustee, Medical Center
of Princeton; and
Trustee, United
Way-Greater Mercer County
from 1996-1997.
Robert M. Hernandez Trustee Director since 1991, Vice
USX Corporation Chairman and Chief
600 Grant Street Financial Officer
6105 USX Tower since 1994, Executive
Pittsburgh, PA 15219 Vice President -
Age: 53 Accounting and Finance
and Chief 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
</TABLE>
_____________________
/1/ This trustee may be deemed an "interested person" of the Fund as defined in
the 1940 Act.
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<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION
NAME AND ADDRESS POSITION WITH FUND DURING PAST FIVE YEARS
- ---------------- ------------------ ----------------------
<S> <C> <C>
Foundation; Director,
Marinette Marine
Corporation; Director,
Pittsburgh Baseball, Inc.
from 1994-96; Director,
Transtar, Inc.
(transportation company)
since 1996; and Director
and Chairman of the
Board, RMI Titanium
Company.
Anthony M. Santomero Vice Chairman Deputy Dean from
The Wharton School of the Board 1990 to 1994, Richard
University of Pennsylvania K. Mellon Professor
Room 2344 of Finance since April
Steinberg Hall-Dietrich Hall 1984, Director, Wharton
Philadelphia, PA 19104-6367 Financial Institutions
Age: 51 Center, since 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; 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. Chairman of Chairman, Gee,
One Aldwyn Center the Board Wilmerding & Associ-
- -Villanova, PA 19085 ates, Inc.
Age: 62 (investment 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 Assistant President, Compass
BlackRock, Inc. Secretary Capital Group, Inc. since
345 Park Avenue 1995;
New York, NY 10154 Managing Director
Age: 31 of BlackRock Financial
Management, Inc. since
1993; prior to 1993, Vice
President of BlackRock
Financial Management, Inc.
Ellen L. Corson Assistant Vice President and
PFPC Inc. Treasurer Director of Mutual Fund
103 Bellevue Parkway Accounting and Adminis-
Wilmington, DE 19809 tration, PFPC Inc. since
Age: 33 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>
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<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION
NAME AND ADDRESS POSITION WITH FUND DURING PAST FIVE YEARS
- ---------------- ------------------ ----------------------
<S> <C> <C>
Brian P. Kindelan Secretary Senior Counsel, PNC Bank
PNC Bank Corp. Corp. since May 1995;
1600 Market Street, Associate, Stradley, Ronon,
28th Fl. Stevens & Young from March
Philadelphia, PA 19103 1990 to May 1995.
Age: 38
</TABLE>
The Fund pays trustees who are not affiliated with BlackRock, Inc.
(formerly PNC Asset Management Group, Inc.) or BlackRock Distributors, Inc.
("BDI" or "Distributor") $10,000 annually and $275 per Portfolio for each full
meeting of the Board that they attend. The Fund pays the Chairman and Vice
Chairman of the Board an additional $10,000 and $5,000 per year, respectively,
for their service in such capacities. Trustees who are not affiliated with
BlackRock, Inc. or the Distributor are reimbursed for any expenses incurred in
attending meetings of the Board of Trustees or any committee thereof. No
officer, director or employee of BlackRock, Inc., PNC Institutional Management
Corporation ("PIMC"), Provident Capital Management, Inc. ("PCM"), BlackRock
Financial Management, Inc. ("BlackRock"), PNC Equity Advisors Company ("PEAC"),
CastleInternational Asset Management Limited ("CastleInternational"), PFPC Inc.
("PFPC"), BDI (collectively with PFPC and BlackRock, Inc., the
"Administrators"), 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 Portfolio.
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<PAGE>
The table below sets forth the compensation actually received from the Fund
and the Fund Complex of which the Fund is a part by the trustees for the fiscal
year ended September 30, 1997:
<TABLE>
<CAPTION>
TOTAL
PENSION OR COMPENSATION
RETIREMENT FROM REGISTRANT
AGGREGATE BENEFITS ESTIMATED AND FUND
COMPENSATION ACCRUED AS ANNUAL COMPLEX/1/
NAME OF PERSON, FROM PART OF FUND BENEFITS UPON PAID TO
POSITION REGISTRANT EXPENSES RETIREMENT TRUSTEES
- -------- ---------- -------- ---------- ---------
<S> <C> <C> <C> <C>
Anthony M. $52,300 N/A N/A (3)/2/ $64,300
Santomero, Vice
Chairman of the
Board
David R. Wilmerding, $61,050 N/A N/A (3)/2/ $73,050
Jr., Chairman of the
Board
William O. $43,550 N/A N/A (1)/2/ $43,550
Albertini, Trustee ------
Raymond J. Clark, $43,550 N/A N/A (1)/2/ $43,550
Trustee
Robert M. Hernandez, $43,550 N/A N/A (1)/2/ $43,550
Trustee
</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
investment 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.
-73-
<PAGE>
THE TRUST
The names, addresses and dates of birth of the trustees and officers of the
Trust and a brief statement of their present positions and principal occupations
during the past five years are set forth below. As used below, "DFA Entities"
refers to the following: Dimensional Fund Advisors Inc., Dimensional Fund
Advisors Ltd., DFA Australia Limited, DFA Investment Dimensions Group Inc.
(Registered Investment Company), Dimensional Emerging Markets Fund Inc.
(Registered Investment Company), Dimensional Investment Group Inc. (Registered
Investment Company) and DFA Securities Inc.
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION DURING
TRUSTEES POSITION WITH TRUST LAST FIVE YEARS
- -------- ------------------- ---------------
<S> <C> <C>
David G. Booth* Trustee, President President, Chairman-Chief
Santa Monica, CA and Chairman-Chief Executive Officer and Director
Birthdate: Executive Officer of all DFA Entities, except
12/2/46 Dimensional Fund Advisors Ltd.,
of which he is Chairman and
Director
George M. Trustee Leo Melamed Professor of
Constantinides Finance, Graduate School of
Chicago, IL Business, University of Chicago.
Birthdate: Director, DFA Investment
9/22/47 Dimensions Group Inc.,
Dimensional Investment Group
Inc. and Dimensional Emerging
Markets Fund Inc.
John P. Gould Trustee Steven G. Rothmeier
Distinguished Service Professor
Chicago, IL of Economics, Graduate School of
Birthdate: Business, University of Chicago.
1/19/39 Trustee, First Prairie Funds
(registered investment
companies). Director, DFA
Investment Dimensions Group
Inc., Dimensional Investment
Group Inc., Dimensional Emerging
Markets Fund Inc. and Harbor
Investment Advisors. Executive
Vice President, Lexecon Inc.
(economics, law, strategy, and
finance consulting).
</TABLE>
-74-
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION DURING
TRUSTEES POSITION WITH TRUST LAST FIVE YEARS
- -------- ------------------- ---------------
<S> <C> <C>
Roger G. Professor in Practice of
Ibbotson Trustee Finance, Yale School of
New Haven, CT Management. Director, DFA
Birthdate: Investment Dimensions Group
5/27/43 Inc., Dimensional Investment
Group Inc., Dimensional Emerging
Markets Fund Inc., Hospital
Fund, Inc. (investment
management services) and BIRR
Portfolio Analysis, Inc.
(software products). Chairman
and President, Ibbotson
Associates, Inc., Chicago, IL
(software, data, publishing and
consulting).
Merton H. Miller Trustee Robert R. McCormick
Chicago, IL Distinguished Service Professor
Birthdate: Emeritus, Graduate School of
5/16/23 Business, University of Chicago.
Director, DFA Investment
Dimensions Group Inc.,
Dimensional Investment Group
Inc. and Dimensional Emerging
Markets Fund Inc. Public
Director, Chicago Mercantile
Exchange.
Myron S. Scholes Trustee Limited Partner, Long-Term
Greenwich, CT Capital Management L.P. (money
Birthdate:7/1/42 manager). Frank E. Buck
Professor Emeritus of Finance,
Graduate School of Business and
Professor of Law, Law School,
Senior Research Fellow, Hoover
Institution, (all) Stanford
University. Director, DFA
Investment Dimensions Group
Inc., Dimensional Investment
Group Inc., Dimensional Emerging
Markets Fund Inc., Benham
Capital Management Group of
Investment Companies and Smith
Breedon Group of Investment
Companies.
</TABLE>
-75-
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION DURING
TRUSTEES POSITION WITH TRUST LAST FIVE YEARS
- -------- ------------------- ---------------
<S> <C> <C>
Trustee, Chairman Chairman-Chief Investment
and Chief Officer and Director of all DFA
Rex A. Investment Officer Entities, except Dimensional
Sinquefield* Fund Advisors Ltd., of which he
Santa Monica, CA is Chairman, Chief Executive
Birthdate: Officer and Director.
9/7/44
*Interested
Trustee of the
Trust.
_____________
</TABLE>
-76-
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION DURING
OFFICERS POSITION WITH TRUST LAST FIVE YEARS
- -------- -------------------- ---------------
<S> <C> <C>
Arthur Barlow Vice President Vice President of all DFA
Santa Monica, CA Entities.
Birthdate:
11/7/55
Truman Clark Vice President Vice President of all DFA
Santa Monica, Entities. Consultant until
CA October 1995 and Principal and
Birthdate: Manager of Product Development,
4/8/41 Wells Fargo Nikko Investment
Advisors from 1990-1994.
Maureen Connors Vice President Vice President of Entities
Santa Monica, CA
Birthdate:
11/17/36
Robert Deere Vice President Vice President of all DFA
Santa Monica, CA Entities.
Birthdate:
10/8/57
Irene R. Diamant Vice President, Vice President and Secretary of
Santa Monica, CA Secretary all DFA Entities, except
Birthdate: Dimensional Fund Advisors Ltd.,
7/16/50 for which she is Vice President.
Eugene Fama, Jr. Vice President Vice President of all DFA
Santa Monica, CA Entities.
Birthdate:
1/21/61
Kamyab Hashemi- Vice President, Vice President, Controller and
Nejad, Controller and Assistant Treasurer of all DFA
Santa Monica, CA Assistant Treasurer Entities.
Birthdate:
1/22/61
Stephen P. Vice President Managing Director, ANB
Manus, Investment Management and Trust
Santa Monica, CA Company from 1985-1993;
Birthdate: President, ANB Investment
12/26/50 Management and Trust Company
from 1993-1997. Vice President
of all DFA Entities.
Karen McGinley, Vice President Vice President of all DFA
Santa Monica, CA Entities.
Birthdate:
3/10/66
</TABLE>
-77-
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION DURING
OFFICERS POSITION WITH TRUST LAST FIVE YEARS
- -------- -------------------- ---------------
<S> <C> <C>
Catherine L. Vice President and Associate, Morrison & Foerster,
Newell, Assistant Secretary LLP from 1989-1996. Vice
Santa Monica, CA President of all DFA Entities.
Birthdate:
5/7/64
David Plecha Vice President Vice President of all DFA
Santa Monica, CA Entities.
Birthdate:
10/26/61
George Sands Vice President Vice President of all DFA
Santa Monica, CA Entities.
Birthdate:
2/8/56
Michael T. Vice President, Vice President, Chief Financial
Scardina Chief Financial Officer, and Treasurer of all
Santa Monica, CA Officer, and DFA Entities.
Birthdate: Treasurer
10/12/55
Jeanne C. Executive Vice Executive Vice President of all
Sinquefield, President DFA Entities.
Ph.D.
Santa Monica, CA
Birthdate:
12/2/46
Scott Thornton, Vice President Vice President of all DFA
Santa Monica, CA Entities.
Birthdate:
3/1/63
Weston Vice President Vice President of all DFA
Wellington, Entities. Vice President,
Santa Monica, CA Director of Research, LPL
Birthdate: Financial Services, Inc.
3/1/51
</TABLE>
Rex A. Sinquefield, Trustee, Chairman and Chief Investment Officer of the Trust
and Jeanne C. Sinquefield, Executive Vice President of the Trust, are husband
and wife.
Set forth below is a table listing, for each trustee of the Trust entitled
to receive compensation, the compensation received from the Trust during the
fiscal year ended November 30, 1997 and the total compensation
-78-
<PAGE>
received from all four registered investment companies for which Dimensional
Fund Advisors Inc. ("DFA") served as investment adviser during that same fiscal
year.
<TABLE>
<CAPTION>
TOTAL
PENSION OR COMPENSATION
RETIREMENT FROM
AGGREGATE BENEFITS ESTIMATED REGISTRANT AND
COMPENSATION ACCRUED AS ANNUAL TRUST COMPLEX/1/
NAME OF PERSON, FROM PART OF TRUST BENEFITS UPON Paid to
POSITION REGISTRANT EXPENSES RETIREMENT Trustees
- ------- ---------- -------- ---------- --------
<S> <C> <C> <C> <C>
George M. $5,000 N/A N/A $30,000
Constantinides,
Trustee
John P. Gould, $5,000 N/A N/A $30,000
Trustee
Roger G. Ibbotson, $5,000 N/A N/A $30,000
Trustee
Merton H. Miller, $5,000 N/A N/A $30,000
Trustee
Myron S. Scholes, $5,000 N/A N/A $30,000
Trustee
</TABLE>
SHAREHOLDER AND TRUSTEE LIABILITY OF THE FUND
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
____________________
/1/ A Trust 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.
-79-
<PAGE>
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 AND SUB-ADVISORY AGREEMENTS. The advisory and sub-advisory
services provided by BlackRock, Inc., PIMC, BlackRock, PCM, PEAC,
CastleInternational and, with respect to the Index Master Portfolio, Dimensional
Fund Advisors Inc. ("DFA") and the fees received by each of them for such
services are described in the Prospectuses. As stated in the Prospectuses,
BlackRock, Inc. may from time to time voluntarily waive its advisory fees with
respect to a Portfolio and may voluntarily reimburse the Portfolios for
expenses.
BlackRock, Inc., a wholly-owned indirect subsidiary of PNC Bank Corp.,
renders advisory services to each of the Portfolios, except the Index Equity
Portfolio, pursuant to an Investment Advisory Agreement. From the commencement
of operations of each Portfolio (other than the New Jersey Municipal Money
Market, New Jersey Tax-Free Income, Core Bond, Low Duration Bond and
International Bond Portfolios) until January 4, 1996 (June 1, 1996 in the case
of the Index Equity Portfolio), PIMC served as adviser.
From July 1, 1991 to December 31, 1995, Midlantic Bank, N.A. ("Midlantic
Bank") served as investment adviser to the predecessor portfolios of the
International Bond, New Jersey Tax-Free Income and New Jersey Municipal Money
Market Portfolios. From January 1, 1996 through January 12, 1996 (February 12,
1996 with respect to the predecessor portfolio of the International Bond
Portfolio): (i) BlackRock, Inc. and Morgan Grenfell Investment Services Limited
("Morgan Grenfell") served as investment adviser and sub-adviser, respectively,
to the predecessor portfolio to the International Bond Portfolio; (ii) PIMC
served as investment adviser to the predecessor portfolio to
-80-
<PAGE>
the New Jersey Municipal Money Market Portfolio; and (iii) BlackRock served as
investment adviser to the predecessor portfolio to the New Jersey Tax-Free
Income Portfolio pursuant to interim advisory and sub-advisory agreements
approved by the shareholders of the Compass Capital Group of Funds. From
December 9, 1992 to January 13, 1996, BlackRock served as investment adviser to
the predecessor portfolio of the Core Bond Portfolio. From July 17, 1992 to
January 13, 1996, BlackRock served as investment adviser to the predecessor
portfolio of the Low Duration Bond Portfolio.
PCM renders sub-advisory services to the Balanced, Large Cap Value Equity,
Mid-Cap Value Equity, Small Cap Value Equity and Select Equity Portfolios
pursuant to Sub-Advisory Agreements. CastleInternational renders sub-advisory
services to the International Equity, International Emerging Markets and
International Small Cap Equity Portfolios pursuant to Sub-Advisory Agreements.
PIMC renders sub-advisory services 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, Virginia
Municipal Money Market and New Jersey Municipal Money Market Portfolios pursuant
to Sub-Advisory Agreements. BlackRock renders sub-advisory services to the
Balanced, Managed Income, Intermediate Government Bond, Tax-Free Income, Ohio
Tax-Free Income, Pennsylvania Tax-Free Income, Low Duration Bond, Intermediate
Bond, New Jersey Tax-Free Income, Delaware Tax-Free Income, Kentucky Tax-Free
Income, Core Bond, Government Income, International Bond and GNMA Portfolios
pursuant to Sub-Advisory Agreements. PEAC renders sub-advisory services to the
Large Cap Growth Equity, Mid-Cap Growth Equity, Small Cap Growth Equity and
Micro-Cap Equity Portfolios pursuant to Sub-Advisory Agreements. DFA renders
advisory services to the Index Master Portfolio, the registered investment
company in which the Index Equity Portfolio invests all of its assets, pursuant
to an Investment Management Agreement. The Investment Advisory Agreement with
BlackRock, Inc., the Investment Management Agreement with DFA and the above-
referenced Sub-Advisory Agreements are collectively referred to as the "Advisory
Contracts."
From December 1, 1992 (commencement of operations) to March 29, 1995, PNC
Bank, Ohio, National Association ("PNC Bank Ohio") served as sub-adviser to the
Ohio Tax-Free Income Portfolio. From November 1, 1989 (commencement of
operations) to September 10, 1993, PNC Bank Ohio served as sub-adviser to the
Municipal Money Market Portfolio. From November 1, 1989 (commencement of
operations) to September 10, 1993, PNC Bank Ohio served as sub-adviser to the
Managed Income and Large Cap Growth Equity Portfolios. From April 20, 1992 to
September 10, 1993, PCM served as sub-adviser to the Intermediate Government
Bond Portfolio. From July 23, 1992 to March 29, 1995, PNC Bank served
-81-
<PAGE>
as sub-adviser to the Index Equity Portfolio. From September 11, 1993 to March
29, 1995, PNC Bank served as sub-adviser to the Managed Income, Intermediate
Government Bond and Large Cap Growth Equity Portfolios. From December 1, 1992
(commencement of operations) to March 29, 1995, PNC Bank served as sub-adviser
to the Ohio Tax-Free Income and Pennsylvania Tax-Free Income Portfolios. From
September 13, 1993 (commencement of operations) to March 29, 1995, PNC Bank
served as sub-adviser to the Select Equity Portfolio. From September 14, 1993
(commencement of operations) to March 29, 1995, PNC Bank served as sub-adviser
to the Small Cap Growth Equity Portfolio. From September 17, 1993 (commencement
of operations) to March 29, 1995, PNC Bank served as sub-adviser to the
Intermediate Bond Portfolio. From May 14, 1990 (commencement of operations) to
July 1, 1995, PNC Bank served as sub-adviser to the Tax-Free Income Portfolio.
PCM served as sub-adviser to the International Equity and International Emerging
Markets Portfolios from commencement of operations (April 27, 1992 in the case
of the International Equity Portfolio; June 17, 1994 in the case of the
International Emerging Markets Portfolio) to April 19, 1996.
PNC Bank served as sub-adviser for the Money Market Portfolio from October
4, 1989 (commencement of operations) to January 4, 1996; for the Municipal Money
Market Portfolio from September 10, 1993 to January 4, 1996; for the U.S.
Treasury Money Market Portfolio from November 1, 1989 (commencement of
operations) to January 4, 1996; for the Ohio Municipal Money Market Portfolio
from June 1, 1993 (commencement of operations) to January 4, 1996; for the
Pennsylvania Municipal Money Market Portfolio from June 1, 1993 (commencement of
operations) to January 4, 1996; for the North Carolina Municipal Money Market
Portfolio from May 4, 1993 (commencement of operations) to January 4, 1996; for
the Virginia Municipal Money Market Portfolio from July 25, 1994 (commencement
of operations) to January 4, 1996; and for the New Jersey Municipal Money Market
Portfolio from January 13, 1996 to June 6, 1996. From April 4, 1990
(commencement of operations) to January 4, 1996, PNC Bank served as sub-adviser
to the Balanced Portfolio. From March 1, 1993 to January 4, 1996, PEAC served
as sub-adviser to the Select Equity Portfolio. From March 29, 1995 to June 1,
1996, PEAC served as sub-adviser to the Index Equity Portfolio. From July 1,
1996 through December 31, 1996, Morgan Grenfell served as sub-adviser to the
International Bond Portfolio.
Under the relevant Advisory Contracts, BlackRock, Inc., PIMC, PCM, PEAC,
BlackRock and CastleInternational are not liable for any error of judgment or
mistake of law or for any loss suffered by the Fund or a Portfolio in connection
with the performance of the Advisory Contracts. Under the Advisory Contracts,
BlackRock, Inc., PIMC, PCM, PEAC, BlackRock, CastleInternational and DFA are
liable for a loss resulting from willful misfeasance, bad faith or gross
negligence in the
-82-
<PAGE>
performance of their respective duties or from reckless disregard of their
respective duties and obligations thereunder. Each of the Advisory Contracts
(except the Advisory Contract relating to the Index Master Portfolio) is
terminable as to a Portfolio by vote of the Fund's Board of Trustees or by the
holders of a majority of the outstanding voting securities of the relevant
Portfolio, at any time without penalty, on 60 days' written notice to BlackRock,
Inc., PIMC, PCM, PEAC, BlackRock or CastleInternational, as the case may be.
BlackRock, Inc., PIMC, PCM, PEAC, BlackRock and CastleInternational may also
terminate their advisory relationship with respect to a Portfolio on 60 days'
written notice to the Fund. The Advisory Contract relating to the Index Master
Portfolio is terminable by vote of the Trust's Board of Trustees or by the
holders of a majority of the outstanding voting securities of the Index Master
Portfolio at any time without penalty on 60 days' written notice to DFA. DFA may
also terminate its advisory relationship with respect to the Index Master
Portfolio on 90 days' written notice to the Trust. Each of the Advisory
Contracts terminates automatically in the event of its assignment.
For the period from October 1, 1996 (December 27, 1996 in the case of the
Mid-Cap Growth Equity and Mid-Cap Value Equity Portfolios; and September 26,
1997 in the case of the International Small Cap Equity Portfolio) through
September 30, 1997, the Fund paid BlackRock, Inc. advisory fees, and BlackRock,
Inc. waived advisory fees and reimbursed expenses, as follows:
<TABLE>
<CAPTION>
FEES PAID
PORTFOLIOS (AFTER WAIVERS) WAIVERS REIMBURSEMENTS
- --------------------------------------- --------------- ------------- --------------
<S> <C> <C> <C>
Money Market............................ $ 2,648,951 $ 8,355,021 $ 0
U.S. Treasury Money Market.............. 865,528 3,842,169 0
Municipal Money Market.................. 247,591 1,482,338 0
New Jersey Municipal Money Market....... 67,821 483,238 0
North Carolina Municipal Money Market... 94,458 602,236 0
Ohio Municipal Money Market............. 66,919 434,972 0
Pennsylvania Municipal Money Market..... 378,571 2,048,282 0
Virginia Municipal Money Market......... 4,280 267,307 18,025
Low Duration Bond....................... 599,206 517,845 0
Intermediate Government Bond............ 462,943 308,628 0
Intermediate Bond....................... 973,237 648,825 0
Core Bond............................... 1,040,492 1,005,843 0
Government Income....................... 465 84,527 47,550
Managed Income.......................... 2,629,559 1,126,954 0
International Bond...................... 220,526 12,573 0
Tax-Free Income......................... 158,143 123,004 0
Pennsylvania Tax-Free Income............ 268,228 178,819 0
New Jersey Tax-Free Income.............. 254,415 179,069 0
Ohio Tax-Free Income.................... 10,355 43,390 0
Large Cap Value Equity.................. 6,487,065 480,085 0
Large Cap Growth Equity................. 3,718,080 233,396 0
Mid-Cap Value Equity.................... 499,380 4,043 0
Mid-Cap Growth Equity................... 499,026 4,087 0
Small Cap Value Equity.................. 2,036,977 6,910 0
Small Cap Growth Equity................. 3,169,739 32,560 0
International Equity.................... 4,101,006 556,548 0
International Small Cap Equity.......... 0 0 0
International Emerging Markets.......... 1,786,671 152,118 0
</TABLE>
-83-
<PAGE>
<TABLE>
<CAPTION>
FEES PAID
PORTFOLIOS (AFTER WAIVERS) WAIVERS REIMBURSEMENTS
- ---------- --------------- ------------- --------------
<S> <C> <C> <C>
Select Equity........................... 2,562,623 154,197 0
Balanced................................ 1,486,866 92,278 0
</TABLE>
For the period from October 1, 1995 through January 4, 1996, the Fund paid
PIMC advisory fees, and PIMC waived advisory fees and reimbursed expenses, as
follows:
<TABLE>
<CAPTION>
FEES PAID
(AFTER REIMBURSE-
PORTFOLIOS WAIVERS) WAIVERS MENTS
- ---------- ---------- ------- ----------
<S> <C> <C> <C>
Money Market $321,268 $1,818,401 $0
Municipal Money Market 46,804 304,226 0
U.S. Treasury Money Market 114,639 745,150 0
Ohio Municipal Money Market 11,052 71,841 0
Pennsylvania Municipal Money Market 64,257 417,675 0
North Carolina Municipal Money 11,026 71,666 0
Market
Virginia Municipal Money Market 0 7,024 0
Managed Income 520,724 223,168 0
Government Income 0 17,234 0
Tax-Free Income 3,933 11,137 0
Intermediate Government Bond 114,345 130,122 0
Ohio Tax-Free Income 723 10,100 0
Pennsylvania Tax-Free Income 43,145 37,663 0
Intermediate Bond 136,544 119,059 0
Large Cap Value Equity 829,764 147,027 0
Large Cap Growth Equity 361,240 95,914 0
Small Cap Growth Equity 304,284 23,327 0
Select Equity 369,071 97,791 0
Index Equity 4,647 88,292 0
Small Cap Value Equity 320,588 24,942 0
International Equity 697,319 127,354 0
International Emerging Markets 144,937 11,380 0
Balanced 201,642 53,929 0
</TABLE>
For the period from January 5, 1996 (February 1, 1996 in the case of the
New Jersey Tax-Free Income and New Jersey Municipal Money Market Portfolios;
February 13, 1996 in the case of the International Bond Portfolio; and April 1,
1996 in the case of the Core Bond and Low Duration Bond Portfolios) through
September 30, 1996 (June 1, 1996 in the case of the Index Equity Portfolio), the
Fund paid BlackRock, Inc. (PIMC in the case of the Index Equity Portfolio)
advisory fees, and BlackRock, Inc. (PIMC in the case of the Index Equity
Portfolio) waived advisory fees and reimbursed expenses, as follows:
-84-
<PAGE>
<TABLE>
<CAPTION>
FEES PAID
(AFTER
PORTFOLIOS WAIVERS) WAIVERS REIMBURSEMENTS
- ---------- --------- -------- --------------
<S> <C> <C> <C>
Money Market $1,443,913 $6,290,596 $ 0
Municipal Money Market 158,379 1,029,459 0
U.S. Treasury Money Market 691,448 3,584,858 0
Ohio Municipal Money Market 32,275 209,784 0
Pennsylvania Municipal Money Market 240,350 1,562,271 0
North Carolina Municipal Money 45,997 298,983 0
Market
Virginia Municipal Money Market 0 180,685 14,604
New Jersey Municipal Money Market 32,663 212,365 0
Managed Income 1,796,762 770,041 0
Government Income 0 52,817 7,027
Tax-Free Income 109,211 74,939 0
Intermediate Government Bond 425,069 283,380 0
Ohio Tax-Free Income 4,764 31,253 3,479
Pennsylvania Tax-Free Income 185,302 123,326 0
Intermediate Bond 514,322 342,880 0
New Jersey Tax-Free Income 184,448 122,966 0
International Bond 133,797 4,580 0
Core Bond 424,691 283,127 0
Low Duration Bond 338,287 225,525 0
Large Cap Value Equity 4,159,395 421,173 0
Large Cap Growth Equity 2,109,685 210,969 0
Small Cap Growth Equity 1,596,126 7,204 0
Select Equity 1,457,052 145,705 0
Index Equity 28,380 174,535 0
Small Cap Value Equity 1,223,651 0 0
International Equity 2,836,323 202,595 0
International Emerging Markets 740,140 63,810 0
Balanced 917,400 91,740 0
</TABLE>
For the year or periods ended September 30, 1995, the Fund paid PIMC
advisory fees, and PIMC waived advisory fees and reimbursed expenses, as
follows:
<TABLE>
<CAPTION>
FEES PAID
(AFTER REIMBURSE-
PORTFOLIOS WAIVERS) WAIVERS MENTS
- ---------- -------- ------- ----------
<S> <C> <C> <C>
Money Market $1,051,446 $5,217,130 $ 0
Municipal Money Market 189,929 921,718 0
U.S. Treasury Money Market 489,209 2,327,266 0
Ohio Municipal Money Market 49,133 245,955 0
Pennsylvania Municipal Money Market 304,651 1,264,187 0
North Carolina Municipal Money
Market 46,472 369,591 4,999
Managed Income 1,790,332 767,285 0
Tax-Free Income 0 49,671 1,599
Intermediate Government Bond 379,534 569,302 0
Ohio Tax-Free Income 0 42,044 6,713
Pennsylvania Tax-Free Income 161,038 137,951 0
Intermediate Bond 342,301 335,908 0
Large Cap Value Equity 2,832,644 746,727 0
</TABLE>
-85-
<PAGE>
<TABLE>
<CAPTION>
FEES PAID
(AFTER REIMBURSE-
PORTFOLIOS WAIVERS) WAIVERS MENTS
- ---------- -------- ------- ----------
<S> <C> <C> <C>
Large Cap Growth Equity 866,271 324,851 0
Small Cap Growth Equity 618,374 137,615 0
Select Equity 691,447 259,293 0
Index Equity 30,772 382,205 0
Small Cap Value Equity 1,143,071 114,307 0
International Equity 2,391,607 597,902 0
Balanced 642,763 241,037 0
Virginia Municipal Money Market 0 85,063 35,957
International Emerging Markets 258,648 52,186 0
Government Income/1/ 0 37,256 11,980
</TABLE>
_______________
/1/ For the period from commencement of operations (October 3, 1994) through
September 30, 1995. For the period from October 1, 1996 (December 27, 1996
in the case of the Mid-Cap Growth Equity and Mid-Cap Value Equity
Portfolios; and September 26, 1997 in the case of the International Small
Cap Equity Portfolio) through September 30, 1997, BlackRock, Inc. paid sub-
advisory fees to the specified Portfolios' sub-advisers, after waivers, and
such sub-advisers waived sub-advisory fees as follows:
-86-
<PAGE>
<TABLE>
<CAPTION>
FEES PAID
(AFTER
PORTFOLIOS WAIVERS) WAIVERS
- ---------- --------- -------
<S> <C> <C>
Money Market $1,300,023 $9,370,873
U.S. Treasury Money Market 577,321 3,631,808
Municipal Money Market 212,376 1,325,338
New Jersey Municipal Money Market 75,204 414,553
North Carolina Municipal Money Market 81,568 536,785
Ohio Municipal Money Market 62,070 384,055
Pennsylvania Municipal Money Market 298,167 1,859,027
Virginia Municipal Money Market 350 241,044
Low Duration Bond 36,930 745,005
Intermediate Government Bond 14,450 525,649
Intermediate Bond 15,164 1,120,194
Core Bond 104,500 1,327,935
Government Income 0 59,494
Managed Income 86,420 2,542,897
International Bond 79,789 89,738
Tax-Free Income 48,652 148,151
Pennsylvania Tax-Free Income 34,191 278,742
New Jersey Tax-Free Income 26,000 277,439
Ohio Tax-Free Income 38,606 0
Large Cap Value Equity 583,448 4,590,272
Large Cap Growth Equity 172,041 2,701,759
Mid-Cap Value Equity 15,821 413,497
Mid-Cap Growth Equity 15,422 413,851
Small Cap Value Equity 383,789 1,102,690
Small Cap Growth Equity 725,498 1,603,447
International Equity 269,395 3,456,696
International Small Cap Equity 0 727
International Emerging Markets 107,739 1,598,368
Select Equity 105,481 1,870,387
Balanced 297,047 851,422
</TABLE>
-87-
<PAGE>
For the period from October 1, 1995 through January 4, 1996, PIMC paid sub-
advisory fees to the specified Portfolios' sub-advisers, after waivers, and such
sub-advisers waived sub-advisory fees as follows:
<TABLE>
<CAPTION>
FEES PAID
(AFTER
PORTFOLIOS WAIVERS) WAIVERS
- ---------- ---------- -------
<S> <C> <C>
Money Market $ 0 $235,363
Municipal Money Market 0 38,613
U.S. Treasury Money Market 0 94,577
Ohio Municipal Money Market 0 9,118
Pennsylvania Municipal Money 0 53,013
Market
North Carolina Municipal Money 0 9,096
Market
Virginia Municipal Money Market 0 773
Managed Income 497,581 82,654
Government Income 0 12,063
Tax-Free Income 3,693 9,207
Intermediate Government 73,585 97,542
Bond
Ohio Tax-Free Income 3,258 4,318
Pennsylvania Tax-Free Income 24,323 32,242
Intermediate Bond 76,937 101,986
Large Cap Value Equity 213,057 0
Large Cap Growth Equity 333,722 0
Small Cap Growth Equity 239,156 0
Select Equity 340,809 0
Index Equity 12,385 73,920
Small Cap Value Equity 252,237 0
International Equity 659,738 0
International Emerging Markets 137,559 0
Balanced 186,567 0
</TABLE>
For the period from January 5, 1996 (February 1, 1996 in the case of the
New Jersey Tax-Free Income and New Jersey Municipal Money Market Portfolios;
February 13, 1996 in the case of the International Bond Portfolio; and April 1,
1996 in the case of the Core Bond and Low Duration Bond Portfolios) through
September 30, 1996 (June 1, 1996 in the case of the Index Equity Portfolio),
BlackRock, Inc. (PIMC in the case of the Index Equity Portfolio) paid sub-
advisory fees to the specified Portfolios' sub-advisers, after waivers, and such
sub-advisers waived sub-advisory fees as follows:
-88-
<PAGE>
<TABLE>
<CAPTION>
FEES PAID
(AFTER
PORTFOLIOS WAIVERS) WAIVERS
- ---------- ----------- ---------
<S> <C> <C>
Money Market $1,443,913 $5,342,421
Municipal Money Market 158,382 897,064
U.S. Treasury Money Market 694,221 3,095,647
Ohio Municipal Money Market 32,275 182,796
Pennsylvania Municipal Money
Market 240,350 1,361,445
North Carolina Municipal Money 45,997 260,560
Market
Virginia Municipal Money Market 0 160,601
New Jersey Municipal Money 32,663 149,411
Market
Managed Income 1,488,836 248,415
Government Income 0 36,973
Tax-Free Income 95,609 50,559
Intermediate Government 412,698 2,499
Bond
Ohio Tax-Free Income 1,428 23,786
Pennsylvania Tax-Free Income 170,395 84,589
Intermediate Bond 402,873 188,333
New Jersey Tax-Free Income 153,707 61,483
International Bond 106,486 0
Core Bond 353,907 141,564
Low Duration Bond 281,905 112,763
Large Cap Value Equity 3,314,383 0
Large Cap Growth Equity 1,686,503 0
Small Cap Growth Equity 1,164,980 0
Select Equity 1,164,368 0
Index Equity 20,642 123,200
Small Cap Value Equity 888,986 0
International Equity 2,431,134 0
International Emerging Markets 707,475 0
Balanced 733,223 0
</TABLE>
For the year or periods ended September 30, 1995, PIMC paid sub-advisory
fees to the specified Portfolios' sub-advisers, after waivers, and such sub-
advisers waived sub-advisory fees as follows:
-89-
<PAGE>
<TABLE>
<CAPTION>
FEES PAID
(AFTER
PORTFOLIOS WAIVERS) WAIVERS
- ---------- ----------- -------
<S> <C> <C>
Money Market $ 0 $721,072
Municipal Money Market 0 123,516
U.S. Treasury Money Market 0 312,942
Ohio Municipal Money Market 0 32,788
Pennsylvania Municipal Money
Market 0 174,315
North Carolina Municipal Money
Market 0 46,229
Managed Income 1,253,232 537,100
Tax-Free Income 0 34,770
Intermediate Government 265,674 398,511
Bond
Ohio Tax-Free Income 0 29,431
Pennsylvania Tax-Free Income 112,727 96,566
Intermediate Bond 239,611 235,136
Large Cap Value Equity 2,060,105 543,074
Large Cap Growth Equity 630,015 236,255
Small Cap Growth Equity 449,727 100,084
Select Equity 502,871 188,576
Index Equity 30,772 286,654
Small Cap Value Equity 831,324 83,132
International Equity 1,913,286 478,322
Balanced 467,464 175,299
Virginia Municipal Money Market 0 9,451
International Emerging Markets 227,610 45,924
Government Income/1/ 0 26,079
</TABLE>
/1/ Commenced operations October 3, 1994.
For the services it provides as investment adviser to the Index Master
Portfolio, DFA is paid a monthly fee calculated as a percentage of average net
assets of the Index Master Portfolio. For the fiscal years ending November 30,
1995, 1996 and 1997, the Index Master Portfolio paid advisory fees to DFA
totalling $18,816, $62,405 and $160,156, respectively. The Index Equity
Portfolio did not invest in the Index Master Portfolio until June 2, 1996.
The predecessor portfolio to the New Jersey Tax-Free Income Portfolio was
advised by Midlantic Bank from July 1, 1991 through December 31, 1995, and by
BlackRock from January 1, 1996 through January 12, 1996. For the period from
January 1, 1996 through January 12, 1996, the predecessor portfolio to the New
Jersey Tax-Free Income Portfolio paid $20,165 in advisory fees to BlackRock.
For the period from March 1, 1995 through December
-90-
<PAGE>
31, 1995 and for the fiscal years ended February 28, 1995 and 1994, the
predecessor portfolio to the New Jersey Tax-Free Income Portfolio paid $496,305,
$607,485 and $159,582, respectively, in investment advisory fees to Midlantic
Bank pursuant to its prior investment advisory contract. In addition, during
the period from March 1, 1995 through December 31, 1995 and during the fiscal
year ended February 28, 1995, Midlantic Bank waived $0 and $2,451, respectively,
in investment advisory fees. During the period from January 13, 1996 through
January 31, 1996, the New Jersey Tax-Free Income Portfolio paid BlackRock, Inc.
$12,779 in investment advisory fees, and BlackRock, Inc. waived $8,520 in
investment advisory fees. During the period from January 13, 1996 through
January 31, 1996, BlackRock, Inc. paid BlackRock $8,945 in sub-advisory fees
with respect to the New Jersey Tax-Free Income Portfolio and BlackRock waived
$5,964 in sub-advisory fees.
The predecessor portfolio to the International Bond Portfolio was advised
by Midlantic Bank from July 1, 1991 through December 31, 1995, and by BlackRock,
Inc. from January 1, 1996 through February 12, 1996. For the period from
February 1, 1996 through February 12, 1996, the predecessor portfolio to the
International Bond Portfolio paid $4,134 in advisory fees to BlackRock, Inc.,
and BlackRock, Inc. waived advisory fees and reimbursed expenses totalling $0
and $0, respectively. For the period from February 1, 1996 through February 12,
1996, BlackRock, Inc. paid Morgan Grenfell $4,898 in sub-advisory fees with
respect to the predecessor portfolio to the International Bond Portfolio, and
Morgan Grenfell waived sub-advisory fees totalling $0. For the period from
January 1, 1996 through January 31, 1996, the predecessor portfolio to the
International Bond Portfolio paid $24,832 in advisory fees to BlackRock, Inc.
For the period from January 1, 1996 through January 31, 1996, BlackRock, Inc.
paid Morgan Grenfell $20,176 in sub-advisory fees with respect to the
predecessor portfolio to the International Bond Portfolio. For the period from
March 1, 1995 through December 31, 1995 and for the fiscal year ended February
28, 1995, the predecessor portfolio to the International Bond Portfolio paid
$305,176 and $361,620, respectively, in investment advisory fees to Midlantic
Bank pursuant to its prior investment advisory contract.
The predecessor portfolio to the New Jersey Municipal Money Market
Portfolio was advised by Midlantic Bank from July 1, 1991 through December 31,
1995, and by PIMC from January 1, 1996 through January 12, 1996. For the period
from January 1, 1996 through January 12, 1996, the predecessor portfolio to the
New Jersey Municipal Money Market Portfolio paid $8,000 in advisory fees to
PIMC. For the period from March 1, 1995 through December 31, 1995 and for the
fiscal years ended February 28, 1995, the predecessor portfolio to the New
Jersey Municipal Money Market Portfolio paid $155,696 and $158,240,
respectively, in investment
-91-
<PAGE>
advisory fees to Midlantic Bank pursuant to its prior investment advisory
contract. During the period from January 13, 1996 through January 31, 1996, the
New Jersey Municipal Money Market Portfolio paid PIMC $2,128 in investment
advisory fees, and PIMC waived $13,826 in investment advisory fees. During the
period from January 13, 1996 through January 31, 1996, PNC Bank waived all of
the sub-advisory fees (in the amount of $1,125) with respect to the New Jersey
Municipal Money Market Portfolio.
The predecessor portfolio to the Core Bond Portfolio was advised by
BlackRock. For the period from July 1, 1995 through January 12, 1996, the
predecessor portfolio to the Core Bond Portfolio paid BlackRock $53,125 in
investment advisory fees and BlackRock waived $21,255 in investment advisory
fees. For the fiscal years ended June 30, 1995 and 1994, BlackRock waived its
investment advisory fee with respect to the predecessor portfolio to the Core
Bond Portfolio in the amounts of $56,894 and $34,010, respectively, and
reimbursed expenses amounting to $137,364 and $137,179, respectively. During
the period from January 13, 1996 through March 31, 1996, the Core Bond Portfolio
paid BlackRock, Inc. $182,709 in investment advisory fees, and BlackRock, Inc.
waived $121,806 in investment advisory fees. During the period from January 13,
1996 through March 31, 1996, BlackRock, Inc. paid BlackRock $127,896 in sub-
advisory fees with respect to the Core Bond Portfolio, and BlackRock waived
$85,264 in sub-advisory fees.
The predecessor portfolio to the Low Duration Bond Portfolio was advised by
BlackRock. For the period from July 1, 1995 through January 12, 1996, the
predecessor portfolio to the Low Duration Bond Portfolio paid BlackRock $56,481
in investment advisory fees and BlackRock waived $11,186 in investment advisory
fees. For the fiscal years ended June 30, 1995 and 1994, BlackRock waived its
investment advisory fee with respect to the predecessor portfolio to the Low
Duration Bond Portfolio in the amounts of $102,707 and $110,232, respectively,
and reimbursed expenses amounting to $61,195 and $55,582, respectively. During
the period from January 13, 1996 through March 31, 1996, the Low Duration Bond
Portfolio paid BlackRock, Inc. $149,488 in investment advisory fees, and
BlackRock, Inc. waived $99,659 in investment advisory fees. During the period
from January 13, 1996 through March 31, 1996, BlackRock, Inc. paid BlackRock
$104,642 in sub-advisory fees with respect to the Low Duration Bond Portfolio,
and BlackRock waived $69,761 in sub-advisory fees.
ADMINISTRATION AGREEMENTS. BlackRock, Inc., PFPC and BDI serve as the
Fund's co-administrators pursuant to administration agreements (collectively,
the "Administration Agreement"). PFPC and BDI have 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
-92-
<PAGE>
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 the Portfolio's shares;
and provide certain other services required by the Fund. As stated in the
Prospectuses, the Administrators may from time to time voluntarily waive
administration fees with respect to a Portfolio and may voluntarily reimburse
the Portfolios for expenses.
BlackRock, Inc. serves as an Administrator to the Fund pursuant to a Co-
Administration Agreement. Under the Co-Administration Agreement, BlackRock,
Inc. is responsible for: (i) the supervision and coordination of the performance
of the Fund's service providers; (ii) the negotiation of service contracts and
arrangements between the Fund and its service providers; (iii) acting as liaison
between the trustees of the Fund and the Fund's service providers; and (iv)
providing ongoing business management and support services in connection with
the Fund's operations.
The Administration Agreement provides that BlackRock, Inc., PFPC and BDI
will not be liable for any error of judgment or mistake of law or for any loss
suffered by the Fund or a 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.
PFPC serves as the administrative services agent for the Index Master
Portfolio pursuant to an Administration and Accounting Services Agreement. The
services provided by PFPC are subject to supervision by the executive officers
and the Board of Trustees of the Trust, and include day-to-day keeping and
maintenance of certain records, calculation of the offering price of the shares,
preparation of reports and acting as liaison with the Trust's custodians and
dividend and disbursing agents. For its services, PFPC is entitled to
compensation from the Index Master Portfolio at the annual rate of .015% of the
Index Master Portfolio's average daily net assets. The Index Equity Portfolio
bears its pro rata portion of the Index Master Portfolio's administrative
services expenses.
From February 1, 1993 until January 13, 1996, PFPC and Provident
Distributors, Inc. ("PDI") served as co-administrators
-93-
<PAGE>
to the Fund. From December 1, 1995 to January 28, 1998, Compass Capital Group,
Inc. ("CCG") served as Co-Administrator to the Fund. BlackRock, Inc. became Co-
Administrator to the Fund on January 28, 1998. For the purposes of the following
fee information, CCG is also considered an "Administrator."
For the period from October 1, 1996 (December 27, 1996 in the case of the
Mid-Cap Growth Equity and Mid-Cap Value Equity Portfolios; and September 26,
1997 in the case of the International Small Cap Equity Portfolio) through
September 30, 1997, the Fund paid the Administrators combined administration
fees (after waivers), and the Administrators waived combined administration fees
and reimbursed expenses, as follows:
<TABLE>
<CAPTION>
FEES PAID
PORTFOLIOS (AFTER WAIVERS) WAIVERS REIMBURSEMENTS
- ---------- --------------- --------- --------------
<S> <C> <C> <C>
Money Market............................ $3,006,036 $161,687 $ 0
U.S. Treasury Money Market.............. 1,391,777 83,462 0
Municipal Money Market................. 510,438 66,205 0
New Jersey Municipal Money Market....... 134,020 49,666 0
North Carolina Municipal Money Market... 149,859 81,039 0
Ohio Municipal Money Market............. 136,900 30,397 0
Pennsylvania Municipal Money Market.... 701,182 105,262 0
Virginia Municipal Money Market........ 13,709 76,820 0
Low Duration Bond....................... 266,343 180,478 0
Intermediate Government Bond........... 136,304 172,324 0
Intermediate Bond...................... 359,159 291,462 0
Core Bond............................... 628,096 188,359 0
Government Income....................... 910 33,087 0
Managed Income.......................... 696,869 755,201 0
International Bond...................... 56,066 28,697 0
Tax-Free Income......................... 36,907 75,552 0
Pennsylvania Tax-Free Income............ 84,673 94,146 0
New Jersey Tax-Free Income.............. 77,981 95,412 0
Ohio Tax-Free Income.................... 9,942 11,556 0
Large Cap Value Equity.................. 2,173,719 195,769 0
Large Cap Growth Equity................ 1,146,084 247,130 0
Mid-Cap Value Equity................... 106,481 19,571 0
Mid-Cap Growth Equity................... 106,838 19,149 0
Small Cap Value Equity.................. 713,311 29,928 0
Small Cap Growth Equity................. 1,156,894 0 0
International Equity.................... 1,149,080 68,733 0
International Small Cap Equity......... 0 0 0
International Emerging Markets......... 379,822 596 0
Select Equity........................... 794,449 189,515 0
Index Equity............................ 134,085 549,869 0
Balanced................................ 501,727 72,507 0
</TABLE>
For the period from October 1, 1995 through January 13, 1996, the Fund paid
CCG, PFPC and PDI combined administration fees (after waivers), and CCG, PFPC
and PDI waived combined administration fees and reimbursed expenses, as follows:
<TABLE>
<CAPTION>
FEES PAID
(AFTER REIMBURSE-
PORTFOLIOS WAIVERS) WAIVERS MENTS
- ----------------------------- ---------- ------- ----------
<S> <C> <C> <C>
Money Market $645,001 $51,681 $0
Municipal Money Market 117,010 8,088 0
</TABLE>
-94-
<PAGE>
<TABLE>
<CAPTION>
FEES PAID
(AFTER REIMBURSE-
PORTFOLIOS WAIVERS) WAIVERS MENTS
- ----------------------------- ---------- ------- ----------
<S> <C> <C> <C>
U.S. Treasury Money Market 242,075 52,266 0
Ohio Municipal Money Market $ 17,189 $12,366 $0
Pennsylvania Municipal 143,962 28,455 0
Money Market
North Carolina Municipal 11,644 17,455 0
Money Market
Virginia Municipal Money 0 12,768 0
Market
Managed Income 226,271 82,078 0
Government Income 353 6,893 0
Tax-Free Income 1,455 4,890 0
Intermediate Government 69,369 33,385 0
Bond
Ohio Tax-Free Income 604 3,942 0
Pennsylvania Tax-Free 23,054 10,922 0
Income
Intermediate Bond 70,091 37,396 0
Large Cap Value Equity 287,181 75,970 0
Large Cap Growth Equity 142,578 32,289 0
Small Cap Growth Equity 105,681 19,886 0
Select Equity 150,292 28,337 0
Index Equity 32,455 65,337 0
Small Cap Value Equity 127,936 4,181 0
International Equity 200,396 30,791 0
International Emerging 26,329 0 0
Markets
Balanced 73,163 24,504 0
</TABLE>
For the period from January 14, 1996 (February 1, 1996 in the case of the
New Jersey Tax-Free Income and New Jersey Municipal Money Market Portfolios;
February 13, 1996 in the case of the International Bond Portfolio; and April 1,
1996 in the case of the Core Bond and Low Duration Bond Portfolios) through
September 30, 1996, the Fund paid the Administrators combined administration
fees (after waivers), and the Administrators waived combined administration fees
and reimbursed expenses, as follows:
-95-
<PAGE>
<TABLE>
<CAPTION>
FEES PAID
(AFTER REIMBURSE-
PORTFOLIOS WAIVERS) WAIVERS MENTS
- ---------- ----------- ------- ----------
<S> <C> <C> <C>
Money Market $2,319,935 $460,119 $ 0
Municipal Money Market 303,192 171,943 0
U.S. Treasury Money Market 1,325,463 264,620 0
Ohio Municipal Money Market 57,595 37,497 0
Pennsylvania Municipal 576,488 139,781 0
Money Market
North Carolina Municipal 57,612 78,873 0
Money Market
Virginia Municipal Money 0 60,792 4,868
Market
New Jersey Municipal Money 47,930 52,585 0
Market
Managed Income 740,845 412,076 0
Government Income 1,394 22,902 0
Tax-Free Income 47,371 37,838 0
Intermediate Government 207,399 118,488 0
Bond
Ohio Tax-Free Income 10,045 6,523 0
Pennsylvania Tax-Free 85,441 56,528 0
Income
Intermediate Bond 221,810 172,503 0
New Jersey Tax-Free Income 68,934 69,374 0
International Bond 27,454 28,993 0
Core Bond 196,853 128,743 0
Low Duration Bond 175,769 83,391 0
Large Cap Value Equity 1,589,313 235,958 0
Large Cap Growth Equity 729,234 236,170 0
Small Cap Growth Equity 652,784 17,700 0
Select Equity 471,931 198,312 0
Index Equity 55,265 345,636 0
Small Cap Value Equity 511,980 3,984 0
International Equity 727,738 201,501 0
International Emerging 147,927 0 0
Markets
Balanced 339,671 80,233 0
</TABLE>
-96-
<PAGE>
For the year or periods ended September 30, 1995, the Fund paid PFPC and
PDI combined administration fees (after waivers), and PFPC and PDI waived
combined administration fees and reimbursed expenses, as follows:
<TABLE>
<CAPTION>
FEES PAID
(AFTER
PORTFOLIOS WAIVERS) WAIVERS REIMBURSEMENTS
- ---------- ----------- ------- --------------
<S> <C> <C> <C>
Money Market $1,686,008 $200,348 $ 0
Municipal Money Market 208,246 162,303 0
U.S. Treasury Money Market 631,041 281,107 0
Ohio Municipal Money Market 43,263 55,100 0
Pennsylvania Municipal
Money Market 322,632 200,313 0
North Carolina Municipal
Money Market 24,058 114,630 1,666
Managed Income 751,452 267,310 0
Tax-Free Income 0 19,868 2,132
Intermediate Government 244,417 135,117 0
Bond
Ohio Tax-Free Income 0 16,817 8,950
Pennsylvania Tax-Free
Income 68,050 51,546 0
Intermediate Bond 139,960 131,323 0
Large Cap Value Equity 1,083,967 187,474 0
Large Cap Growth Equity 360,966 72,170 0
Small Cap Growth Equity 238,595 36,310 0
Select Equity 288,666 57,058 0
Index Equity 96,814 316,163 0
Small Cap Value Equity 359,637 97,592 0
International Equity 689,601 107,601 0
Balanced 216,630 104,752 0
Virginia Municipal Money
Market 0 28,354 11,986
International Emerging
Markets 41,383 8,350 0
Government Income/1/ 0 14,903 15,973
</TABLE>
/1/ Commenced operations October 3, 1994.
The predecessor portfolios to the New Jersey Municipal Money Market,
International Bond and New Jersey Tax-Free Income Portfolios received
administrative services from SEI Financial Management Corporation ("SEI").
During the period from March 1, 1995 through January 12, 1996 and during the
fiscal year ended February 28, 1995, the predecessor portfolio to the New Jersey
Municipal Money Market Portfolio paid $73,663 and $44,863, respectively, in
administration fees to SEI pursuant to the prior administration agreement, and
SEI waived $0 and $26,345, respectively, in administration fees. During the
period from
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<PAGE>
January 13, 1996 through January 31, 1996, the New Jersey Municipal Money Market
Portfolio paid the Administrators $3,050 in administration fees, and the
Administrators waived $3,691 in administration fees. During the period from
March 1, 1995 through January 12, 1996 and during the fiscal year ended February
28, 1995, the predecessor portfolio to the New Jersey Tax-Free Income Portfolio
paid $154,232 and $105,029, respectively, in administrative fees to SEI pursuant
to the prior administration agreement, and SEI waived $4 and $77,951,
respectively, in administrative fees. During the period from January 13, 1996
through January 31, 1996, the New Jersey Tax-Free Income Portfolio paid the
Administrators $4,443 in administration fees, and the Administrators waived
$5,347 in administration fees. During the period from March 1, 1995 through
January 12, 1996 and during the fiscal year ended February 28, 1995, the
predecessor portfolio to the International Bond Portfolio paid $77,924 and
$81,364, respectively, in administrative fees to SEI pursuant to the prior
administration agreement. During the period from January 13, 1996 through
January 31, 1996, the predecessor portfolio to the International Bond Portfolio
paid the Administrators $2,141 in administrative fees. During the period from
February 1, 1996 through February 12, 1996, the predecessor portfolio to the
International Bond Portfolio paid the Administrators $2,357 in administrative
fees, and the Administrators waived fees and reimbursed expenses totalling
$1,212 and $0, respectively.
The predecessor portfolios to the Low Duration Bond and Core Bond
Portfolios received administrative services from State Street Bank and Trust
Company ("State Street"). During the period from July 1, 1995 through January
12, 1996 and during the fiscal year ended June 30, 1995, the predecessor
portfolio to the Core Bond Portfolio paid $29,752 and $73,257, respectively, in
administrative fees to State Street pursuant to the prior administration
agreement, and State Street waived $0 and $0, respectively, in administrative
fees. During the period from January 13, 1996 through March 31, 1996, the Core
Bond Portfolio paid the Administrators $79,269 in administration fees, and the
Administrators waived $60,808 in administration fees. During the period from
July 1, 1995 through January 12, 1996 and during the fiscal year ended June 30,
1995, the predecessor portfolio to the Low Duration Bond Portfolio paid $31,578
and $69,234, respectively, in administrative fees to State Street pursuant to
the prior administration agreement. During the period from January 13, 1996
through March 31, 1996, the Low Duration Bond Portfolio paid the Administrators
$74,552 in administration fees, and the Administrators waived $40,055 in
administration fees.
The Fund and its service providers may engage third party plan
administrators who provide trustee, administrative and recordkeeping services
for certain employee benefit, profit-sharing and retirement plans as agent for
the Fund with
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<PAGE>
respect to such plans, for the purpose of accepting orders for the purchase and
redemption of shares of the Fund.
CUSTODIAN AND TRANSFER AGENCY AGREEMENTS. PNC Bank 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 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 each investment 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. PNC Bank has undertaken to waive its custody fees with
respect to the Index Equity Portfolio, which invests substantially all of its
assets in the Index Master Portfolio.
PFPC, which has its principal offices at 400 Bellevue Parkway, Wilmington,
DE 19809 and is 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 Service,
Investor, Institutional and BlackRock classes of 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 Fund's Institutional and Service Shares under the Transfer Agency Agreement,
PFPC receives fees at the annual rate of .03% of the average net asset value of
outstanding Institutional and Service Shares in each Portfolio, plus per account
fees and disbursements. For its services with respect to the Fund's BlackRock
Shares under the Transfer Agency
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<PAGE>
Agreement, PFPC receives fees at the annual rate of .01% of the average net
asset value of outstanding BlackRock Shares in each Portfolio, plus per account
fees and disbursements. For its services under the Transfer Agency Agreement
with respect to Investor Shares, PFPC receives per account fees, with minimum
annual fees of $24,000 for each series of Investor Shares in each Portfolio,
plus disbursements. Until further notice, the transfer agency fees for each
series of Investor Shares in each Portfolio will not exceed the annual rate of
.10% of the series' average daily net assets.
PNC Bank serves as the Trust's custodian and PFPC serves as the Trust's
transfer and dividend disbursing agent. The Index Equity Portfolio bears its
pro rata portion of the Index Master Portfolio's custody and transfer and
dividend disbursing fees and expenses.
DISTRIBUTOR AND DISTRIBUTION AND SERVICE PLAN. The Fund has entered into a
distribution agreement with the Distributor under which the Distributor, as
agent, offers shares of each 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.
Pursuant to the Fund's Amended and Restated Distribution and Service Plan
(the "Plan"), the Fund may pay the Distributor and/or BlackRock, Inc. or any
other affiliate of PNC Bank fees for distribution and sales support services.
Currently, as described further below, only Investor A Shares, Investor B Shares
and Investor C Shares bear the expense of distribution fees under the Plan. In
addition, the Fund may pay BlackRock, Inc. fees for the provision of personal
services to shareholders and the processing and administration of shareholder
accounts. BlackRock, Inc., in turn, determines the amount of the service fee
and shareholder processing fee to be paid to brokers, dealers, financial
institutions and industry professionals (collectively, "Service Organizations").
The Plan provides, among other things, that: (i) the Board of Trustees shall
receive quarterly reports regarding the amounts expended under the Plan and the
purposes for which such expenditures were made; (ii) the Plan will continue in
effect for so long as its continuance is approved at least annually by the Board
of Trustees in accordance with Rule 12b-1 under the 1940 Act; (iii) any material
amendment thereto must be approved by the Board of Trustees, including the
trustees who are not "interested persons" of the Fund (as defined in the 1940
Act) and who have no direct or indirect financial interest in the operation of
the Plan or any agreement entered into in connection with the Plan (the "12b-1
Trustees"), acting in person at a meeting called for said purpose; (iv) any
amendment to increase materially the costs which any class of shares may bear
for distribution services pursuant to the Plan shall be effective only upon
approval by a
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<PAGE>
vote of a majority of the outstanding shares of such class and by a majority of
the 12b-1 Trustees; and (v) 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.
The Plan is terminable as to any class of shares without penalty at any
time by a vote of a majority of the 12b-1 Trustees, or by vote of the holders of
a majority of the shares of such class.
With respect to Investor A Shares, the front-end sales charge and the
distribution fee payable under the Plan (at a maximum annual rate of .10% of the
average daily net asset value of each Portfolio's outstanding Investor A Shares)
are used to pay commissions and other fees payable to Service Organizations and
other broker/dealers who sell Investor A Shares.
With respect to Investor B Shares, Service Organizations and other
broker/dealers receive commissions from the Distributor for selling Investor B
Shares, which are paid at the time of the sale. The distribution fees payable
under the Plan (at a maximum annual rate of .75% of the average daily net asset
value of each Portfolio's outstanding Investor B Shares) are intended to cover
the expense to the Distributor of paying such up-front commissions, as well as
to cover ongoing commission payments to broker/dealers. The contingent deferred
sales charge is calculated to charge the investor with any shortfall that would
occur if Investor B Shares are redeemed prior to the expiration of the
conversion period, after which Investor B Shares automatically convert to
Investor A Shares.
With respect to Investor C Shares, Service Organizations and other
broker/dealers receive commissions from the Distributor for selling Investor C
Shares, which are paid at the time of the sale. The distribution fees payable
under the Plan (at a maximum annual rate of .75% of the average daily net asset
value of each Portfolio's outstanding Investor C Shares) are intended to cover
the expense to the Distributor of paying such up-front commissions, as well as
to cover ongoing commission payments to the broker/dealers. The contingent
deferred sales charge is calculated to charge the investor with any shortfall
that would occur if Investor C Shares are redeemed within 12 months of purchase.
The Fund is not required or permitted under the Plan to make distribution
payments with respect to Service, Institutional or BlackRock Shares. However,
the Plan permits BDI, BlackRock, Inc., 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, Inc. and their
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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") would
be in addition to the payments by the Fund described in the Fund's Prospectuses
and this Statement of Additional Information for distribution and shareholder
servicing and processing, and would also be in addition to the sales commissions
payable to dealers as set forth in the Prospectuses for Investor Shares. These
Additional Payments may take the form of "due diligence" payments for a dealer's
examination of the Portfolios and payments for providing extra employee training
and information relating to Portfolios; "listing" fees for the placement of the
Portfolios 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, BlackRock, Inc. and their
affiliates may make Additional Payments for subaccounting, administrative and/or
shareholder processing services that are in addition to the shareholder
servicing and processing fees paid by the Fund. The Additional Payments made by
the Distributor, BlackRock, Inc. 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, BlackRock, Inc. 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, BlackRock, Inc. 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.
Service Organizations may charge their clients additional fees for account-
related services.
The Fund intends to enter into service arrangements with Service
Organizations pursuant to which Service Organizations will render certain
support services to their customers ("Customers") who are the beneficial owners
of Service, Investor A, Investor B and Investor C Shares. Such services will be
provided to Customers who are the beneficial owners of Shares of such classes
and are intended to supplement the services provided by the Fund's
Administrators and transfer agent to the Fund's shareholders of record. In
consideration for payment of a
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<PAGE>
service fee of up to .25% (on an annualized basis) of the average daily net
asset value of the Investor A, Investor B and Investor C Shares owned
beneficially by their Customers and .15% (on an annualized basis) of the average
daily net asset value of the Service Shares beneficially owned by their
Customers, Service Organizations may provide general shareholder liaison
services, including, but not limited to (i) answering customer inquiries
regarding account status and history, the manner in which purchases, exchanges
and redemptions of shares may be effected and certain other matters pertaining
to the Customers' investments; and (ii) assisting Customers in designating and
changing dividend options, account designations and addresses. In consideration
for payment of a shareholder processing fee of up to a separate .15% (on an
annualized basis) of the average daily net asset value of Service, Investor A,
Investor B and Investor C Shares owned beneficially by their Customers, Service
Organizations may provide one or more of these additional services to such
Customers: (i) providing necessary personnel and facilities to establish and
maintain Customer accounts and records; (ii) assistance in aggregating and
processing purchase, exchange and redemption transactions; (iii) placement of
net purchase and redemption orders with the Distributor; (iv) arranging for
wiring of funds; (v) transmitting and receiving funds in connection with
Customer orders to purchase or redeem shares; (vi) processing dividend payments;
(vii) verifying and guaranteeing Customer signatures in connection with
redemption orders and transfers and changes in Customer-designated accounts, as
necessary; (viii) providing periodic statements showing Customers' account
balances and, to the extent practicable, integrating such information with other
Customer transactions otherwise effected through or with a Service Organization;
(ix) furnishing (either separately or on an integrated basis with other reports
sent to a shareholder by a Service Organization) monthly and year-end statements
and confirmations of purchases, exchanges and redemptions; (x) transmitting on
behalf of the Fund, proxy statements, annual reports, updating prospectuses and
other communications from the Fund to Customers; (xi) receiving, tabulating and
transmitting to the Fund proxies executed by Customers with respect to
shareholder meetings; (xii) providing subaccounting with respect to shares
beneficially owned by Customers or the information to the Fund necessary for
subaccounting; (xiii) providing sub-transfer agency services; and (xiv)
providing such other similar services as the Fund or a Customer may request.
For the twelve months ended September 30, 1997 (from December 27, 1996
through September 30, 1997 in the case of the Mid-Cap Growth Equity and Mid-Cap
Value Equity Portfolios; and from September 26, 1997 through September 30, 1997
in the case of the International Small Cap Equity Portfolio), the Portfolios'
share classes bore the following distribution, shareholder
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servicing and shareholder processing fees under the Portfolios' current plans:
<TABLE>
<CAPTION>
DISTRIBUTION SHAREHOLDER SHAREHOLDER
PORTFOLIOS - INVESTOR A SHARES FEES SERVICING FEES PROCESSING FEES
- ---------------------------------------- ------------ -------------- ---------------
<S> <C> <C> <C>
Money Market............................ N/A $459,377 $275,626
U.S. Treasury Money Market.............. N/A 47,849 28,709
Municipal Money Market................ N/A 7,046 4,227
New Jersey Municipal Money Market....... N/A 67,930 40,758
North Carolina Municipal Money Market. N/A 498 299
Ohio Municipal Money Market............. N/A 22,520 13,512
Pennsylvania Municipal Money Market... N/A 252,489 151,493
Virginia Municipal Money Market....... N/A 1.213 728
Low Duration Bond....................... N/A 2,253 1,352
Intermediate Government Bond............ N/A 12,926 7,756
Intermediate Bond..................... N/A 2,420 1,452
Core Bond............................... N/A 2,091 1,255
Government Income....................... N/A 8,699 5,219
Managed Income.......................... N/A 27,512 16,507
International Bond.................... N/A 1,173 704
Tax-Free Income......................... N/A 11,481 6,888
Pennsylvania Tax-Free Income.......... N/A 79,632 47,779
New Jersey Tax-Free Income.............. N/A 2,089 1,254
Ohio Tax-Free Income.................... N/A 5,927 3,556
Large Cap Value Equity.................. N/A 82,231 49,339
Large Cap Growth Equity............... N/A 47,342 28,405
Mid-Cap Value Equity.................. N/A 1,270 762
Mid-Cap Growth Equity................... N/A 1,556 934
Small Cap Value Equity.................. N/A 60,827 36,496
Small Cap Growth Equity............... N/A 87,777 52,666
International Equity.................. N/A 50,243 30,146
International Small Cap Equity........ N/A 12 7
International Emerging Markets.......... N/A 8,082 4,849
Select Equity........................... N/A 23,489 14,093
Index Equity.......................... N/A 45,703 27,422
Balanced.............................. N/A 177,097 106,258
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
DISTRIBUTION SHAREHOLDER SHAREHOLDER
PORTFOLIOS - INVESTOR B SHARES FEES SERVICING FEES PROCESSING FEES
- ---------------------------------------- ------------ -------------- ---------------
<S> <C> <C> <C>
Money Market............................ $ 286 $ 1,276 $ 0
U.S. Treasury Money Market.............. 0 0 0
Municipal Money Market.................. 0 0 0
New Jersey Municipal Money Market....... 30 89 0
North Carolina Municipal Money Market... 0 0 0
Ohio Municipal Money Market............. 0 0 0
Pennsylvania Municipal Money Market..... 0 0 0
Virginia Municipal Money Market......... 0 0 0
Low Duration Bond....................... 102 119 72
Intermediate Government Bond............ 103 121 73
Intermediate Bond....................... 0 0 0
Core Bond............................... 10,005 14,857 8,914
Government Income....................... 42,389 59,913 35,948
Managed Income.......................... 10 80 48
International Bond...................... 1,150 1,564 938
Tax-Free Income....................... 1,279 1,735 1,041
Pennsylvania Tax-Free Income.......... 32,624 46,409 27,846
New Jersey Tax-Free Income............ 1,253 1,998 1,193
Ohio Tax-Free Income.................. 1,336 1,989 1,193
Large Cap Value Equity................ 32,130 49,211 29,527
Large Cap Growth Equity............... 14,820 22,498 13,499
Mid-Cap Value Equity.................. 1,677 3,223 1,934
Mid-Cap Growth Equity................. 1,798 3,619 2,171
Small Cap Value Equity................ 14,589 21,446 12,868
Small Cap Growth Equity............... 60,450 84,056 50,434
International Equity.................. 12,419 18,209 10,926
International Small Cap Equity........ 0 0 0
International Emerging Markets.......... 2,514 4,040 2,424
Select Equity......................... 17,090 29,568 17,741
Index Equity.......................... 60,788 78,885 47,331
Balanced.............................. 42,515 64,488 38,693
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
DISTRIBUTION SHAREHOLDER SHAREHOLDER
PORTFOLIOS - INVESTOR C SHARES FEES SERVICING FEES PROCESSING FEES
- ---------------------------------------- ------------ -------------- ---------------
<S> <C> <C> <C>
Money Market............................ $ 645 $ 1,225 $ 0
U.S. Treasury Money Market.............. 0 0 0
Municipal Money Market.................. 2 5 0
New Jersey Municipal Money Market....... 0 0 0
North Carolina Municipal Money Market... 0 0 0
Ohio Municipal Money Market............. 0 0 0
Pennsylvania Municipal Money Market..... 0 0 0
Virginia Municipal Money Market......... 0 0 0
Low Duration Bond....................... 120 141 85
Intermediate Government Bond............ 79 92 55
Intermediate Bond....................... 0 0 0
Core Bond............................... 180 211 127
Government Income....................... 653 750 450
Managed Income.......................... 0 0 0
International Bond...................... 447 462 277
Tax-Free Income......................... 0 1 1
Pennsylvania Tax-Free Income............ 0 0 0
New Jersey Tax-Free Income.............. 0 0 0
Ohio Tax-Free Income.................... 0 0 0
Large Cap Value Equity.................. 2,871 3,372 2,023
Large Cap Growth Equity............... 186 217 130
Mid-Cap Value Equity.................... 31 41 24
Mid-Cap Growth Equity................... 133 158 95
Small Cap Value Equity.................. 1,796 2,104 1,263
Small Cap Growth Equity............... 22,944 26,890 16,134
International Equity.................. 147 172 103
International Small Cap Equity.......... 0 0 0
International Emerging Markets.......... 85 99 60
Select Equity........................... 369 433 260
Index Equity............................ 36,025 41,362 24,817
Balanced.............................. 95 111 67
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
DISTRIBUTION SHAREHOLDER SHAREHOLDER
PORTFOLIOS - SERVICE SHARES FEES SERVICING FEES PROCESSING FEES
- ---------------------------------------- ------------ -------------- ---------------
<S> <C> <C> <C>
Money Market............................ N/A $2,425,112 $2,425,112
U.S. Treasury Money Market.............. N/A 1,280,124 1,280,124
Municipal Money Market................ N/A 493,398 493,398
New Jersey Municipal Money Market....... N/A 141,044 141,044
North Carolina Municipal Money Market. N/A 15,790 15,790
Ohio Municipal Money Market............. N/A 85,080 85,080
Pennsylvania Municipal Money Market... N/A 361,364 361,364
Virginia Municipal Money Market....... N/A 15,542 15,542
Low Duration Bond....................... N/A 127,215 127,215
Intermediate Government Bond.......... N/A 73,283 73,283
Intermediate Bond..................... N/A 73,197 73,197
Core Bond............................... N/A 181,486 181,486
Government Income....................... N/A 0 0
Managed Income.......................... N/A 320,482 320,482
International Bond.................... N/A 10,859 10,859
Tax-Free Income......................... N/A 63,453 63,453
Pennsylvania Tax-Free Income.......... N/A 58,664 58,664
New Jersey Tax-Free Income.............. N/A 127,605 127,605
Ohio Tax-Free Income.................. N/A 10,309 10,309
Large Cap Value Equity.................. N/A 769,724 769,724
Large Cap Growth Equity............... N/A 327,593 327,593
Mid-Cap Value Equity.................. N/A 14,145 14,145
Mid-Cap Growth Equity................... N/A 14,097 14,097
Small Cap Value Equity.................. N/A 137,408 137,408
Small Cap Growth Equity............... N/A 249,073 249,073
International Equity.................. N/A 256,801 256,801
International Small Cap Equity........ N/A 0 0
International Emerging Markets.......... N/A 80,289 80,289
Select Equity........................... N/A 208,609 208,609
Index Equity.......................... N/A 214,177 214,177
Balanced.............................. N/A 231,115 231,115
</TABLE>
EXPENSES
Expenses are deducted from the total income of each Portfolio before
dividends and distributions are paid. These expenses include, but are not
limited to, fees paid to BlackRock, Inc. and the Administrators, transfer agency
fees, fees and expenses of officers and trustees who are not affiliated with
BlackRock, Inc., the Distributor or any of their affiliates, taxes, interest,
legal fees, custodian fees, auditing fees, distribution fees, shareholder
processing fees, shareholder servicing fees, fees and expenses in registering
and qualifying 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, fidelity
bond and trustees and officers liability insurance premiums, the expense of
independent pricing services and other expenses which are not expressly assumed
by BlackRock, Inc. or the Fund's service providers under their agreements with
the Fund. 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
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<PAGE>
Trustees in a manner the Board determines to be fair and equitable.
BlackRock, Inc., the sub-advisers and the Administrators expect to waive
voluntarily a portion of their respective advisory, sub-advisory and
administration fees during the Portfolios' current fiscal year.
PORTFOLIO TRANSACTIONS
In executing portfolio transactions, the adviser and sub-advisers seek to
obtain the best price and most favorable execution for a Portfolio, taking into
account such factors as the price (including the applicable brokerage commission
or dealer spread), size of the order, difficulty of execution and operational
facilities of the firm involved. While the adviser and sub-advisers generally
seek reasonably competitive commission rates, payment of the lowest commission
or spread is not necessarily consistent with obtaining the best price and
execution in particular transactions. Payments of commissions to brokers who
are affiliated persons of the Fund, or the Trust with respect to the Index
Master Portfolio, (or affiliated persons of such persons) will be made in
accordance with Rule 17e-1 under the 1940 Act. With respect to the Index Master
Portfolio, commissions paid on such transactions would be commensurate with the
rate of commissions paid on similar transactions to brokers that are not so
affiliated.
No Portfolio has any obligation to deal with any broker or group of brokers
in the execution of Portfolio transactions. The adviser and sub-advisers may,
consistent with the interests of a Portfolio, select brokers on the basis of the
research, statistical and pricing services they provide to a Portfolio and the
adviser's or sub-adviser's other clients. Information and research received
from such brokers will be in addition to, and not in lieu of, the services
required to be performed by the adviser and sub-advisers under their respective
contracts. A commission paid to such brokers may be higher than that which
another qualified broker would have charged for effecting the same transaction,
provided that the adviser or sub-adviser determines in good faith that such
commission is reasonable in terms either of the transaction or the overall
responsibility of the adviser or sub-adviser to a Portfolio and its other
clients and that the total commissions paid by a Portfolio will be reasonable in
relation to the benefits to a Portfolio over the long-term. With respect to the
Index Master Portfolio, it will seek to acquire and dispose of securities in a
manner which would cause as little fluctuation in the market prices of stocks
being purchased or sold as possible in light of the size of the transactions
being effected, and brokers will be selected with this goal in view. DFA
monitors the performance of brokers which
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<PAGE>
effect transactions for the Index Master Portfolio to determine the effect that
the Index Master Portfolio's trading has on the market prices of the securities
in which they invest. DFA also checks the rate of commission being paid by the
Index Master Portfolio to its brokers to ascertain that they are competitive
with those charged by other brokers for similar services. Transactions also may
be placed with brokers who provide DFA with investment research, such as reports
concerning individual issuers, industries and general economic and financial
trends and other research services. The Investment Management Agreement permits
DFA knowingly to pay commissions on such transactions which are greater than
another broker might charge if DFA, in good faith, determines that the
commissions paid are reasonable in relation to the research or brokerage
services provided by the broker or dealer when viewed in terms of either a
particular transaction or DFA's overall responsibilities to the Trust.
Commission rates for brokerage transactions on foreign stock exchanges are
generally fixed. In addition, the adviser or sub-adviser may take into account
the sale of shares of the Fund in allocating purchase and sale orders for
portfolio securities to brokers (including brokers that are affiliated with them
or Distributor).
For the year or period ended September 30, 1997, the following Portfolios
paid brokerage commissions as follows:
<TABLE>
<CAPTION>
PORTFOLIOS BROKERAGE COMMISSIONS
- ---------- ---------------------
<S> <C>
Large Cap Value Equity $1,309,867
Large Cap Growth Equity 1,033,730
Mid-Cap Value Equity 199,394
Mid-Cap Growth Equity 152,521
Small Cap Value Equity 612,318
Small Cap Growth Equity 413,189
International Equity 1,884,858
International Small Cap Equity 57,239
International Emerging Markets 570,670
Select Equity 317,435
Balanced 75,685
</TABLE>
For the year or period ended September 30, 1996, the following Portfolios
paid brokerage commissions as follows:
<TABLE>
<CAPTION>
PORTFOLIOS BROKERAGE COMMISSIONS
---------- ---------------------
<S> <C>
Large Cap Value Equity $1,455,318
Large Cap Growth Equity 696,494
Small Cap Growth Equity 165,153
Select Equity 443,114
Index Equity 44,380
Small Cap Value Equity 380,356
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
PORTFOLIOS BROKERAGE COMMISSIONS
---------- ---------------------
<S> <C>
International Equity 1,912,522
Balanced 95,277
International Emerging Markets 588,860
</TABLE>
For the year or period ended September 30, 1995, the following Portfolios
paid brokerage commissions as follows:
<TABLE>
<CAPTION>
PORTFOLIOS BROKERAGE COMMISSIONS
---------- ---------------------
<S> <C>
Large Cap Value Equity $ 364,680
Large Cap Growth Equity 356,156
Small Cap Growth Equity 88,691
Select Equity 341,935
Index Equity 73,946
Small Cap Value Equity 251,396
International Equity 2,667,245
Balanced 144,451
International Emerging Markets 356,727
</TABLE>
For the Index Master Portfolio's fiscal years ended November 30, 1995, 1996
and 1997, the Index Master Portfolio paid brokerage commissions totalling
$15,289, $72,562 and $116,563, respectively.
Over-the-counter issues, including corporate debt and U.S. Government
securities, are normally traded on a "net" basis without a stated commission,
through dealers acting for their own account and not as brokers. The Portfolios
will primarily engage in transactions with these dealers or deal directly with
the issuer unless a better price or execution could be obtained by using a
broker. Prices paid to a dealer with respect to both foreign and domestic
securities will generally include a "spread," which is the difference between
the prices at which the dealer is willing to purchase and sell the specific
security at the time, and includes the dealer's normal profit.
Purchases of money market instruments by a Portfolio are made from dealers,
underwriters and issuers. The Portfolios do not currently expect to incur any
brokerage commission expense on such transactions because money market
instruments are generally traded on a "net" basis with dealers acting as
principal for their own accounts without a stated commission. The price of the
security, however, usually includes a profit to the dealer. Each Money Market
Portfolio intends to purchase only securities with remaining maturities of 13
months or less as determined in accordance with the rules of the SEC. As a
result, the portfolio turnover rates of a Money Market Portfolio will be
relatively high. However, because brokerage commissions will not normally be
paid with respect to investments made by a Money Market
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<PAGE>
Portfolio, the turnover rates should not adversely affect the Portfolio's net
asset values or net income.
Securities purchased in underwritten offerings include a fixed amount of
compensation to the underwriter, generally referred to as the underwriter's
concession or discount. When securities are purchased or sold directly from or
to an issuer, no commissions or discounts are paid.
The adviser or sub-advisers may seek to obtain an undertaking from issuers
of commercial paper or dealers selling commercial paper to consider the
repurchase of such securities from a Portfolio prior to maturity at their
original cost plus interest (sometimes adjusted to reflect the actual maturity
of the securities), if it believes that a Portfolio's anticipated need for
liquidity makes such action desirable. Any such repurchase prior to maturity
reduces the possibility that a Portfolio would incur a capital loss in
liquidating commercial paper, especially if interest rates have risen since
acquisition of such commercial paper.
Investment decisions for each Portfolio and for other investment accounts
managed by the adviser or sub-advisers are made independently of each other in
light of differing conditions. However, the same investment decision may be
made for two or more such accounts. In such cases, simultaneous transactions
are inevitable. Purchases or sales are then averaged as to price and allocated
as to amount in a manner deemed equitable to each such account. While in some
cases this practice could have a detrimental effect upon the price or value of
the security as far as a Portfolio is concerned, in other cases it could be
beneficial to a Portfolio. A Portfolio will not purchase securities during the
existence of any underwriting or selling group relating to such securities of
which BlackRock, Inc., PIMC, BlackRock, PNC Bank, PCM, PEAC,
CastleInternational, 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, Inc., PIMC, BlackRock, PNC Bank, PCM, PEAC,
CastleInternational, 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. The Index Master Portfolio
ordinarily will not sell portfolio securities except to reflect
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<PAGE>
additions or deletions of stocks that comprise the S&P 500 Index, including
mergers, reorganizations and similar transactions and, to the extent necessary,
to provide cash to pay redemptions of the Index Master Portfolio's shares.
The Fund is required to identify any securities of its regular brokers or
dealers (as defined in Rule 10b-1 under the 1940 Act) or their parents held by
the Fund as of the end of its most recent fiscal year. As of September 30,
1997, the following Portfolios held the following securities:
<TABLE>
<CAPTION>
PORTFOLIO SECURITY VALUE
- ------------------------------------------------------------------------------------------------------
<S> <C> <C>
Money Market
- ------------
Morgan Stanley & Co., Inc. Commercial Paper $ 49,402,000
Morgan Stanley & Co., Inc. Variable Rate Obligation 36,997,742
Merrill Lynch & Co. Commercial Paper 128,081,269
Lehman Brothers, Inc. Commercial Paper 49,837,542
Lehman Brothers, Inc. Variable Rate Obligation 50,000,000
U.S. Treasury Money Market
- --------------------------
Morgan Stanley & Co., Inc. Repurchase Agreement $247,000,000
Greenwich Capital Repurchase Agreement 225,000,000
Goldman, Sachs & Co. Repurchase Agreement 50,000,000
Merrill Lynch & Co. Repurchase Agreement 50,000,000
Swiss Bank Corp. Repurchase Agreement 50,000,000
Low Duration Bond
- -----------------
Morgan Stanley & Co., Inc. Mortgage Pass-Through $ 168,166
Lehman Brothers, Inc. Corporate Bond 3,689,617
Salomon Brothers, Inc. Mortgage Pass-Through 3,065,061
Salomon Brothers, Inc. Corporate Bond 4,037,134
Intermediate Government Bond
- ----------------------------
Merrill Lynch & Co. Mortgage Pass-Through $ 4,367,211
Morgan Stanley & Co., Inc. Commercial Mortgage-Backed Security 1,407,311
Intermediate Bond
- -----------------
Salomon Brothers, Inc. Mortgage Pass-Through $ 2,117,624
Salomon Brothers, Inc. Corporate Bond 527,865
PaineWebber Jackson & Curtis, Inc. Corporate Bond 1,577,526
Morgan Stanley & Co., Inc. Commercial Mortgage-Backed Security 3,266,973
Merrill Lynch & Co. Mortgage Pass-Through 10,190,099
Merrill Lynch & Co. Commercial Mortgage-Backed Security 1,236,217
Core Bond
- ---------
Salomon Brothers, Inc. Mortgage Pass-Through $ 6,900,254
Salomon Brothers, Inc. Corporate Bond 5,701,504
Goldman, Sachs & Co. Commercial Mortgage-Backed Security 2,942,012
Merrill Lynch & Co. Mortgage Pass-Through 428,155
Merrill Lynch & Co. Commercial Mortgage-Backed Security 3,397,277
Merrill Lynch & Co. Asset Backed Security 303,703
Merrill Lynch & Co. Corporate Bond 4,226,051
Government Income
- -----------------
Salomon Brothers, Inc. Mortgage Pass-Through $ 632,894
</TABLE>
-112-
<PAGE>
<TABLE>
<CAPTION>
PORTFOLIO SECURITY VALUE
- ------------------------------------------------------------------------------------------------------
<S> <C> <C>
Managed Income
- --------------
Salomon Brothers, Inc. Corporate Bond $ 2,639,323
Morgan Stanley & Co., Inc. Commercial Mortgage-Backed Security 1,063,281
PaineWebber Jackson & Curtis, Inc. Corporate Bond 5,004,177
HSBC Securities Corporate Bond 7,852,743
Merrill Lynch & Co. Corporate Bond 8,250,862
Merrill Lynch & Co. Commercial Mortgage-Backed Security 12,884,829
Large Cap Value Equity
- ----------------------
Morgan Stanley & Co., Inc. Common Stock $ 29,257,111
Mid-Cap Value Equity
- --------------------
Donaldson, Lufkin & Jenrette Securities Corp. Common Stock $ 1,073,437
Select Equity
- -------------
Morgan Stanley & Co., Inc. Common Stock $ 7,595,781
Balanced
- --------
Morgan Stanley & Co., Inc. Common Stock $ 4,941,312
Salomon Brothers, Inc. Mortgage Pass-Through 1,593,589
Salomon Brothers, Inc. Corporate Bond 316,719
PaineWebber Jackson & Curtis, Inc. Corporate Bond 1,051,684
Merrill Lynch & Co. Corporate Bond 1,006,203
Merrill Lynch & Co. Commercial Mortgage-Backed Security 2,015,045
</TABLE>
PURCHASE AND REDEMPTION INFORMATION
COMPUTATION OF PUBLIC OFFERING PRICES FOR INVESTOR A SHARES OF THE NON-
MONEY MARKET PORTFOLIOS. An illustration of the computation of the public
offering price per Investor A Share of the respective Non-Money Market
Portfolios, based on the value of such Portfolios' net assets as of September
30, 1997 follows:
TABLE
-----
<TABLE>
<CAPTION>
LOW INTERMEDIATE INTERMEDIATE CORE GOVERNMENT
DURATION GOVERNMENT BOND BOND INCOME
BRAND PORTFOLIO BOND PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO
--------------- -------------- ------------ --------- ----------
<S> <C> <C> <C> <C> <C>
Net Assets................................................ $1,078,619 $5,373,962 $1,115,865 $2,440,633 $4,875,820
Outstanding Shares........................................ 109,020 531,600 117,568 248,559 464,801
========== ========== ========== ========== ==========
Net Asset Value Per Share................................. $ 9.89 $ 10.11 $ 9.49 $ 9.82 $ 10.49
Maximum Sales Charge, 4.00% of offering price
(4.17% of net asset value per share)*......... .31 .42 .40 .41 .49
---------- ---------- ---------- ---------- ----------
Offering to Public........................................ $ 10.20 $ 10.53 $ 9.89 $ 10.23 $ 10.98
========== ========== ========== ========== ==========
</TABLE>
___________________
* 3.00%/3.09% for Low Duration Bond Portfolio; 4.50%/4.71% for Government
Income Portfolio.
-113-
<PAGE>
<TABLE>
<CAPTION>
PENNSYLVANIA NEW JERSEY
MANAGED INTERNATIONAL TAX-FREE TAX-FREE TAX-FREE
INCOME BOND INCOME INCOME INCOME
PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO
--------- ------------- --------- ------------ ----------
<S> <C> <C> <C> <C> <C>
Net Assets................................................ $15,231,004 $1,015,272 $5,529,698 $32,899,562 $1,547,924
Outstanding Shares........................................ 1,463,584 92,713 487,696 3,054,223 132,824
=========== ========== ========== =========== ==========
Net Asset Value Per Share................................. $ 10.41 $ 10.95 $ 11.34 $ 10.77 $ 11.65
Maximum Sales Charge, 4.00% of offering price .49 .58 .47 .45 .49
(4.17% of net asset value per share)*...................
----------- ---------- ---------- ----------- ----------
Offering to Public........................................ $ 10.90 $ 11.53 $ 11.81 $ 11.22 $ 12.14
=========== ========== ========== =========== ==========
</TABLE>
____________________
* 4.50%/4.71% for Managed Income Portfolio; 5.00%/5.26% for International Bond
Portfolio.
<TABLE>
<CAPTION>
OHIO LARGE CAP LARGE CAP MID-CAP MID-CAP
TAX-FREE VALUE GROWTH VALUE GROWTH
INCOME EQUITY EQUITY EQUITY EQUITY
PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Net Assets................................................ $2,613,993 $47,130,883 $25,574,775 $2,314,615 $2,649,715
Outstanding Shares........................................ 248,893 2,690,305 1,352,284 181,200 218,185
========== =========== =========== ========== ==========
Net Asset Value Per Share................................. $ 10.50 $ 17.52 $ 18.91 $ 12.77 $ 12.14
Maximum Sales Charge, 4.50% of offering price
(4.71% of net asset value per share)*......... .44 .82 .89 .60 .57
---------- ----------- ----------- ---------- ----------
Offering to Public........................................ $ 10.94 $ 18.34 $ 19.80 $ 13.37 $ 12.71
========== =========== =========== ========== ==========
</TABLE>
__________________
* 4.00%/4.17% for Ohio Tax-Free Income Portfolio.
<TABLE>
<CAPTION>
SMALL CAP INTERNATIONAL INTERNATIONAL
SMALL CAP GROWTH INTERNATIONAL SMALL CAP EMERGING
VALUE EQUITY EQUITY EQUITY EQUITY MARKETS
PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO
------------ --------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Net Assets................................................ $34,031,124 $57,323,064 $22,335,232 $325,738 $4,454,003
Outstanding Shares........................................ 1,684,915 2,466,020 1,533,040 32,754 463,777
=========== =========== =========== ======== ==========
Net Asset Value Per Share................................. $ 20.20 $ 23.25 $ 14.57 $ 9.94 $ 9.60
Maximum Sales Charge, 5.00% of offering price
(5.26% of net asset value per share)*......... .95 1.10 .77 .52 .51
----------- ----------- ----------- -------- ----------
Offering to Public........................................ $ 21.15 $ 24.35 $ 15.34 $ 10.46 $ 10.11
=========== =========== =========== ======== ==========
</TABLE>
____________________
* 4.50%/4.71% for Small Cap Value Equity and Small Cap Growth Equity
Portfolios.
-114-
<PAGE>
<TABLE>
<CAPTION>
SELECT INDEX
EQUITY EQUITY BALANCED
PORTFOLIO PORTFOLIO PORTFOLIO
----------- ----------- -----------
<S> <C> <C> <C>
Net Assets.................................................................... $18,948,763 $33,933,239 $87,202,151
Outstanding Shares............................................................ 1,082,651 1,852,190 4,785,456
=========== =========== ===========
Net Asset Value Per Share..................................................... $ 17.50 $ 18.32 $ 18.22
Maximum Sales Charge, 4.50% of offering price (4.71% of net asset .82 .57 .86
value per share)*.................................................
----------- ----------- -----------
Offering to Public............................................................ $ 18.32 $ 18.89 $ 19.08
=========== =========== ===========
</TABLE>
_____________
* 3.00%/3.09% for Index Equity Portfolio.
Total front-end sales charges paid by shareholders of Investor A Shares of
the Portfolios for the year or period ended September 30, 1997 (for the
period from December 27, 1996 through September 30, 1997 in the case of the
Mid-Cap Growth Equity and Mid-Cap Value Equity Portfolios; and for the
period from September 26, 1997 through September 30, 1997 in the case of
the International Small Cap Equity Portfolio) were as follows:
<TABLE>
<CAPTION>
FRONT-END
PORTFOLIOS SALES CHARGES
- ---------------------------------------------------------------------------------------------
<S> <C>
Low Duration Bond $ 3,758
Intermediate Government Bond 11,644
Intermediate Bond 7,367
Core Bond 39,657
Government Income 32,856
Managed Income 68,493
International Bond 29,718
Tax-Free Income 19,830
Pennsylvania Tax-Free Income 80,642
New Jersey Tax-Free Income 4,104
Ohio Tax-Free Income 5,336
Large Cap Value Equity 277,224
Large Cap Growth Equity 146,897
Mid-Cap Value Equity 55,834
Mid-Cap Growth Equity 46,954
Small Cap Value Equity 107,051
Small Cap Growth Equity 668,832
International Equity 104,956
International Small Cap Equity 0
International Emerging Markets 49,056
Select Equity 272,796
Index Equity 159,501
Balanced 223,646
</TABLE>
Total front-end sales charges paid by shareholders of Investor A Shares of
the Portfolios for the year or period ended September 30, 1996 (for the
period from February 1, 1996 through September 30, 1996 in the case of the
New Jersey Tax-Free Income and International Bond Portfolios; for the
period from April 1, 1996 through September 30, 1996 in the case of the Low
Duration Bond and Core Bond Portfolios) were as follows:
-115-
<PAGE>
<TABLE>
<CAPTION>
PORTFOLIOS FRONT-END SALES CHARGES
---------- -----------------------
<S> <C>
Managed Income $ 43,417
Tax-Free Income 9,109
Intermediate Government Bond 22,989
Ohio Tax-Free Income 4,649
Pennsylvania Tax-Free Income 81,436
Intermediate Bond 8,598
Large Cap Value Equity 141,011
Large Cap Growth Equity 95,694
Small Cap Growth Equity 344,911
Select Equity 44,112
Index Equity 78,263
Small Cap Value Equity 51,676
International Equity 85,795
Balanced 143,547
International Emerging Markets 18,147
Government Income 30,034
Core Bond 8,481
New Jersey Tax Free Income 17,606
Low Duration Bond 6,294
International Bond $ 7,565
</TABLE>
Total front-end sales charges paid by shareholders of Investor A Shares of the
Portfolios for the year or period ended September 30, 1995 were as follows:
<TABLE>
<CAPTION>
PORTFOLIOS FRONT-END SALES CHARGES
---------- -----------------------
<S> <C>
Managed Income $ 37,132
Tax-Free Income 8,850
Intermediate Government Bond 42,765
Ohio Tax-Free Income 2,725
Pennsylvania Tax-Free Income 121,089
Intermediate Bond 1,513
Large Cap Value Equity 68,289
Large Cap Growth Equity 47,859
Small Cap Growth Equity 77,356
Select Equity 34,761
Index Equity 51,229
Small Cap Value Equity 61,709
International Equity 83,938
Balanced 144,255
International Emerging Markets 24,915
Government Income 69,712
</TABLE>
For the period from January 13, 1996 through January 31, 1996, the total
front-end sales charges paid by the shareholders of Investor A Shares of the New
Jersey Tax-Free Income Portfolio were $435. For the period from January 13,
1996 through March
-116-
<PAGE>
31, 1996, the total front-end sales charges paid by the shareholders of Investor
A Shares of the Low Duration Bond and Core Bond Portfolios were $3,848 and
$1,723, respectively.
There is no initial sales charge on purchases of $1,000,000 or more of
Investor A Shares of the Non-Money Market Portfolios. However, a contingent
deferred sales charge of 1.00% will be imposed on the lesser of the net offering
price or the asset value of the shares on the redemption date for Investor A
Shares purchased on a no-load basis and subsequently redeemed within 18 months
after purchase.
Investor A Shares of the Non-Money Market Portfolios will be made available
to plan participants at net asset value with the waiver of the initial sales
charge on purchases through an eligible 401(k) plan participating in a Merrill
Lynch 401(k) Program (an "ML 401(k) Plan") if:
(i) the ML 401(k) Plan is recordkept on a daily valuation basis
by Merrill Lynch and, on the date the ML 401(k) Plan sponsor signs the
Merrill Lynch Recordkeeping Service Agreement, the ML 401(k) Plan has $3
million or more in assets invested in broker/dealer funds not advised or
managed by Merrill Lynch Asset Management, L.P. ("MLAM") that are made
available pursuant to a Services Agreement between Merrill Lynch and the
fund's principal underwriter or distributor and in funds advised or managed
by MLAM (collectively, the "Applicable Investments"); or
(ii) the ML 401(k) Plan is recordkept on a daily valuation
basis by an independent recordkeeper whose services are provided through a
contract or alliance arrangement with Merrill Lynch, and on the date the ML
401(k) Plan sponsor signs the Merrill Lynch Recordkeeping Service
Agreement, the ML 401(k) Plan has $3 million or more in assets, excluding
money market funds, invested in Applicable Investments; or
(iii) the ML 401(k) Plan has 500 or more eligible employees, as
determined by the Merrill Lynch plan conversion manager, on the date the ML
401(k) Plan sponsor signs the Merrill Lynch Recordkeeping Service
Agreement.
Investor B Shares of the Non-Money Market Portfolios are sold at the net
asset value per share next determined after a purchase order is received.
Investor B Shares of the Non-Money Market Portfolios are subject to a contingent
deferred sales charge which is payable on redemption of such Investor B Shares.
Investor B Shares of the Non-Money Market Portfolios will be made available
to plan participants at net asset value with the waiver of the contingent
deferred sales charge if the shares were purchased through an ML 401(k) Plan if:
-117-
<PAGE>
(i) the ML 401(k) Plan is recordkept on a daily valuation basis by
Merrill Lynch and, on the date the ML 401(k) Plan sponsor signs the Merrill
Lynch Recordkeeping Service Agreement, the ML 401(k) Plan has less than $3
million in assets invested in Applicable Investments; or
(ii) the ML 401(k) Plan is recordkept on a daily valuation basis by
an independent recordkeeper whose services are provided through a contract
or alliance arrangement with Merrill Lynch, and on the date the ML 401(k)
Plan sponsor signs the Merrill Lynch Recordkeeping Service Agreement, the
ML 401(k) Plan has less than $3 million in assets, excluding money market
funds, invested in Applicable Investments; or
(iii) the ML 401(k) Plan has less than 500 eligible employees, as
determined by the Merrill Lynch plan conversion manager, on the date the ML
401(k) Plan sponsor signs the Merrill Lynch Recordkeeping Service
Agreement.
ML 401(k) Plans recordkept on a daily basis by Merrill Lynch or an
independent recordkeeper under a contract with Merrill Lynch that are currently
investing in Investor B shares of Non-Money Market Portfolios of the Fund
convert to Investor A shares once the ML 401(k) Plan has reached $5 million
invested in Applicable Investments. The ML 401(k) Plan will receive a plan-level
share conversion.
Investor C Shares of the Non-Money Market Portfolios are sold at the net
asset value per share next determined after a purchase order is received. In
addition, Investor C Shares of the Non-Money Market Portfolios are subject to a
contingent deferred sales charge which is payable on redemptions of such
Investor C Shares within 12 months of purchase.
Service and Institutional Shares of each Portfolio are sold at the net
asset value per share next determined after a purchase order is received without
a sales charge.
EXCHANGE PRIVILEGE. By use of the exchange privilege, the investor
authorizes the Fund's transfer agent to act on telephonic or written exchange
instructions from any person representing himself to be the investor and
believed by the Fund's transfer agent to be genuine. The records of the Fund's
transfer agent pertaining to such instructions are binding. The exchange
privilege may be modified or terminated at any time upon 60 days' notice to
affected shareholders. The exchange privilege is only available in states where
the exchange may legally be made.
A front-end sales charge or a contingent deferred sales charge will be
imposed (unless an exemption from either sales charge applies) when Investor
Shares of a Money Market Portfolio
-118-
<PAGE>
are redeemed and the proceeds are used to purchase Investor A Shares, Investor B
Shares or Investor C Shares of a Non-Money Market Portfolio.
MISCELLANEOUS. The Fund reserves the right, if conditions exist which make
cash payments undesirable, to honor any request for redemption or repurchase of
a 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 a 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 a 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 a Portfolio.
With respect to the Index Master Portfolio, when the Trustees of the Trust
determine that it would be in the best interests of the Index Master Portfolio,
the Index Master Portfolio may pay the redemption price in whole or in part by a
distribution of portfolio securities from the Index Master Portfolio of the
shares being redeemed in lieu of cash in accordance with Rule 18f-1 under the
Investment Company Act of 1940. Investors, such as the Index Equity Portfolio,
may incur brokerage charges and other transaction costs selling securities that
were received in payment of redemptions.
The Fund will accept and process purchase and redemption orders with
respect to the Large Cap Value Equity, Large Cap Growth Equity, Index Equity,
Small Cap Value Equity, Small Cap Growth Equity, Mid-Cap Value Equity, Mid-Cap
Growth Equity, Select Equity, Micro-Cap Equity, International Equity,
International Emerging Markets, Balanced and International Small Cap Equity
Portfolios on days on which the Federal Reserve Bank of Philadelphia is closed
if the New York Stock Exchange (the "NYSE") is open for business.
Under the 1940 Act, a Portfolio may suspend the right to redemption or
postpone the date of payment upon redemption for any period during which 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 Prospectuses, the Fund may
redeem shares involuntarily to reimburse a Portfolio for any loss sustained by
reason of the failure of a shareholder
-119-
<PAGE>
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
In determining the 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 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.
MONEY MARKET PORTFOLIOS. The net asset value for each class of each share
of the Money Market Portfolios for the purpose of pricing purchase and
redemption orders is determined twice each day, once as of 12:00 noon (Eastern
Time) and once as of 4:00 p.m. (Eastern Time) on each Business Day. Each
Portfolio's net asset value per share is calculated by adding the value of all
securities, cash and other assets of the respective classes of the Portfolio,
subtracting the liabilities and dividing the result by the number of outstanding
shares of such classes. The net asset value per share of each class of each
Portfolio is determined independently of the other classes and the other
Portfolios.
The Fund seeks to maintain for each of the Money Market Portfolios a net
asset value of $1.00 per share for purposes of purchase and redemptions and
values their portfolio securities on the basis of the amortized cost method of
valuation.
Under this method the market value of an instrument is approximated by
amortizing the difference between the acquisition cost and value at maturity of
the instrument on a straight-line basis over the remaining life of the
instrument. The effect of changes in the market value of a security as a result
of fluctuating interest rates is not taken into account. The market value of
debt securities usually reflects yields generally available on securities of
similar quality. When such yields
-120-
<PAGE>
decline, market values can be expected to increase, and when yields increase,
market values can be expected to decline.
As indicated, the amortized cost method of valuation may result in the
value of a security being higher or lower than its market price, the price a
Money Market Portfolio would receive if the security were sold prior to
maturity. The Fund's Board of Trustees has established procedures for the
purpose of maintaining a constant net asset value of $1.00 per share for each
Money Market Portfolio, which include a review of the extent of any deviation of
net asset value per share, based on available market quotations, from the $1.00
amortized cost per share. Should that deviation exceed 1/2 of 1% for a Money
Market Portfolio, the Fund's Board of Trustees will promptly consider whether
any action should be initiated to eliminate or reduce material dilution or other
unfair results to shareholders. Such action may include redeeming shares in
kind, selling portfolio securities prior to maturity, reducing or withholding
dividends, shortening the average portfolio maturity, reducing the number of
outstanding shares without monetary consideration, and utilizing a net asset
value per share as determined by using available market quotations.
Each Money Market Portfolio will maintain a dollar-weighted average
portfolio maturity of 90 days or less, will not purchase any instrument with a
deemed maturity under Rule 2a-7 of the 1940 Act greater than 13 months, and will
limit portfolio investments, including repurchase agreements, to those
instruments that the adviser or sub-adviser determines present minimal credit
risks pursuant to guidelines adopted by the Fund's Board of Trustees. There can
be no assurance that a constant net asset value will be maintained for any Money
Market Portfolio.
EQUITY PORTFOLIOS. Net asset value is calculated separately for each class
of shares of each Equity Portfolio as of the close of regular trading hours on
the NYSE (currently 4:00 p.m. Eastern Time) on each Business Day by dividing the
value of all securities, cash and other assets owned by a Portfolio that are
allocated to a particular class of shares, less the liabilities charged to that
class, by the total number of outstanding shares of the class.
Valuation of securities held by each Equity Portfolio is as follows:
securities traded on a national securities exchange or on the NASDAQ National
Market System are valued at the last reported sale price that day; securities
traded on a national securities exchange or on the NASDAQ National Market System
for which there were no sales on that day and securities traded on other over-
the-counter markets for which market quotations are readily available are valued
at the mean of the bid and asked prices; 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
-121-
<PAGE>
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); 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. 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
investment adviser and/or sub-adviser under the supervision of the Board of
Trustees determines such method does not represent fair value.
Valuation of securities of foreign issuers is as follows: to the extent
sale prices are available, securities which are 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. In the event that there are no sales, the
mean between the last available bid and asked prices will be used. 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. 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
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). In the event that
application of these methods of valuation results in a price for a security
which is deemed not to be representative of the market value of such security,
the security will be valued by, under the direction of or in accordance with a
method specified by the Board of Trustees as reflecting fair value. The
amortized cost method of valuation will be used with respect to debt obligations
with sixty days or less remaining to maturity unless the investment adviser
and/or sub-adviser under the supervision of the Board of Trustees determines
such method does not represent fair value. All other assets and securities held
by the Portfolios (including restricted securities) are valued at fair value as
determined in good faith by the Board of Trustees or by someone under its
direction. Any assets 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 International Equity,
International Emerging Markets and International Small Cap Equity Portfolios may
be traded on foreign exchanges or over-the-counter markets on days on which a
Portfolio's net asset value is not calculated. In such cases, the net asset
value of the Portfolio's shares may be significantly affected on days when
investors can neither purchase nor redeem shares of the Portfolio.
A Portfolio may use a pricing service, bank or broker/dealer experienced in
such matters to value the Portfolio's securities.
-122-
<PAGE>
The valuation of securities held by the Index Master Portfolio is discussed
in its Registration Statement.
BOND PORTFOLIOS. Net asset value is calculated separately for each class
of shares of each Bond Portfolio as of the close of regular trading hours on the
NYSE on each Business Day by dividing the value of all securities, cash and
other assets owned by a Portfolio that are allocated to a particular class of
shares, less the liabilities charged to that class, by the total number of
outstanding shares of the class.
Valuation of securities held by each Bond 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
investment adviser or sub-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 or sub-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 International Bond Portfolio may
be traded on foreign exchanges or over-the-counter markets on days on which the
Portfolio's net asset value is not calculated. In such cases, the net asset
value of the Portfolio's shares may be significantly affected on days when
investors can neither purchase nor redeem shares of the Portfolio.
-123-
<PAGE>
PERFORMANCE INFORMATION
A Portfolio may quote performance in various ways. All performance
information supplied by a Portfolio in advertising is historical and is not
intended to indicate future returns.
MONEY MARKET PORTFOLIO PERFORMANCE. Each Money Market Portfolio's current
and effective yields for Service, Investor A, Investor B, Investor C and
Institutional Shares are computed separately using standardized methods required
by the SEC. The annualized yield for a class of Service, Investor A, Investor
B, Investor C or Institutional Shares is computed by: (a) determining the net
change in the value of a hypothetical account having a balance of one share at
the beginning of a seven-calendar day period; (b) dividing the net change by the
value of the account at the beginning of the period to obtain the base period
return; and (c) annualizing the results (i.e., multiplying the base period
----
return by 365/7). The net change in the value of the account reflects the value
of additional shares purchased with dividends declared and all dividends
declared on both the original share and such additional shares, but does not
include realized gains and losses or unrealized appreciation and depreciation.
Compound effective yields are computed by adding 1 to the base period return
(calculated as described above) raising the sum to a power equal to 365/7 and
subtracting 1. In addition, a standardized "tax-equivalent yield" may be quoted
for Service, Investor A, Investor B, Investor C and Institutional Shares in the
Municipal Money Market, Ohio Municipal Money Market, Pennsylvania Municipal
Money Market, North Carolina Municipal Money Market, Virginia Municipal Money
Market and New Jersey Municipal Money Market Portfolios, which is computed
separately for each class by: (a) dividing the portion of the Portfolio's yield
for shares (as calculated above) that is exempt from Federal or state income tax
by one minus a stated Federal or state income tax rate; and (b) adding the
figure resulting from (a) above to that portion, if any, of the yield that is
not exempt from Federal and state income tax.
The annualized yield information for each Money Market Portfolio for the
seven-day period ended September 30, 1997 before waivers was as follows:
-124-
<PAGE>
<TABLE>
<CAPTION>
TAX-EQUIVALENT
YIELD (ASSUMES A
FEDERAL INCOME
PORTFOLIOS YIELD EFFECTIVE YIELD TAX RATE OF 28%)
- -------------------------------------- ---------- ------------------- --------------------
<S> <C> <C> <C>
Money Market
Institutional Shares 5.05% 5.18% 7.01%
Service Shares 4.75 4.86 6.60
Investor A Shares 4.67 4.78 6.49
Investor B Shares 3.98 4.06 5.53
Investor C Shares 3.98 4.06 5.53
U.S. Treasury Money Market
Institutional Shares 4.96% 5.08% 6.89%
Service Shares 4.66 4.77 6.47
Investor A Shares 4.49 4.59 6.24
Municipal Money Market
Institutional Shares 3.25% 3.30% 4.51%
Service Shares 2.95 2.99 4.10
Investor A Shares 2.78 2.82 3.86
Investor C Shares 2.19 2.21 3.04
New Jersey Municipal Money Market
Institutional Shares 3.02% 3.07% 4.19%
Service Shares 2.72 2.76 3.78
Investor A Shares 2.47 2.50 3.43
North Carolina Municipal Money Market
Institutional Shares 3.21% 3.26% 4.46%
Service Shares 2.91 2.95 4.04
Investor A Shares 2.74 2.78 3.81
Ohio Municipal Money Market
Institutional Shares 3.23% 3.28% 4.49%
Service Shares 2.93 2.97 4.07
Investor A Shares 2.75 2.79 3.82
Pennsylvania Municipal Money Market
Institutional Shares 3.24% 3.29% 4.50%
Service Shares 2.94 2.98 4.08
Investor A Shares 2.78 2.82 3.86
Virginia Municipal Money Market
Institutional Shares 3.15% 3.20% 4.38%
Service Shares 2.85 2.89 3.96
Investor A Shares 2.53 2.56 3.51
</TABLE>
The Investor B Class had not commenced operations as of September 30, 1997,
except with respect to the Money Market Portfolio. The Investor C Class had not
commenced operations as of September 30,1997, except with respect to the Money
Market Portfolio and the Municipal Money Market Portfolio.
The annualized yield information for each Money Market Portfolio for the
seven-day period ended September 30, 1997 after waivers was as follows:
-125-
<PAGE>
<TABLE>
<CAPTION>
TAX-EQUIVALENT
YIELD (ASSUMES A
FEDERAL INCOME
PORTFOLIOS YIELD EFFECTIVE YIELD TAX RATE OF 28%)
- -------------------------------------- ---------- ------------------- --------------------
<S> <C> <C> <C>
Money Market
Institutional Shares 5.38% 5.52% 7.47%
Service Shares 5.08 5.21 7.06
Investor A Shares 5.00 5.12 6.94
Investor B Shares 4.31 4.40 5.99
Investor C Shares 4.31 4.40 5.99
U.S. Treasury Money Market
Institutional Shares 5.34% 5.48% 7.42%
Service Shares 5.04 5.17 7.00
Investor A Shares 4.87 4.99 6.76
Municipal Money Market
Institutional Shares 3.66% 3.73% 5.08%
Service Shares 3.36 3.42 4.67
Investor A Shares 3.19 3.24 4.43
Investor C Shares 2.60 2.63 3.61
New Jersey Municipal Money Market
Institutional Shares 3.46% 3.52% 4.81%
Service Shares 3.16 3.21 4.39
Investor A Shares 2.91 2.95 4.04
North Carolina Municipal Money Market
Institutional Shares 3.66% 3.73% 5.08%
Service Shares 3.36 3.42 4.67
Investor A Shares 3.19 3.24 4.43
Ohio Municipal Money Market
Institutional Shares 3.65% 3.72% 5.07%
Service Shares 3.35 3.41 4.65
Investor A Shares 3.17 3.22 4.40
Pennsylvania Municipal Money Market
Institutional Shares 3.64% 3.71% 5.06%
Service Shares 3.34 3.40 4.64
Investor A Shares 3.18 3.23 4.42
Virginia Municipal Money Market
Institutional Shares 3.74% 3.81% 5.19%
Service Shares 3.44 3.50 4.78
Investor A Shares 3.12 3.17 4.33
</TABLE>
The Investor B Class had not commenced opera to recalculate tab set> tions
as of September 30, 1997, except with respect to the Money Market Portfolio. The
Investor C Class had not commenced operations as of September 30, 1997, except
with respect to the Money Market Portfolio and the Municipal Money Market
Portfolio.
The fees which may be imposed by institutions on their Customers are not
reflected in the calculations of yields for the Money Market Portfolios. Yields
on Institutional Shares will generally be higher than yields on Service Shares;
yields on Service Shares will generally be higher than yields on Investor A
Shares; and yields on Investor A Shares will generally be higher than yields on
Investor B Shares and Investor C Shares.
From time to time, in advertisements, sale literature, reports to
shareholders and other materials, the yields of a Money Market Portfolio's
Service, Investor A, Investor B, Investor C or Institutional Shares may be
quoted and compared to
-126-
<PAGE>
those of other mutual funds with similar investment objectives and relevant
securities indexes. For example, the yield of a Portfolio's Service, Investor A,
Investor B, Investor C or Institutional Shares may be compared to the Donoghue's
Money Fund Average, which is an average compiled by IBC/Donoghue's MONEY FUND
REPORT(R), a widely-recognized independent publication that monitors the
performance of money market funds, the average yields reported by the Bank Rate
Monitor from money market deposit accounts offered by the 50 leading banks and
thrift institutions in the top five standard metropolitan statistical areas, or
to the data prepared by Lipper Analytical Services, Inc., a widely-recognized
independent service that monitors the performance of mutual funds. Yield may
also be compared to yields set forth in the weekly statistical release H.15(519)
or the monthly statistical release designated G.13(415) published by the Board
of Governors of the Federal Reserve system. In addition, each Money Market
Portfolio may quote from time to time its total return in accordance with SEC
regulations.
TOTAL RETURN. For purposes of quoting and comparing the performance of
shares of the Non-Money Market 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. The total return for each class of a Non-
Money Market Portfolio will be calculated independently of the other classes
within that Portfolio. Under the rules of the SEC, funds advertising
performance must include total return quotes calculated according to the
following formula:
ERV to the power of 1/n
T = [(-----) - 1]
P
Where: T = average annual total return.
ERV = ending redeemable value at the end of the period
covered by the computation of a hypothetical $1,000
payment made at the beginning of the period.
P = hypothetical initial payment of $1,000.
n = period covered by the computation, expressed in terms
of years.
In calculating the ending redeemable value for Investor A Shares of the
Fund's Non-Money Market Portfolios, the maximum front-end sales charge is
deducted from the initial $1,000 payment and all dividends and distributions by
the particular Portfolio are assumed to have been reinvested at net asset value
as described in the particular Prospectus on the reinvestment dates during the
period. In calculating the ending redeemable value for Investor B Shares of the
Non-Money Market Portfolios,
-127-
<PAGE>
the maximum contingent deferred sales charge is deducted at the end of the
period and all dividends and distributions by the particular Portfolio are
assumed to have been reinvested at net asset value as described in the
particular Prospectus on the reinvestment dates during the period. In
calculating the ending redeemable value for Investor C Shares of the Fund's Non-
Money Market Portfolios, the maximum contingent deferred sales charge is
deducted at the end of the period, and all dividends and distributions by the
particular Portfolio are assumed to have been reinvested at net asset value as
described in the particular Prospectus on the reinvestment dates during the
period. 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.
Performance information presented for the following Non-Money Market
Portfolio includes performance information for a corresponding predecessor
portfolio which transferred its assets and liabilities to the related Non-Money
Market Portfolio pursuant to a reorganization consummated on January 13, 1996
(February 13, 1996 with respect to the International Bond Portfolio):
<TABLE>
<CAPTION>
COMMENCEMENT OF
NON-MONEY MARKET PREDECESSOR OPERATIONS OF
PORTFOLIO PORTFOLIO PREDECESSOR PORTFOLIO
- --------- --------- ---------------------
<S> <C> <C>
New Jersey Tax-Free Income Compass Capital Group July 1, 1991
Portfolio New Jersey Municipal
Bond Fund
International Bond Portfolio Compass Capital Group July 1, 1991
International Fixed Income
Fund
Core Bond Portfolio BFM Institutional Trust December 9, 1992
Core Fixed Income
Portfolio
Low Duration Bond Portfolio BFM Institutional Trust July 17, 1992
Short Duration Portfolio
</TABLE>
-128-
<PAGE>
Performance information presented for the following Non-Money Market
Portfolios includes performance information for a corresponding predecessor fund
which will transfer its assets and liabilities to the related Non-Money Market
Portfolio:
<TABLE>
<CAPTION>
COMMENCEMENT OF
NON-MONEY MARKET PREDECESSOR OPERATIONS OF
PORTFOLIO PORTFOLIO PREDECESSOR PORTFOLIO
- --------- --------- ---------------------
<S> <C> <C>
Delaware Tax-Free Income January __, 1990
Portfolio
Kentucky Tax Free Income October __, 1986
Portfolio
GNMA Portfolio January __, 1990
</TABLE>
Performance information presented for the Delaware Tax-Free Income
Portfolio, the Kentucky Tax-Free Income Portfolio and the GNMA Portfolio is
based upon the performance of _________, _________, and _______ respectively,
for periods prior to such transfer.
Each Non-Money Market Portfolio presents performance information for each
class thereof since the commencement of operations of that Portfolio (or the
related predecessor portfolio), rather than the date such class was introduced.
Performance information for each class introduced after the commencement of
operations of the related Portfolio (or predecessor portfolio) is therefore
based on the performance history of a predecessor class or predecessor classes.
If a class of shares in a Portfolio (the "Subsequent Class") has more than one
predecessor class, the performance data predating the introduction of the
Subsequent Class is based initially on the performance of the Portfolio's first
operational predecessor class (the "Initial Class"); thereafter, the performance
of the Subsequent Class is based upon the performance of any other predecessor
class or classes which were introduced after the Initial Class and which had
total operating expenses more similar to those of the Subsequent Class.
Performance information is restated to reflect the current maximum front-end
sales charge (in the case of Investor A Shares) or the maximum contingent
deferred sales charge (in the case of Investor B Shares) when presented
inclusive of sales charges. Additional performance information is presented
which does not reflect the deduction of sales charges. Historical expenses
reflected in performance information are based upon the distribution,
shareholder servicing and processing fees and other expenses actually incurred
during the
-129-
<PAGE>
periods presented and have not been restated, in cases in which the performance
information for a particular class includes the performance history of a
predecessor class or predecessor classes, to reflect the ongoing expenses
currently borne by the particular class.
Based on the foregoing, the average annual total returns for each Non-Money
Market Portfolio for periods ended September 30, 1997 were as follows*:
-130-
<PAGE>
INVESTOR A SHARES
-----------------
<TABLE>
<CAPTION>
INVESTOR A SHARES
TOTAL RETURN (NAV) TOTAL RETURN (LOAD ADJUSTED)
FUND CLASS SINCE FUND SINCE FUND
INCEPTION INTRO 3 YEAR 5 YEAR INCEPTION 3 YEAR 5 YEAR INCEPTION
DATE DATE 1 YEAR ANN. ANN. ANN. 1 YEAR ANN. ANN. ANN.
----------- -------- ------ ------ ------ ---------- ------ ------ ------ ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Large Cap Value Equity 04/20/92 05/02/92 37.01 27.40 21.11 18.95 30.88 25.45 20.00 17.96
Large Cap Growth Equity 11/01/89 03/14/92 33.18 26.71 17.07 13.70 27.22 24.70 15.99 13.04
Mid Cap Value Equity 12/27/96 12/27/96 N/A N/A N/A 39.03 N/A N/A N/A 30.89
Mid Cap Growth Equity 12/27/96 12/27/96 N/A N/A N/A 29.02 N/A N/A N/A 21.46
Small Cap Value Equity 04/13/92 06/02/92 46.85 24.39 21.57 19.87 40.26 22.49 20.46 18.86
Small Cap Growth Equity 09/14/93 09/15/93 15.28 35.19 N/A 25.42 10.11 33.12 (0.92) 24.00
International Equity 04/27/92 06/02/92 14.36 7.88 12.06 10.92 8.67 6.02 10.91 9.88
International Small Cap Equity 09/26/97 09/28/97 N/A N/A N/A (19.71) N/A N/A N/A (98.16)
International Emerging Markets 06/17/94 06/17/94 10.51 (2.04) N/A (0.28) 4.97 (3.70) N/A (1.83)
Select Equity 09/13/93 10/13/93 41.85 27.78 N/A 20.25 35.55 25.84 N/A 18.89
Index Equity 04/20/92 08/02/92 39.49 28.93 19.84 18.40 35.31 27.63 19.11 17.74
Balanced 05/14/90 05/14/90 27.93 20.45 14.42 13.73 22.19 18.63 13.38 13.03
Low Duration Bond 07/17/92 01/18/96 6.39 6.48 5.35 5.30 3.20 5.41 4.72 4.68
Intermediate Government Bond 04/20/92 05/11/92 7.87 7.28 4.97 5.89 3.30 5.83 4.12 5.10
Intermediate Bond 09/17/93 05/20/94 7.89 7.64 N/A 4.62 3.56 6.18 N/A 3.57
Core Bond 12/09/92 01/31/96 9.52 9.12 N/A 7.08 5.14 7.65 (0.81) 6.18
Government Income 10/03/94 10/04/94 10.48 N/A N/A 9.66 5.52 N/A N/A 7.99
Managed Income 11/01/89 02/05/92 9.74 8.71 6.30 7.76 4.76 7.06 5.33 7.14
International Bond 07/01/91 04/22/96 11.02 12.77 9.44 9.59 5.47 10.86 8.33 8.70
GNMA [01/__/90] [ ]* [ ] [ ] [ ] [ ] [ ] [ ] [ ] [ ]
----------- -------- ------ ------ ------ ---------- ------ ------ ------ --------
Tax-Free Income 03/14/90 05/14/90 9.58 9.16 7.18 8.02 5.21 7.68 6.31 7.42
Pennsylvania Tax-Free Income 12/01/92 12/01/92 7.95 8.01 N/A 8.89 7.95 8.01 N/A 6.60
New Jersey Tax-Free Income 07/01/91 01/25/96 7.94 7.36 6.32 7.34 3.62 5.91 5.45 6.64
Ohio Tax-Free Income 12/01/92 12/01/92 8.03 8.04 N/A 5.98 3.74 6.57 N/A 5.08
Delaware Tax-Free Income [01/__/90] [ ]* [ ] [ ] [ ] [ ] [ ] [ ] [ ] [ ]
----------- --------- ------ ------ ------ ---------- ------ ------ ------ --------
Kentucky Tax-Free Income [10/__/86] [ ]* [ ] [ ] [ ] [ ] [ ] [ ] [ ] [ ]
----------- --------- ------ ------ ------ ---------- ------ ------ ------ --------
</TABLE>
_____________________________
* Operations not yet commenced.
-131-
<PAGE>
Investor B Shares
-----------------
<TABLE>
<CAPTION>
INVESTOR B SHARES
TOTAL RETURN (NAV) TOTAL RETURN (LOAD ADJUSTED)
FUND CLASS SINCE FUND SINCE FUND
INCEPTION INTRO 3 YEAR 5 YEAR INCEPTION 3 YEAR 5 YEAR INCEPTIO
DATE DATE 1 YEAR ANN. ANN. ANN. 1 YEAR ANN. ANN. ANN.
---- ---- ------ --- --- --- ------ --- --- ---
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Large Cap Value Equity 04/20/92 01/16/96 36.00 26.89 20.82 18.69 29.88 25.39 20.33 18.25
Large Cap Growth Equity 11/01/89 01/24/96 32.18 26.13 16.74 13.51 26.23 24.65 16.27 13.51
Mid Cap Value Equity 12/27/96 12/27/96 N/A N/A N/A 38.84 N/A N/A N/A 30.43
Mid Cap Growth Equity 12/27/96 12/27/96 N/A N/A N/A 26.60 N/A N/A N/A 21.12
Small Cap Value Equity 04/13/92 10/03/94 45.67 23.57 21.09 19.44 39.14 22.11 20.61 19.00
Small Cap Growth Equity 09/14/93 01/18/96 14.47 34.54 N/A 24.98 9.32 32.95 (0.40) 24.04
International Equity 04/27/92 10/03/94 13.63 7.16 11.62 10.52 8.50 5.89 11.17 10.11
International Small Cap 09/26/97 09/26/97 N/A N/A N/A (19.71) N/A N/A N/A (98.16)
Equity
International Emerging 06/17/94 04/25/96 9.78 (2.34) N/A (0.56) 4.84 (3.66) (0.40) (1.83)
Markets
Select Equity 09/13/93 03/27/96 40.70 27.28 N/A 19.90 34.37 25.77 (0.40) 19.00
Index Equity 04/20/92 02/07/96 38.31 28.43 19.56 18.14 32.09 26.91 19.07 17.71
Balanced 05/14/90 10/04/94 26.95 19.60 13.93 13.42 21.21 18.19 13.47 13.42
Low Duration Bond 07/17/92 11/18/96 5.73 6.26 5.22 6.17 0.97 5.01 4.80 4.76
Intermediate Government 04/20/92 10/11/96 6.80 7.02 4.82 5.76 1.99 5.76 4.40 5.36
Bond
Intermediate Bond 09/17/93 10/01/97 7.89 7.64 N/A 4.62 3.03 6.37 (0.40) 3.71
Core Bond 12/09/92 03/18/96 8.71 8.72 N/A 6.83 3.82 7.43 (0.40) 6.16
Government Income 10/03/94 10/03/94 9.66 N/A N/A 8.90 4.73 N/A N/A 7.43
Managed Income 11/01/89 07/15/97 9.67 8.69 6.30 7.76 4.73 7.40 5.87 7.76
International Bond 07/01/91 04/19/96 10.11 12.35 9.19 9.39 5.16 11.02 8.75 9.22
GNMA [01/__/90] [ ]* [ ] [ ] [ ] [ ] [ ] [ ] [ ] [ ]
Tax-Free Income 05/14/90 07/18/96 8.77 8.83 6.97 7.88 3.88 7.55 6.54 7.88
Pennsylvania Tax-Free 12/01/92 10/03/94 7.12 7.22 N/A 6.14 2.30 5.95 (0.40) 5.48
Income
New Jersey Tax-Free Income 07/01/91 07/02/96 7.14 7.02 6.12 7.18 2.32 5.76 5.69 7.01
Ohio Tax-Free Income 12/01/92 10/13/94 7.23 7.20 N/A 5.47 2.40 5.94 (0.40) 4.81
Delaware Tax-Free Income [01/__/90] [ ]* [ ] [ ] [ ] [ ] [ ] [ ] [ ] [ ]
Kentucky Tax-Free Income [10/__/86] [ ]* [ ] [ ] [ ] [ ] [ ] [ ] [ ] [ ]
</TABLE>
_______________________
* Operations not yet commenced.
-132-
<PAGE>
INVESTOR C SHARES
-----------------
<TABLE>
<CAPTION>
INVESTOR C SHARES
TOTAL RETURN (NAV) TOTAL RETURN (LOAD ADJUSTED)
FUND CLASS SINCE FUND SINCE FUND
INCEPTION INTRO 3 YEAR 5 YEAR INCEPTION 3 YEAR 5 YEAR INCEPTION
DATE DATE 1 YEAR ANN. ANN. ANN. 1 YEAR ANN. ANN. ANN.
---- ---- ------ --- --- --- ------ --- --- ---
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Large Cap Value Equity 04/20/82 08/16/96 36.00 26.89 20.82 18.69 34.64 N/A N/A N/A
Large Cap Growth Equity 11/01/89 01/24/97 32.18 26.13 16.74 13.51 30.86 N/A N/A N/A
Mid Cap Value Equity 12/27/96 12/27/96 N/A N/A N/A 38.64 (1.00) N/A N/A 35.64
Mid Cap Growth Equity 12/27/96 12/27/96 N/A N/A N/A 28.60 (1.00) N/A N/A 26.93
Small Cap Value Equity 04/13/92 10/01/96 45.67 23.57 21.09 19.44 44.21 N/A N/A N/A
Small Cap Growth Equity 09/14/93 09/06/96 14.47 34.54 N/A 24.98 13.33 N/A N/A N/A
International Equity 04/27/92 12/05/96 13.63 7.16 11.62 10.52 12.49 N/A N/A N/A
International Small Cap 09/26/97 09/26/97 N/A N/A N/A (19.71) (1.00) N/A N/A (61.55)
Equity
International Emerging 06/17/94 03/21/97 9.78 (2.34) N/A (0.56) 8.68 N/A N/A N/A
Markets
Select Equity 09/13/93 09/27/96 40.70 27.28 N/A 19.90 39.29 N/A N/A N/A
Index Equity 04/20/92 08/14/96 38.31 28.43 19.56 18.14 36.93 N/A N/A N/A
Balanced 05/14/90 12/20/96 26.95 19.60 13.93 13.42 25.68 N/A N/A N/A
Low Duration Bond 07/17/92 06/03/97 5.73 6.26 5.22 5.17 4.67 N/A N/A N/A
Intermediate Government 04/20/92 10/08/96 6.80 7.02 4.82 5.75 21.35 N/A N/A N/A
Bond
Intermediate Bond 09/17/93 N/A N/A N/A N/A N/A N/A N/A N/A N/A
Core Bond 12/09/92 05/01/97 8.71 8.72 N/A 8.83 7.62 N/A N/A N/A
Government Income 10/03/94 02/28/97 9.66 N/A N/A 8.90 8.56 N/A N/A N/A
Managed Income 11/01/89 N/A N/A N/A N/A N/A N/A N/A N/A N/A
International Bond 07/01/91 09/11/96 10.11 12.35 9.19 9.39 9.01 N/A N/A N/A
GNMA [01/__/90] [ ]* [ ] [ ] [ ] [ ] [ ] [ ] [ ] [ ]
Tax-Free Income 05/14/90 02/28/97 8.77 8.83 6.97 7.88 7.68 N/A N/A N/A
Pennsylvania Tax-Free 12/01/92 N/A N/A N/A N/A N/A N/A N/A N/A N/A
Income
New Jersey Tax-Free Income 07/01/91 N/A N/A N/A N/A N/A N/A N/A N/A N/A
Ohio Tax-Free Income 12/01/92 N/A N/A N/A N/A N/A N/A N/A N/A N/A
Delaware Tax-Free Income [01/__/90] [ ]* [ ] [ ] [ ] [ ] [ ] [ ] [ ] [ ]
Kentucky Tax-Free Income [10/__/86] [ ]* [ ] [ ] [ ] [ ] [ ] [ ] [ ] [ ]
</TABLE>
________________________
* Operations not yet commenced.
-133-
<PAGE>
SERVICE SHARES
--------------
<TABLE>
<CAPTION>
SERVICE SHARES
TOTAL RETURN (NAV)
FUND INCEPTION CLASS INTRO SINCE FUND
DATE DATE 1 YEAR 3 YEAR ANN. 5 YEAR ANN. INCEPTION ANN.
----------------- ------------- ------------- -------------- ------------ ----------------
<S> <C> <C> <C> <C> <C> <C>
Large Cap Value Equity 04/20/92 07/29/93 37.22 27.58 21.24 19.07
Large Cap Growth Equity 11/01/89 07/29/93 33.38 26.89 17.23 13.81
Mid Cap Value Equity 12/27/96 12/27/96 N/A N/A N/A 39.46
Mid Cap Growth Equity 12/27/96 12/27/96 N/A N/A N/A 29.44
Small Cap Value Equity 04/13/92 07/29/93 46.95 24.58 21.71 19.99
Small Cap Growth Equity 09/14/93 09/15/93 15.54 35.43 N/A 25.66
International Equity 04/27/92 07/29/93 14.52 8.03 12.19 11.03
International Small Cap Equity 09/26/97 09/26/97 N/A N/A N/A (19.71)
International Emerging Markets 06/17/94 06/17/94 10.74 (1.85) N/A (0.07)
Select Equity 09/13/93 09/15/93 42.12 27.96 N/A 20.43
Index Equity 04/20/92 07/29/93 39.58 29.08 19.96 18.51
Balanced 05/14/90 07/29/93 28.07 20.57 14.52 13.80
Low Duration Bond 07/17/92 01/12/96 6.57 6.59 5.35 5.35
Intermediate Government Bond 04/20/92 07/29/93 7.75 7.39 5.05 5.96
Intermediate Bond 09/17/93 09/23/93 8.07 7.75 N/A 4.72
Core Bond 12/09/92 01/12/96 9.71 9.24 N/A 7.15
Managed Income 11/01/89 07/29/93 9.93 8.92 6.48 7.87
International Bond 07/01/91 07/01/91 11.23 12.87 9.50 9.64
GNMA [01/__/90] [ ]* [ ] [ ] [ ] [ ]
- ---- ---------- ---------- ---------- ---------- ---------- ----------
Tax-Free Income 05/14/90 07/29/93 9.77 9.37 7.35 8.14
- ----
Pennsylvania Tax-Free Income 12/01/92 07/29/93 8.10 8.18 N/A 6.69
New Jersey Tax-Free Income 07/01/91 07/01/91 8.11 7.47 6.39 7.39
Ohio Tax-Free Income 12/01/92 07/29/93 8.53 8.45 N/A 5.98
Delaware Tax-Free Income [01/__/90] [ ]* [ ] [ ] [ ] [ ]
- ------------------------ ---------- ---------- ---------- ---------- ---------- ----------
Kentucky Tax-Free Income [10/__/86] [ ]* [ ] [ ] [ ] [ ]
- ------------------------ ---------- ---------- ---------- ---------- ---------- ----------
</TABLE>
________________________
* Operations not yet commenced.
- --------------------------------
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<PAGE>
INSTITUTIONAL SHARES
--------------------
<TABLE>
<CAPTION>
INSTITUTIONAL SHARES
TOTAL RETURN (NAV)
FUND INCEPTION CLASS INTRO SINCE FUND
DATE DATE 1 YEAR 3 YEAR ANN. 5 YEAR ANN. INCEPTION ANN.
----------------- ------------- ------------- -------------- ------------ ----------------
<S> <C> <C> <C> <C> <C> <C>
Large Cap Value Equity 04/20/92 04/20/92 37.66 27.94 21.51 19.32
Large Cap Growth Equity 11/01/89 11/01/89 33.69 27.25 17.47 13.96
Mid Cap Value Equity 12/27/96 12/27/96 N/A N/A N/A 39.89
Mid Cap Growth Equity 12/27/96 12/27/96 N/A N/A N/A 29.85
Small Cap Value Equity 04/13/92 10/01/96 47.36 24.91 21.98 20.24
Small Cap Growth Equity 09/14/93 09/06/96 15.89 35.91 N/A 26.06
International Equity 04/27/92 04/27/92 14.88 8.34 12.45 11.28
International Small Cap Equity 09/26/97 09/26/97 N/A N/A N/A (19.71)
International Emerging Markets 06/17/94 06/17/94 11.16 (1.54) N/A 0.24
Select Equity 09/13/93 09/13/93 42.50 28.33 N/A 20.74
Index Equity 04/20/92 04/20/92 39.98 29.44 20.23 18.76
Balanced 05/14/90 05/01/92 28.43 20.92 14.80 13.99
Low Duration Bond 07/17/92 07/17/92 6.89 6.78 5.54 5.47
Intermediate Government Bond 04/20/92 04/20/92 8.08 7.70 5.29 6.18
Intermediate Bond 09/17/93 09/17/93 8.40 8.06 N/A 5.02
Core Bond 12/09/92 12/09/92 10.03 9.40 N/A 7.25
Managed Income 11/01/89 11/01/89 10.25 9.22 6.72 8.03
International Bond 07/01/91 06/07/96 7.64 13.02 9.59 9.71
GNMA [01/__/90] [ ]* [ ] [ ] [ ] [ ]
- ---- ---------- ---------- ---------- ---------- ---------- ----------
Tax-Free Income 05/14/90 01/21/93 10.09 9.68 7.60 8.31
- ---- ---------- ---------- ---------- ---------- ---------- ----------
Pennsylvania Tax-Free Income 12/01/92 12/01/92 8.43 8.50 N/A 6.91
New Jersey Tax-Free Income 07/01/91 10/01/97 8.11 7.47 6.39 7.39
Ohio Tax-Free Income 12/01/92 12/01/92 8.53 8.45 N/A 6.22
Delaware Tax-Free Income [01/__/90] [ ]* [ ] [ ] [ ] [ ]
- ------------------------ ---------- ---------- ---------- ---------- ---------- ----------
Kentucky Tax-Free Income [10/__/86] [ ]* [ ] [ ] [ ] [ ]
- ------------------------- ---------- ---------- ---------- ---------- ---------- ----------
</TABLE>
________________________
* Operations not yet commenced.
- --------------------------------
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<PAGE>
/*/Notes
-----
Performance information presented for Investor A, Investor B, Investor
C and Service Shares of a Portfolio prior to their introduction dates
does not reflect shareholder servicing and processing and/or
distribution fees and certain other expenses borne by these share
classes which, if reflected, would reduce the performance quoted.
Performance information presented assumes the reinvestment of
dividends and distributions. Performance information presented for
Investor A, Investor B, Investor C and Service Shares of a Portfolio
prior to their introduction as indicated in the table above is based
upon historical expenses of the predecessor class or classes which do
not reflect the actual expenses that an investor would incur as a
holder of shares of these classes of the Portfolios. The ongoing fees
and expenses borne by Investor B Shares and Investor C Shares are
greater than those borne by Investor A Shares; the ongoing fees and
expenses borne by a Portfolio's Investor A, Investor B and Investor C
Shares are greater than those borne by the Portfolio's Service Shares;
the ongoing fees and expenses borne by a Portfolio's Investor A,
Investor B, Investor C and Service Shares are greater than those borne
by the Portfolio's Institutional Shares; and the ongoing fees and
expenses borne by a Portfolio's Investor A, Investor B, Investor C,
Service and Institutional Shares are greater than those borne by the
Portfolio's BlackRock Shares. Performance information presented for
Institutional Shares of the Balanced, Tax-Free Income, New Jersey Tax-
Free Income and International Bond Portfolios prior to their
introduction dates is based upon historical expenses of predecessor
classes which are higher than the actual expenses that an investor
would incur as a holder of Institutional Shares of the above-mentioned
Portfolios. Accordingly, the performance information may be used in
assessing each Portfolio's performance history but does not reflect
how the distinct classes would have performed on a relative basis
prior to the introduction of these classes, which would require an
adjustment to the ongoing expenses.
For each of the Delaware Tax-Free Income Portfolio, the Kentucky Tax-
Free Income Portfolio and the GNMA Portfolio, performance presented in
the tables above and in each table that follows is based upon the
performance of the respective predecessor fund, adjusted for each
class to reflect historical expenses at levels indicated (absent
waivers and reimbursements) in the section entitled "What Are The
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<PAGE>
Expenses Of The Portfolios" for that class of that Portfolio as
disclosed in its prospectus.
The original class or classes of shares of each Portfolio were as
follows: Balanced - Investor A Shares; Index Equity - Institutional
Shares; Select Equity - Institutional Shares; Large Cap Growth Equity
- Institutional Shares; Large Cap Value Equity -Institutional Shares;
Small Cap Value Equity -Institutional Shares; Small Cap Growth Equity
-Institutional Shares; International Equity -Institutional Shares;
International Emerging Markets -Investor A, Institutional and Service
Shares; Low Duration Bond - Institutional Shares; Intermediate
Government Bond - Institutional Shares; Intermediate Bond -
Institutional Shares; Core Bond - Institutional Shares; Managed Income
- Institutional Shares; Tax-Free Income - Investor A Shares; New
Jersey Tax-Free Income - Service Shares; Pennsylvania Tax-Free Income
-Investor A and Institutional Shares; Ohio Tax-Free Income - Investor
A and Institutional Shares; Government Income - Investor A Shares;
International Bond - Service Shares; Mid-Cap Growth Equity - Investor
A, Investor B, Investor C, Institutional and Service Shares; Mid-Cap
Value Equity - Investor A, Investor B, Investor C, Institutional and
Service Shares; and International Small Cap Equity - Investor A,
Investor B, Investor C, Institutional and Service Shares.
The performance quoted, except with respect to performance shown for
the GNMA Portfolio, the Delaware Tax-Free Income Portfolio and the
Kentucky Tax-Free Income Portfolio, reflects fee waivers that
subsidize and reduce the total operating expenses of each Portfolio.
The Portfolios' returns would have been lower if there were not such
waivers. BlackRock, Inc. and the Portfolio's Administrators are under
no obligation to waive or continue waiving their fees, but have
informed the Fund that they expect to waive fees as necessary to
maintain each Portfolio's total operating expenses during the
remainder of the current fiscal year at the levels set forth in the
applicable Prospectus.
Each class of the Non-Money Market Portfolios 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
each class of a Non-Money Market Portfolio's shares with other performance
measures. For example, in comparing the total return of a Non-Money Market
Portfolio's shares with data published by Lipper Analytical Services, Inc., CDA
Investment Technologies,
-137-
<PAGE>
Inc. or Weisenberger Investment Company Service, or with the performance of the
Standard & Poor's 500 Stock Index, EAFE, the Dow Jones Industrial Average or the
Shearson Lehman Hutton Government Corporate Bond Index, as appropriate, a Non-
Money Market Portfolio may calculate the aggregate total return for its shares
of a certain class for the period of time specified in the advertisement or
communication by assuming the investment of $10,000 in such Non-Money Market
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. A Non-Money
Market Portfolio may not, for these purposes, deduct from the initial value
invested or the ending value any amount representing front-end and deferred
sales charges charged to purchasers of Investor A, Investor B or Investor C
Shares. The Investor A, Investor B and Investor C classes of the Portfolio will,
however, disclose, if appropriate, the maximum applicable sales charges and will
also disclose that the performance data does not reflect sales charges and that
inclusion of sales charges would reduce the performance quoted.
In addition to average annual total returns, a Non-Money Market 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 and may be quoted with or without taking sales charges into
account. Excluding the sales charge from a total return calculation produces a
higher total return figure. Total returns, yields, and other performance
information may be quoted numerically or in a table, graph or similar
illustration.
NON-MONEY MARKET PORTFOLIO YIELD. The Balanced, Managed Income, Tax-Free
Income, Intermediate Government Bond, Ohio Tax-Free Income, Pennsylvania Tax-
Free Income, New Jersey Tax-Free Income, Delaware Tax-Free Income, Kentucky Tax-
Free Income, Low Duration Bond, Intermediate Bond, Government Income, Core Bond,
International Bond and GNMA Portfolios may advertise the yields on their
Service, Investor A, Investor B, Investor C, Institutional and BlackRock Shares.
Under the rules of the SEC, each such Portfolio advertising the respective
yields for its Service, Investor A, Investor B, Investor C, Institutional and
BlackRock Shares must calculate yield using the following formula:
-138-
<PAGE>
a-b
YIELD = 2[(----- +1)to the power of 6 - 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 a 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. However,
interest earned on tax-exempt obligations that are issued without original issue
discount and have a current market discount is calculated by using the coupon
rate of interest instead of the yield to maturity. In the case of tax-exempt
obligations that are issued with original issue discount but which have
discounts based on current market value that exceed the then-remaining portion
of the original issue discount (market discount), the yield to maturity is the
imputed rate based on the original issue discount calculation. On the other
hand, in the case of tax-exempt obligations that are issued with original issue
discount but which have discounts based on current market value that are less
than the then-remaining
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<PAGE>
portion of the original issue discount (market premium), the yield to maturity
is based on the market value.
With respect to mortgage or other receivables-backed obligations which are
expected to be subject to monthly payments of principal and interest ("pay
downs"), (a) gain or loss attributable to actual monthly pay downs are accounted
for as an increase or decrease to interest income during the period; and (b) a
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. In the case of Investor A Shares of a Non-Money
Market Portfolio, a Portfolio's maximum offering price per share for purposes of
the formula includes the maximum front-end sales charge imposed by the Portfolio
- -- currently as much as 5.00% of the per share offering price.
Each of the Tax-Free Income, Ohio Tax-Free Income, New Jersey Tax-Free
Income, Pennsylvania Tax-Free Income, Delaware Tax-Free Income and Kentucky Tax-
Free Income Portfolios may advertise the tax-equivalent yield for shares of a
specified class. Under the rules of the SEC, a Portfolio advertising its tax-
equivalent yield must calculate such tax-equivalent yield by dividing that
portion of the yield of the Portfolio which is tax-exempt by one minus a stated
income tax rate and adding the product to that portion, if any, of the yield of
the Portfolio which is not tax-exempt.
The annualized yield information for the 30-day period ended September 30,
1997 for the Portfolios referenced below was as follows:
<TABLE>
<CAPTION>
AFTER WAIVERS BEFORE WAIVERS
--------------------------- ---------------------------
TAX-EQUIVALENT TAX-EQUIVALENT
YIELD (ASSUMES A YIELD (ASSUMES A
FEDERAL INCOME FEDERAL INCOME
PORTFOLIO YIELD TAX RATE OF 28%) YIELD TAX RATE OF 28%)
- --------- --------- ----------------- ----- -----------------
<S> <C> <C> <C> <C>
Low Duration Bond
Institutional Shares 5.84% 8.11% 5.51% 7.65%
Service Shares 5.53 7.68 5.20 7.22
Investor A Shares 5.36 7.44 5.03 6.99
Investor B Shares 4.60 6.39 4.27 5.93
</TABLE>
-140-
<PAGE>
<TABLE>
<CAPTION>
AFTER WAIVERS BEFORE WAIVERS
--------------------------- ---------------------------
TAX-EQUIVALENT TAX-EQUIVALENT
YIELD (ASSUMES A YIELD (ASSUMES A
FEDERAL INCOME FEDERAL INCOME
PORTFOLIO YIELD TAX RATE OF 28%) YIELD TAX RATE OF 28%)
- --------- --------- ----------------- ----- -----------------
<S> <C> <C> <C> <C>
Investor C Shares 4.60 6.39 4.27 5.93
BlackRock Shares 5.99 8.32 5.66 7.86
Intermediate Government Bond
Institutional Shares 5.96% 8.28% 5.65% 7.85%
Service Shares 5.66 7.86 5.35 7.43
Investor A Shares 5.49 7.63 5.18 7.19
Investor B Shares 4.73 6.57 4.42 6.14
Investor C Shares 4.73 6.57 4.42 6.14
Intermediate Bond
Institutional Shares 6.28% 8.72% 5.99% 8.32%
Service Shares 5.98 8.31 5.69 7.90
Investor A Shares 5.81 8.07 5.52 7.67
Core Bond
Institutional Shares 6.32% 8.78% 6.03% 8.38%
Service Shares 6.01 8.35 5.72 7.94
Investor A Shares 5.84 8.11 5.55 7.71
Investor B Shares 5.09 7.07 4.80 6.67
Investor C Shares 5.09 7.07 4.80 6.67
BlackRock Shares 6.47 8.99 6.18 8.58
Government Income
Investor A Shares 6.83% 9.49% 6.11% 8.49%
Investor B Shares 6.08 8.44 5.36 7.44
Investor C Shares 6.08 8.44 5.36 7.44
Managed Income
Institutional Shares 6.78% 9.42% 6.53% 9.07%
Service Shares 6.48 9.00 6.23 8.65
Investor A Shares 6.31 8.76 6.06 8.42
Investor B Shares 5.55 7.71 5.30 7.36
International Bond
Institutional Shares 5.29% 7.35% 5.19% 7.21%
Service Shares 4.99 6.93 4.89 6.79
Investor A Shares 4.82 6.69 4.72 6.56
Investor B Shares 4.07 5.65 3.97 5.51
Investor C Shares 4.07 5.65 3.97 5.51
GNMA
Institutional Shares [__] [__] [__] [__]
Service Shares [__] [__] [__] [__]
Investor A Shares [__] [__] [__] [__]
Investor B Shares [__] [__] [__] [__]
Investor C Shares [__] [__] [__] [__]
Tax-Free Income
Institutional Shares 5.00% 6.94% 4.65% 6.46%
Service Shares 4.70 6.53 4.35 6.04
Investor A Shares 4.53 6.29 4.18 5.81
Investor B Shares 3.77 5.24 3.42 4.75
Investor C Shares 3.77 5.24 3.42 4.75
Pennsylvania Tax-Free Income
Institutional Shares 5.07% 7.04% 4.76% 6.61%
Service Shares 4.77 6.63 4.46 6.19
Investor A Shares 4.63 6.43 4.32 6.00
Investor B Shares 3.84 5.33 3.53 4.90
New Jersey Tax-Free Income
Service Shares 4.64% 6.44% 4.32% 6.00%
Investor A Shares 4.47 6.21 4.15 5.76
Investor B Shares 3.71 5.15 3.39 4.71
Ohio Tax-Free Income
Institutional Shares 4.84% 6.72% 4.33% 6.01%
Service Shares 4.54 6.31 4.03 5.60
Investor A Shares 4.37 6.07 3.86 5.36
</TABLE>
-141-
<PAGE>
<TABLE>
<CAPTION>
AFTER WAIVERS BEFORE WAIVERS
--------------------------- ---------------------------
TAX-EQUIVALENT TAX-EQUIVALENT
YIELD (ASSUMES A YIELD (ASSUMES A
FEDERAL INCOME FEDERAL INCOME
PORTFOLIO YIELD TAX RATE OF 28%) YIELD TAX RATE OF 28%)
- --------- --------- ----------------- ----- -----------------
<S> <C> <C> <C> <C>
Investor B Shares 3.61 5.01 3.10 4.31
Delaware Tax-Free Income
Institutional Shares [__] [__] [__] [__]
Service Shares [__] [__] [__] [__]
Investor A Shares [__] [__] [__] [__]
Investor B Shares [__] [__] [__] [__]
Investor C Shares [__] [__] [__] [__]
Kentucky Tax-Free Income
Institutional Shares [__] [__] [__] [__]
Service Shares [__] [__] [__] [__]
Investor A Shares [__] [__] [__] [__]
Investor B Shares [__] [__] [__] [__]
Investor C Shares [__] [__] [__] [__]
</TABLE>
OTHER INFORMATION REGARDING INVESTMENT RETURNS. In addition to providing
performance information that demonstrates the total return or yield of shares of
a particular class 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 dividends in a dividend reinvestment plan or the impact
of tax-free investing. The Fund may demonstrate, using certain specified
hypothetical data, the compounding effect of dividend reinvestment on
investments in a Non-Money Market Portfolio.
The Money and Non-Money Market Municipal Portfolios may illustrate in
advertising, sales literature, communications to shareholders and other
materials the benefits of tax-free investing. For example, Table 1 shows
taxpayers how to translate Federal tax savings from investments the income on
which is not subject to Federal income tax into an equivalent yield from a
taxable investment. Similarly, Tables 2, 3, 4, 5, 6, 7 and 8 show Pennsylvania,
Ohio, North Carolina, Virginia, New Jersey, Delaware and Kentucky shareholders
the approximate yield that a taxable investment must earn at various income
brackets to produce after-tax yields equivalent to those of the Pennsylvania
Municipal Money Market and Pennsylvania Tax-Free Income Portfolios, the Ohio
Municipal Money Market and Ohio Tax-Free Income Portfolios, the North Carolina
Municipal Money Market Portfolio, the Virginia Municipal Money Market Portfolio,
and the New Jersey Municipal Money Market and New Jersey Tax-Free Income
Portfolios, the Delaware Tax-Free Income Portfolio and the Kentucky Tax-Free
Income Portfolio, respectively. The yields below are for illustration purposes
only and are not intended to represent current or future yields for the Money
and Non-Money Market Municipal Portfolios, which may be higher or lower than the
yields shown. The following information regarding tax rates and tax-exempt
yields is as of January 1, 1998.
-142-
<PAGE>
TABLE 1 - FEDERAL ONLY
- ------- ------------
<TABLE>
<CAPTION>
Federal TAX-EXEMPT YIELD
1998 Taxable Marginal
Income Bracket Tax Rate/*/ 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0%
- --------------------------------------------------------------------------------------------------------------
Single Return Joint Return
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 0 - $25,350 $ 0 - $42,350 15.0% 3.529% 4.118% 4.706% 5.294% 5.882% 6.471% 7.059%
$25,351 - $61,400 $42,351 -$102,300 28.0% 4.167% 4.861% 5.556% 6.250% 6.944% 7.639% 8.333%
$61,401 -$128,100 $102,301-$155,950 31.0% 4.348% 5.072% 5.797% 6.522% 7.246% 7.971% 8.696%
$128,101-$278,450 $155,951-$278,450 36.0% 4.688% 5.469% 6.250% 7.031% 7.812% 8.594% 9.375%
Over $278,450 Over $278,450 39.6% 4.967% 5.795% 6.623% 7.450% 8.278% 9.106% 9.934%
</TABLE>
/*/Rates do not include the phase out of personal exemptions or itemized
deductions. It is assumed that the investor is not subject to the alternative
minimum tax. Where applicable, investors should consider that the benefit of
certain itemized deductions and the benefit of personal exemptions are limited
in the case of higher income individuals. For 1998, taxpayers with adjusted
gross income in excess of a threshold amount of approximately $124,500 are
subject to an overall limitation on certain itemized deductions, requiring a
reduction in such deductions equal to the lesser of (i) 3% of adjusted gross
income in excess of the threshold of approximately $124,500 or (ii) 80% of the
amount of such itemized deductions otherwise allowable. The benefit of each
personal exemption is phased out at the rate of two percentage points for each
$2,700 (or fraction thereof) of adjusted gross income in the phase-out zone.
For single taxpayers the range of adjusted gross income comprising the phase-out
zone for 1998 is estimated to be from $124,500 to $247,000 and for married
taxpayers filing a joint return from $186,800 to $309,300. The Federal tax
brackets, the threshold amounts at which itemized deductions are subject to
reduction, and the range over which personal exemptions are phased out will be
further adjusted for inflation for each year after 1998.
-143-
<PAGE>
TABLE 2 - FEDERAL AND PENNSYLVANIA
- ------- ------------------------
<TABLE>
<CAPTION>
Approx.
Combined
Federal
and PA TAX-EXEMPT YIELD
1998 Federal Marginal
Taxable Income Bracket * Tax Rate * 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0%
- --------------------------------------------------------------------------------------------------------------------
Single Return Joint Return
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 0 - $ 25,350 $ 0 - $42,350 17.380% 3.631% 4.236% 4.841% 5.447% 6.052% 6.657% 7.262%
$25,351 - $ 61,400 $ 42,351 -$102,300 30.016% 4.287% 5.001% 5.716% 6.430% 7.144% 7.859% 8.573%
$61,401 - $128,100 $102,301 -$155,950 32.932% 4.473% 5.219% 5.964% 6.710% 7.455% 8.201% 8.946%
$128,101- $278,450 $155,951 -$278,450 37.792% 4.823% 5.626% 6.430% 7.234% 8.038% 8.841% 9.645%
Over $278,450 Over $278,450 41.291% 5.110% 5.962% 6.813% 7.665% 8.517% 9.368% 10.220%
</TABLE>
/*/The income amount shown is income subject to Federal income tax reduced by
adjustments to income, exemptions, and itemized deductions (including the
deduction for state income taxes). If the standard deduction is taken for
Federal income tax purposes, the taxable equivalent yield required to equal a
specified tax-exempt yield is at least as great as that shown in the table. It
is assumed that the investor is not subject to the alternative minimum tax.
Where applicable, investors should consider that the benefit of certain itemized
deductions and the benefit of personal exemptions are limited in the case of
higher income individuals. For 1998, taxpayers with adjusted gross income in
excess of a threshold amount of approximately $124,500 are subject to an overall
limitation on certain itemized deductions, requiring a reduction in such
deductions equal to the lesser of (i) 3% of adjusted gross income in excess of
the threshold of approximately $124,500 (ii) 80% of the amount of such itemized
deductions otherwise allowable. The benefit of each personal exemption is
phased out at the rate of two percentage points for each $2,700 (or fraction
thereof) of adjusted gross income in the phase-out zone. For single taxpayers
the range of adjusted gross income comprising the phase-out zone for 1998 is
estimated to be from $124,500 to $247,000 and for married taxpayers filing a
joint return from $186,800 to $309,300. The Federal tax brackets, the threshold
amounts at which itemized deductions are subject to reduction, and the range
over which personal exemptions are phased out will be further adjusted for
inflation for each year after 1998.
-144-
<PAGE>
TABLE 3 - FEDERAL AND OHIO
- ------- ----------------
<TABLE>
<CAPTION>
TAX EXEMPT YIELD
------------------------------------------------
1998
TAXABLE FEDERAL OHIO 3 3.5 4 4.5 5 5.5 6
INCOME MARGINAL MARGINAL COMBINED TAXABLE EQUIVALENT YIELD
BRACKETS* TAX RATE TAX RATE* RATE SINGLE RETURN
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 0 - 25,350 15% 4.457% 18.79% 3.69% 4.31% 4.93% 5.54% 6.16% 6.77% 7.39%
25,351- 40,000 28% 4.457% 31.21% 4.36% 5.09% 5.81% 6.54% 7.27% 8.00% 8.72%
40,001- 61,400 28% 5.201% 31.74% 4.40% 5.13% 5.86% 6.59% 7.33% 8.06% 8.79%
61,401- 80,000 31% 5.201% 34.59% 4.59% 5.35% 6.12% 6.88% 7.64% 8.41% 9.17%
80,001- 100,000 31% 5.943% 35.10% 4.62% 5.39% 6.16% 6.93% 7.70% 8.47% 9.25%
100,001- 128,100 31% 6.900% 35.76% 4.67% 5.45% 6.23% 7.01% 7.78% 8.56% 9.34%
128,101- 200,000 36% 6.900% 40.42% 5.03% 5.87% 6.71% 7.55% 8.39% 9.23% 10.07%
200,001- 278,450 36% 7.500% 40.80% 5.07% 5.91% 6.76% 7.60% 8.45% 9.29% 10.14%
OVER 278,450 39.6% 7.500% 44.13% 5.37% 6.26% 7.16% 8.05% 8.95% 9.84% 10.74%
</TABLE>
-145-
<PAGE>
<TABLE>
<CAPTION>
1998 FEDERAL OHIO
TAXABLE INCOME MARGINAL MARGINAL COMBINED TAXABLE EQUIVALENT YIELD
BRACKETS* TAX RATE TAX RATE* RATE JOINT RETURN
- ---------------- --------- --------- -------- ------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 0 - 40,000 15% 4.457% 18.79% 3.69% 4.31% 4.93% 5.54% 6.16% 6.77% 7.39%
40,001- 42,350 15% 5.201% 19.42% 3.72% 4.34% 4.96% 5.58% 6.20% 6.82% 7.45%
42,351- 80,000 28% 5.201% 31.74% 4.40% 5.13% 5.86% 6.59% 7.33% 8.06% 8.79%
80,001- 100,000 28% 5.943% 32.28% 4.43% 5.17% 5.91% 6.64% 7.38% 8.12% 8.86%
100,001- 102,300 28% 6.900% 32.97% 4.48% 5.22% 5.97% 6.71% 7.46% 8.21% 8.95%
102,301- 155,950 31% 6.900% 35.76% 4.67% 5.45% 6.23% 7.01% 7.78% 8.56% 9.34%
155,951- 200,000 36% 6.900% 40.42% 5.03% 5.87% 6.71% 7.55% 8.39% 9.23% 10.07%
200,001- 278,450 36% 7.500% 40.80% 5.07% 5.91% 6.76% 7.60% 8.45% 9.29% 10.14%
OVER 278,450 39.6% 7.500% 44.13% 5.37% 6.26% 7.16% 8.05% 8.95% 9.84% 10.74%
</TABLE>
/*/The income brackets applicable to the state of Ohio do not correspond to the
Federal taxable income brackets. In addition, Ohio taxable income will likely
be different than Federal taxable income because it is computed by reference to
Federal adjusted gross income with specifically-defined Ohio modifications and
exemptions, and does not consider many of the deductions allowed from Federal
adjusted gross income in computing Federal taxable income. No other state tax
credits, exemptions, or local taxes have been taken into account in arriving at
the combined marginal tax rate. In 1997, due to the state having surplus
revenue, a 3.987% across the board reduction in the Ohio income tax rates for
1997 only was effected pursuant to Ohio Revised Code sections 131.44 and
5747.02. It is not yet known whether a reduction in the Ohio income tax rates
will occur in 1998. A reduction in Ohio income tax rates, such as the 1997
reduction, has the effect of reducing the after-tax advantage of Ohio tax-exempt
securities relative to taxable securities. The income amount shown is income
subject to Federal income tax reduced by adjustments to income, exemptions, and
itemized deductions (including the deduction for state and local income taxes).
If the standard deduction is taken for Federal income tax purposes, the taxable
equivalent yield required to equal a specified tax-exempt yield is at least as
great as that shown in the table. It is assumed that the investor is not
subject to the alternative minimum tax. Where applicable, investors should
consider that the benefit of certain itemized deductions and the benefit of
personal exemptions are limited in the case of higher income individuals. For
1998, taxpayers with adjusted gross income in excess of a threshold amount of
approximately $124,500 are subject to an overall limitation on certain itemized
deductions, requiring a reduction in such deductions equal to the lesser of (i)
3% of adjusted gross income in excess of the threshold of approximately $124,500
or (ii) 80% of the amount of such itemized deductions otherwise allowable. The
benefit of each personal exemption is phased out at the rate of two percentage
points for each $2,700 (or fraction thereof) of adjusted gross income in the
phase-out zone. For single taxpayers the range of adjusted gross income
comprising the phase-out zone for 1998 is estimated to be from $124,500 to
$247,000 and for married taxpayers filing a joint return from $186,800 to
$309,300. The Federal tax brackets, the threshold amounts at which itemized
deductions are subject to reduction, and the range over which personal
exemptions are phased out will be further adjusted for inflation for each year
after 1998.
-146-
<PAGE>
TABLE 4 - FEDERAL AND NORTH CAROLINA
- ------- --------------------------
<TABLE>
<CAPTION>
1998 Taxable North
Income Bracket Federal Carolina Combined Federal Tax-Exempt Yield
Marginal Marginal and North Carolina
Single Return Joint Return Tax Rate Tax Rate Marginal Tax Rate* 3 .0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0%
- ------------- ------------ -------- -------- ------------------- ----- ----- ----- ----- ----- ----- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 0 - 12,750 $ 0 - 21,250 15.0% 6.00% 20.100% 3.755% 4.380% 5.006% 5.632% 6.258% 6.884% 7.509%
12,751 - 25,350 21,000 - 42,350 15.0% 7.00% 20.950% 3.795% 4.428% 5.060% 5.693% 6.325% 6.598% 7.590%
25,351 - 60,000 42,351 - 100,000 28.0% 7.00% 33.040% 4.480% 5.227% 5.974% 6.720% 7.467% 8.214% 8.961%
60,001 - 61,400 100,001 - 102,300 28.0% 7.75% 33.580% 4.517% 5.269% 6.022% 6.775% 7.528% 8.281% 9.033%
61,401 - 128,100 102,301 - 155,950 31.0% 7.75% 36.348% 4.713% 5.499% 6.284% 7.070% 7.855% 8.641% 9.426%
128,101 - 278,450 155,951 - 278,450 36.0% 7.75% 40.960% 5.081% 5.928% 6.775% 7.622% 8.469% 9.316% 0.163%
Over 278,450 Over 278,450 39.6% 7.75% 44.281% 5.384% 6.282% 7.179% 8.076% 8.974% 9.871% 10.768%
</TABLE>
/*/The taxable income brackets applicable to North Carolina do not correspond to
the Federal taxable income brackets. The taxable income brackets presented in
this table represent the breakpoints for both the Federal and North Carolina
marginal tax rate changes. When applying these brackets, Federal taxable income
may be different than North Carolina taxable income. No state tax credits,
exemptions, or local taxes have been taken into account in arriving at the
combined marginal tax rate. The income amount shown is income subject to
Federal income tax reduced by adjustments to income, exemptions, and itemized
deductions (including the deduction for state and local income taxes). If the
standard deduction is taken for Federal income tax purposes, the taxable
equivalent yield required to equal a specified tax-exempt yield is at least as
great as that shown in the table. It is assumed that the investor is not
subject to the alternative minimum tax. Where applicable, investors should
consider that the benefit of certain itemized deductions and the benefit of
personal exemptions are limited in the case of higher-income individuals. For
1998, taxpayers with adjusted gross income in excess of the threshold of
approximately $124,500 are subject to an overall limitation on certain itemized
deductions, requiring a reduction in such deductions equal to the lesser of (i)
3% of adjusted gross income in excess of the threshold of approximately $124,500
or (ii) 80% of the amount of such itemized deductions otherwise allowable. The
benefit of each personal exemption is phased out at the rate of two percentage
points for each $2,700 (or fraction thereof) of adjusted gross income in the
phase-out zone. For single taxpayers the range of adjusted gross income
comprising the phase-out zone for 1998 is estimated to be from $124,500 to
$247,000 and for married taxpayers filing a joint return from $186,800 to
$309,300. The Federal tax brackets, the threshold amounts at which itemized
deductions are subject to reduction, and the range over which personal
exemptions are phased out will be further adjusted for inflation for each year
after 1998.
-147-
<PAGE>
TABLE 5 - FEDERAL AND VIRGINIA
- ------- --------------------
<TABLE>
<CAPTION>
1998 Taxable Combined Federal
Income Bracket Federal Virginia and Virginia Tax-Exempt Yield
Joint Marginal Marginal Marginal
Single Return Return Tax Rate Tax Rate Tax Rate* 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0%
------------- ------- -------- -------- ---------- ----- ----- ----- ----- ----- ----- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 0 - 25,350 $ 0 - 42,350 15.0% 5.75% 19.888% 3.745% 4.369% 4.993% 5.617% 6.241% 6.865% 7.489%
25,351 - 61,400 42,351 - 102,300 28.0% 5.75% 32.140% 4.421% 5.158% 5.894% 6.631% 7.368% 8.105% 8.842%
61,401 - 128,100 102,301 - 155,950 31.0% 5.75% 34.968% 4.613% 5.382% 6.151% 6.920% 7.688% 8.457% 9.226%
128,101 - 278,450 155,951 - 36.0 5.75% 5.75% 39.680% 4.973% 5.802% 6.631% 7.460% 8.289% 9.118% 9.947%
OVER 278,450 OVER 278,450 39.6% 5.75% 43.073% 5.270% 6.148% 7.027% 7.905% 8.783% 9.661% 10.540%
</TABLE>
/*/The taxable income brackets applicable to Virginia do not correspond to the
Federal taxable income brackets. Because Virginia imposes a maximum tax rate of
5.75% on taxable income over $17,000, the taxable income brackets presented in
this table represent the breakpoints only for the Federal marginal tax rate
changes. When applying these brackets, Federal taxable income may be different
than Virginia taxable income. No state tax credits, exemptions, or local taxes
have been taken into account in arriving at the combined marginal tax rate. The
income amount shown is income subject to Federal income tax reduced by
adjustments to income, exemptions, and itemized deductions (including the
deduction for state and local income taxes). If the standard deduction is taken
for Federal income tax purposes, the taxable equivalent yield required to equal
a specified tax-exempt yield is at least as great as that shown in the table.
It is assumed that the investor is not subject to the alternative minimum tax.
Where applicable, investors should consider that the benefit of certain itemized
deductions and the benefit of personal exemptions are limited in the case of
higher income individuals. For 1998, taxpayers with adjusted gross income in
excess of a threshold amount of approximately $124,500 are subject to an overall
limitation on certain itemized deductions, requiring a reduction in such
deductions equal to the lesser of (i) 3% of adjusted gross income in excess of
the threshold of approximately $124,500 or (ii) 80% of the amount of such
itemized deductions otherwise allowable. The benefit of each personal exemption
is phased out at the rate of two percentage points for each $2,700 (or fraction
thereof) of adjusted gross income in the phase-out zone. For single taxpayers
the range of adjusted gross income comprising the phase-out zone for 1998 is
estimated to be from $124,500 to $247,000 and for married taxpayers filing a
joint return from $186,800 to $309,300. The Federal tax brackets, the threshold
amounts at which itemized deductions are subject to reduction, and the range
over which personal exemptions are phased out will be further adjusted for
inflation for each year after 1998.
-148-
<PAGE>
TABLE 6 - FEDERAL AND NEW JERSEY
- ------- ----------------------
<TABLE>
<CAPTION>
Approximate
Federal NJ Combined Federal Tax-Exempt Yield
1998 Taxable Marginal Marginal and NJ
Income Bracket* Tax Rate Tax Rate Marginal Tax Rate 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0%
- --------------- -------- -------- ----------------- ----- ----- ------ ----- ----- ----- -----
Single Return Taxable Yield - Single Return
-------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 0 - 20,000 15.0% 1.400% 16.190% 3.580% 4.176% 4.773% 5.369% 5.966% 6.562% 7.159%
20,001 - 25,350 15.0% 1.750% 16.488% 3.592% 4.191% 4.790% 5.388% 5.987% 6.589% 7.185%
25,351 - 35,000 28.0% 1.750% 29.260% 4.240% 4.948% 5.655% 6.361% 7.068% 7.775% 8.481%
35,001 - 40,000 28.0% 3.500% 30.520% 4.318% 5.037% 5.757% 6.471% 7.196% 7.916% 8.636%
40,001 - 61,400 28.0% 5.525% 31.978% 4.410% 5.145% 5.880% 6.616% 7.350% 8.086% 8.820%
61,401 - 75,000 31.0% 5.525% 34.812% 4.602% 5.369% 6.136% 6.903% 7.670% 8.437% 9.204%
75,001 - 128,100 31.0% 6.370% 35.395% 4.643% 5.418% 6.191% 6.965% 7.739% 8.513% 9.287%
128,101 - 278,450 36.0% 6.370% 40.077% 5.006% 5.841% 6.675% 7.510% 8.344% 9.178% 10.013%
OVER 278,450 39.6% 6.370% 43.447% 5.305% 6.189% 7.073% 7.957% 8.841% 9.725% 10.610%
<CAPTION>
1998 Taxable
Income Bracket*
- ---------------
Single Return 6.5% 7.0%
------------- ----- -----
<S> <C> <C>
$ 0 - 20,000 7.756% 8.352%
20,001 - 25,350 7.783% 8.382%
25,351 - 35,000 9.189% 9.895%
35,001 - 40,000 9.355% 10.075%
40,001 - 61,400 9.556% 10.298%
61,401 - 75,000 9.971% 10.738%
75,001 - 128,100 10.061 10.835%
128,101 - 278,450 10.847% 11.682%
OVER 278,450 11.494% 12.378%
</TABLE>
<TABLE>
<CAPTION>
Joint Return Taxable Yield - Joint Return
- -----------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 0 - 20,000 15.0% 1.400% 16.190% 3.580% 4.176% 4.773% 5.369% 5.966% 6.562% 7.159% 7.756% 8.352%
20,001 - 42,350 15.0% 1.750% 16.488% 3.592% 4.191% 4.790% 5.388% 5.987% 6.589% 7.185% 7.783% 8.382%
42,351 - 50,000 28.0% 1.750% 29.260% 4.240% 4.948% 5.655% 6.361% 7.068% 7.775% 8.481% 9.189% 9.895%
50,001 - 70,000 28.0% 2.450% *29.764% 4.271% 4.983% 5.695% 6.407% 7.189% 7.831% 8.543% 9.255% 9.966%
70,001 - 80,000 28.0% 3.500% 30.520% 4.318% 5.037% 5.757% 6.471% 7.196% 7.916% 8.636% 9.355% 10.075%
80,001 - 102,300 28.0% 5.525% 31.978% 4.410% 5.145% 5.880% 6.616% 7.350% 8.086% 8.820% 9.556% 10.298%
102,301 - 150,000/*/ 31.0% 5.525% 34.812% 4.602% 5.369% 6.136% 6.903% 7.670% 8.437% 9.204% 9.971% 10.738%
150,001 - 151,750/**/ 36.0% 6.370% 40.077% 5.006% 5.841% 6.675% 7.510% 8.344% 9.178% 10.013% 10.847% 11.682%
151,751 - 278,450 36.0% 6.370% 40.077% 5.006% 5.841% 6.675% 7.510% 8.344% 9.178% 10.013% 10.847% 11.682%
OVER 278,450 39.6% 6.370% 43.447% 5.305% 6.189% 7.073% 7.957% 8.841% 9.725% 10.610% 11.494% 12.378%
</TABLE>
/*/ The 31% Federal Taxable Income Bracket is $102,301 - $155,950. The
5.525% New Jersey Taxable Income Bracket is $80,001 - $150,000.
/**/ The 36% Federal Taxable Income Bracket is $155,950 - $278,450. The
6.370% New Jersey Taxable Income Bracket is $150,001 - $271,050.
-149-
<PAGE>
* The taxable income brackets applicable to New Jersey do not correspond to
the Federal taxable income brackets. Except where indicated, the taxable
income brackets presented in this table represent the breakpoints for both
the Federal and New Jersey marginal tax rate changes. When applying these
brackets, Federal taxable income will be different than New Jersey taxable
income because New Jersey does not start with Federal taxable income in
computing its own state income tax base. No state tax credits, exemptions,
or local taxes have been taken into account in arriving at the combined
marginal tax rate. The income amount shown is income subject to Federal
income tax reduced by adjustments to income, exemptions, and itemized
deductions (including the deduction for state and local income taxes). If
the standard deduction is taken for Federal income tax purposes, the
taxable equivalent yield required to equal a specified tax-exempt yield is
at least as great as that shown in the table. It is assumed that the
investor is not subject to the alternative minimum tax. Where applicable,
investors should consider that the benefit of certain itemized deductions
and the benefit of personal exemptions are limited in the case of higher-
income individuals. For 1998, taxpayers with adjusted gross income in
excess of a threshold amount of approximately $124,500 are subject to an
overall limitation on certain itemized deductions, requiring a reduction in
such deductions equal to the lesser of (i) 3% of adjusted gross income in
excess of the threshold of approximately $124,500 or (ii) 80% of the amount
of such itemized deductions otherwise allowable. The benefit of each
personal exemption is phased out at the rate of two percentage points for
each $2,700 (or fraction thereof) of adjusted gross income in the phase-out
zone. For single taxpayers the range of adjusted gross income comprising
the phase-out zone for 1998 is estimated to be from $124,500 to $247,000,
and for married taxpayers filing a joint return from $186,800 to $309,300.
The Federal tax brackets, the threshold amounts at which itemized
deductions are subject to reduction, and the range over which personal
exemptions are phased out will be further adjusted for inflation for each
year after 1998.
-150-
<PAGE>
TABLE 7 - FEDERAL AND DELAWARE (SINGLE RETURN)
<TABLE>
<CAPTION>
1998 Combined
Taxable Federal Delaware Federal and Tax-Exempt Yield
Income Marginal Marginal Delaware Marginal
Brackets* Tax Rate Tax Rate* Tax Rate 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0%
--------- -------- --------- -------- ----- ----- ---- ---- ----- ---- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 0 - 2,000 15% 0% 15.00% 3.53% 4.12% 4.71% 5.29% 5.88% 6.47% 7.06%
2,001 - 5,000 15% 3.10% 17.64% 3.64% 4.25% 4.86% 5.46% 6.07% 6.68% 7.29%
5,001 - 10,000 15% 4.85% 19.12% 3.71% 4.33% 4.95% 5.56% 6.18% 6.80% 7.42%
10,001 - 20,000 15% 5.80% 19.93% 3.75% 4.37% 5.00% 5.62% 6.24% 6.87% 7.49%
20,001 - 25,000 15% 6.15% 20.23% 3.76% 4.39% 5.01% 5.64% 6.27% 6.89% 7.52%
25,001 - 25,350 15% 6.45% 20.48% 3.77% 4.40% 5.03% 5.66% 6.29% 6.92% 7.55%
25,351 - 30,000 28% 6.45% 32.64% 4.45% 5.20% 5.94% 6.68% 7.42% 8.17% 8.91%
30,001 - 61,400 28% 6.90% 32.97% 4.48% 5.22% 5.97% 6.71% 7.46% 8.21% 8.95%
61,401 - 128,100 31% 6.90% 35.76% 4.67% 5.45% 6.23% 7.00% 7.78% 8.56% 9.34%
128,101 - 278,450 36% 6.90% 40.42% 5.04% 5.87% 6.71% 7.55% 8.39% 9.23% 10.07%
Over 278,450 39.6% 6.90% 43.77% 5.34% 6.22% 7.11% 8.00% 8.89% 9.78% 10.67%
</TABLE>
-151-
<PAGE>
TABLE 7 (CONT.) - FEDERAL AND DELAWARE (JOINT RETURN)
<TABLE>
<CAPTION>
1998 Combined
Taxable Federal Delaware Federal and Tax-Exempt Yield
Income Marginal Marginal Delaware
Brackets* Tax Rate Tax Rate* Marginal Tax Rate 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0%
--------- -------- --------- ----------------- ----- ----- ---- ---- ----- ---- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 0 - 2,000 15% 0% 15.00% 3.53% 4.12% 4.71% 5.29% 5.88% 6.47% 7.06%
2,001 - 5,000 15% 3.10% 17.64% 3.64% 4.25% 4.86% 5.46% 6.07% 6.68% 7.29%
5,001 - 10,000 15% 4.85% 19.12% 3.71% 4.33% 4.95% 5.56% 6.18% 6.80% 7.42%
10,001 - 20,000 15% 5.80% 19.93% 3.75% 4.37% 5.00% 5.62% 6.24% 6.87% 7.49%
20,001 - 25,000 15% 6.15% 20.23% 3.76% 4.39% 5.01% 5.64% 6.27% 6.89% 7.52%
25,001 - 30,000 15% 6.45% 20.48% 3.77% 4.40% 5.03% 5.66% 6.29% 6.92% 7.55%
30,001 - 42,350 15% 6.90% 20.87% 3.79% 4.42% 5.05% 5.69% 6.32% 6.95% 7.58%
42,351 - 102,300 28% 6.90% 32.97% 4.48% 5.22% 5.97% 6.71% 7.46% 8.21% 8.95%
102,301 - 155,950 31% 6.90% 35.76% 4.67% 5.45% 6.23% 7.00% 7.78% 8.56% 9.34%
155,951 - 278,450 36% 6.90% 40.42% 5.04% 5.87% 6.71% 7.55% 8.39% 9.23% 10.07%
Over 278,450 39.6% 6.90% 43.77% 5.34% 6.22% 7.11% 8.00% 8.89% 9.78% 10.67%
</TABLE>
*The taxable income brackets applicable to Delaware do not correspond to the
Federal taxable income brackets. The taxable income brackets presented in this
table represent the breakpoints for both the Federal and Delaware marginal tax-
rate changes. When applying these brackets, Federal taxable income may be
different from Delaware taxable income. No state tax credits, exemptions or
local taxes have been taken into account in arriving at the combined marginal
tax rate. The income amount shown is income subject to Federal income tax
reduced by adjustments to income, exemptions and itemized deductions (including
the deduction for state and local income taxes). If the standard deduction is
taken for Federal income tax purposes, the taxable-equivalent yield required to
equal a specified tax-exempt yield is at least as great as that shown in the
table. It is assumed that the investor is not subject to the alternative minimum
tax. Where applicable, investors should consider that the benefit of certain
itemized deductions and the benefit of personal exemptions are limited in the
case of higher-income individuals. For 1998, taxpayers with adjusted gross
income in excess of the threshold of approximately $124,500 are subject to an
overall limitation on certain itemized deductions, requiring a reduction in such
deductions equal to the lesser of (i) 3% of adjusted gross income in excess of
the threshold of approximately $124,500, or (ii) 80% of the amount of such
itemized deductions otherwise allocable. The benefit of each personal exemption
is phased out at the rate of two percentage points for each $2,700 (or fraction
thereof) of adjusted gross income in the phase-out zone. For single taxpayers,
the range of adjusted gross income comprising the phase-out zone for 1998 is
estimated to be from $124,500 to $247,000, and for married taxpayers filing a
joint return from $186,800 to $309,300. The Federal tax brackets, the threshold
amounts at which itemized deductions are subject to reduction and the range over
which personal exemptions are phased out will be further adjusted for inflation
for each year after 1998.
-152-
<PAGE>
Table 8 - Federal and Kentucky
------------------------------
<TABLE>
<CAPTION>
1998 Taxable
Income Bracket* Federal Kentucky Combined Federal
Marginal Marginal and Kentucky
Single Return Joint Return Tax Rate Tax Rate Marginal Tax Rate*
- --------------------- ------------------ ---------- ---------- --------------------
<S> <C> <C> <C> <C>
$ 0 - 3,000 $ 0 - 3,000 15.0% 2.00% 16.70%
3,001 - 4,000 3,001 - 4,000 15.0% 3.00% 17.55%
4,001 - 5,000 4,001 - 5,000 15.0% 4.00% 18.40%
5,001 - 8,000 5,001 - 8,000 15.0% 5.00% 19.25%
8,001 - 25,350 8,001 - 42,350 15.0% 6.00% 20.10%
25,351 - 61,400 42,351 - 102,300 28.0% 6.00% 32.32%
61,401 - 128,100 102,301 - 155,950 31.0% 6.00% 35.14%
128,101 - 287,450 155,951 - 278,450 36.0% 6.00% 39.84%
OVER 278,450 OVER 278,450 39.6% 6.00% 43.22%
<CAPTION>
Tax-Exempt Yield
--------------------
3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0%
----------- ----------- ----------- ----------- ----------- ----------- -----------
<C> <C> <C> <C> <C> <C> <C>
3.601% 4.202% 4.802% 5.402% 6.002% 6.603% 7.203%
3.639% 4.245% 4.851% 5.458% 6.064% 6.671% 7.277%
3.676% 4.289% 4.902% 5.515% 6.127% 6.740% 7.353%
3.715% 4.334% 4.954% 5.573% 6.192% 6.811% 7.430%
3.755% 4.380% 5.006% 5.632% 6.258% 6.884% 7.509%
4.433% 5.171% 5.910% 6.649% 7.388% 8.126% 8.865%
4.625% 5.396% 6.167% 6.938% 7.709% 8.480% 9.251%
4.987% 5.818% 6.649% 7.480% 8.311% 9.142% 9.973%
5.284% 6.165% 7.045% 7.926% 8.807% 9.687% 10.568%
</TABLE>
* The taxable income brackets applicable to Kentucky do not correspond to the
Federal taxable income brackets. The taxable income brackets presented in this
table represent the breakpoints for both the Federal and Kentucky marginal tax
rate changes. When applying these brackets, Federal taxable income may be
different than Kentucky taxable income. No state tax credits, exemptions, or
local taxes have been taken into account in arriving at the combined marginal
tax rate. The income amount shown is income subject to Federal income tax
reduced by adjustments to income, exemptions, and itemized deductions (including
the deduction for state taxes). If the standard deduction is taken for Federal
income tax purposes, the taxable equivalent yield required to equal a specified
tax-exempt yield is at least as great as that shown in the table. It is assumed
that the investor is not subject to the alternative minimum tax. Where
applicable, investors should consider that the benefit of certain itemized
deductions and the benefit of personal exemptions are limited in the case of
higher-income individuals. For 1998, taxpayers with adjusted gross income in
excess of the threshold of approximately $124,500 are subject to an overall
limitation on certain itemized deductions, requiring a reduction in such
deductions equal to the lesser of (i) 3% of adjusted gross income in excess of
the threshold of approximately $124,500 or (ii) 80% of the amount of such
itemized deductions otherwise allowable. The benefit of each personal exemption
is phased out at the rate of two percentage points for each $2,700 (or fraction
thereof) of adjusted gross income in the phase-out zone. For single taxpayers
the range of adjusted gross income comprising the phase-out zone for 1998 is
estimated to be from $124,500 to $247,000 and for married taxpayers filing a
joint return from $186,800 to $309,300. The Federal tax brackets, the threshold
amounts at which itemized deductions are subject to reduction, and the range
over which personal exemptions are phased out will be further adjusted for
inflation for each year after 1998.
153
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MISCELLANEOUS. Yields on shares of a Portfolio may fluctuate daily and do
not provide a basis for determining future yields. Because such yields will
fluctuate, they 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 Portfolio to another,
consideration should be given to each Portfolio's investment policies, including
the types of investments made, lengths of maturities of the portfolio
securities, market conditions, operating expenses and whether there are any
special account charges which may reduce the effective yield. The fees which
may be imposed by Service Organizations and other institutions on their
customers are not reflected in the calculations of total returns or yields for
the Portfolios.
When comparing a Portfolio's performance to stock, bond, and money market
mutual fund performance indices prepared by Lipper or other organizations, it is
important to remember the risk and return characteristics of each type of
investment. For example, while stock mutual funds may offer higher potential
returns, they also carry the highest degree of share price volatility.
Likewise, money market funds may offer greater stability of principal, but
generally do not offer the higher potential returns from stock mutual funds.
From time to time, a Portfolio's performance may also be compared to other
mutual funds tracked by financial or business publications and periodicals. For
example a Portfolio may quote Morningstar, Inc. in its advertising materials.
Morningstar, Inc. is a mutual fund rating service that rates mutual funds on the
basis of risk-adjusted performance. Rankings that compare the performance of
Portfolios to one another in appropriate categories over specific periods of
time may also be quoted in advertising.
Ibbotson Associates of Chicago, Illinois ("Ibbotson") provides historical
returns of the capital markets in the United States, including common stocks,
small capitalization stocks, long-term corporate bonds, intermediate-term
government bonds, long-term government bonds, Treasury bills, the U.S. rate of
inflation (based on the Consumer Price Index), and combinations of various
capital markets. The performance of these capital markets is based on the
returns of different indices. Portfolios may use the performance of these
capital markets in order to demonstrate general risk-versus-reward investment
scenarios. Performance comparisons may also include the value of a hypothetical
investment in any of these capital markets. The
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risks associated with the security types in any capital market may or may not
correspond directly to those of the Portfolios. The Portfolios may also compare
performance to that of other compilations or indices that may be developed and
made available in the future.
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 a Portfolio investment are
reinvested by being paid in additional Portfolio shares, any future income or
capital appreciation of a 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,
(including materials that describe general principles of investing, such as
asset allocation, diversification, risk tolerance, and goal setting,
questionnaires designed to help create a personal financial profile, worksheets
used to project savings needs based on assumed rates of inflation and
hypothetical rates of return and action plans offering investment alternatives)
investment management techniques, policies or investment suitability of a
Portfolio (such as value investing, market timing, dollar cost averaging, asset
allocation, constant ratio transfer, automatic account rebalancing, the
advantages and disadvantages of investing in tax-deferred and taxable
investments), economic and political conditions and the relationship between
sectors of the economy and the economy as a whole, 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, sales
literature, communications to shareholders or other materials may summarize the
substance of information contained in shareholder reports (including the
investment composition of a Portfolio), as well as the views of the Portfolios'
adviser and/or sub-advisers 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. In
addition, selected indices may be used to illustrate historic performance of
select asset classes. The Fund may also include in advertisements, sales
literature, communications to shareholders or other materials, 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, sales
literature, shareholder communications or other materials may include a
discussion of certain attributes or
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<PAGE>
benefits to be derived by an investment in a Portfolio and/or other mutual
funds, benefits, characteristics or services associated with a particular class
of shares, shareholder profiles and hypothetical investor scenarios, timely
information on financial management, tax and retirement planning and investment
alternative to certificates of deposit and other financial instruments. Such
advertisements or communicators may include symbols, headlines or other material
which highlight or summarize the information discussed in more detail therein.
Materials may include lists of representative clients of the Portfolios'
investment adviser and sub-advisers. Materials may refer to the CUSIP numbers
of the various classes of the Portfolios and may illustrate how to find the
listings of the Portfolios in newspapers and periodicals. Materials may also
include discussions of other Portfolios, products, and services.
Charts and graphs using net asset values, adjusted net asset values, and
benchmark indices may be used to exhibit performance. An adjusted NAV includes
any distributions paid and reflects all elements of return. Unless otherwise
indicated, the adjusted NAVs are not adjusted for sales charges, if any.
A Portfolio may illustrate performance using moving averages. A long-term
moving average is the average of each week's adjusted closing NAV for a
specified period. A short-term moving average is the average of each day's
adjusted closing NAV for a specified period. Moving Average Activity Indicators
combine adjusted closing NAVs from the last business day of each week with
moving averages for a specified period to produce indicators showing when an NAV
has crossed, stayed above, or stayed below its moving average.
A Portfolio may quote various measures of volatility and benchmark
correlation in advertising. In addition, a Portfolio may compare these measures
to those of other funds. Measures of volatility seek to compare the historical
share price fluctuations or total returns to those of a benchmark. Measures of
benchmark correlation indicate how valid a comparative benchmark may be. All
measures of volatility and correlation are calculated using averages of
historical data.
Momentum indicators indicate a Portfolio's price movements over specific
periods of time. Each point on the momentum indicator represents the
Portfolio's percentage change in price movements over that period.
A Portfolio may advertise examples of the effects of periodic investment
plans, including the principle of dollar cost
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averaging. In such a program, an investor invests a fixed dollar amount in a
fund at periodic intervals, thereby purchasing fewer shares when prices are high
and more shares when prices are low. While such a strategy does not assure a
profit or guard against loss in a declining market, the investor's average cost
per share can be lower than if fixed numbers of shares are purchased at the same
intervals. In evaluating such a plan, investors should consider their ability
to continue purchasing shares during periods of low price levels. A Portfolio
may be available for purchase through retirement plans or other programs
offering deferral of, or exemption from, income taxes, which may produce
superior after-tax returns over time.
A Portfolio may advertise its current interest rate sensitivity, duration,
weighted average maturity or similar maturity characteristics.
Advertisements and sales materials relating to a Portfolio may include
information regarding the background, experience and expertise of the investment
adviser and/or portfolio manager for the Portfolio.
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 Prospectuses. 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 are urged to consult their tax advisers with specific
reference to their own tax situation.
Please note that for purposes of satisfying certain of the requirements for
taxation as a regulated investment company described below, the Index Equity
Portfolio is deemed to own a proportionate share of the assets and gross income
of the Index Master Portfolio in which the Index Equity Portfolio invests all of
its assets. Also, with respect to the Index Equity Portfolio, the discussion
below that relates to the taxation of futures contracts and other rules
pertaining to the timing and character of income apply to the Index Master
Portfolio.
Each Portfolio of the Fund has elected and intends to qualify for taxation
as a regulated investment company under Subchapter M of the Internal Revenue
Code of 1986, as amended (the "Code"). As a regulated investment company, each
Portfolio
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generally is exempt from federal income tax on its net investment income (i.e.,
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 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 the sum of (a) 90% of its net investment income and (b) 90% of its net
tax-exempt interest income, if any, for the year (the "Distribution
Requirement") and satisfies certain other requirements of the Code that are
described below. Distributions of net investment income and net tax-exempt
interest 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, 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 investing 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 a
Portfolio has not invested more than 5% of the value of its total assets in
securities of such issuer and as to which a Portfolio does not hold more than
10% of the outstanding voting securities of such issuer), and no more than 25%
of the value of each 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.
Each of the Money and Non-Money Market Municipal Portfolios is designed to
provide investors with tax-exempt interest income. Shares of the Money and Non-
Money Market Municipal Portfolios would not be suitable for tax-exempt
institutions and may not be suitable for retirement plans qualified under
Section 401 of the Code, H.R. 10 plans and individual retirement accounts
because such plans and accounts are generally tax-exempt and, therefore, not
only would not gain any additional benefit from the Portfolio's dividends being
tax-exempt but also such dividends
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would be taxable when distributed to the beneficiary. In addition, the Money and
Non-Money Market Municipal Portfolios may not be an appropriate investment for
entities which are "substantial users" of facilities financed by private
activity bonds or "related persons" thereof. "Substantial user" is defined under
U.S. Treasury Regulations to include a non-exempt person who regularly uses a
part of such facilities in his trade or business and (a) whose gross revenues
derived with respect to the facilities financed by the issuance of bonds are
more than 5% of the total revenues derived by all users of such facilities, (b)
who occupies more than 5% of the entire usable area of such facilities, or (c)
for whom such facilities or a part thereof were specifically constructed,
reconstructed or acquired. "Related persons" include certain related natural
persons, affiliated corporations, a partnership and its partners and an S
corporation and its shareholders.
In order for the Money and Non-Money Market Municipal Portfolios to pay
exempt interest dividends for any taxable year, at the close of each quarter of
the taxable year at least 50% of the value of each such Portfolio must consist
of exempt interest obligations. Exempt interest dividends distributed to
shareholders are not included in the shareholder's gross income for regular
Federal income tax purposes. However, gain realized by such Portfolios from the
disposition of a tax-exempt bond that was acquired after April 30, 1993 for a
price less than the principal amount of the bond is taxable to shareholders as
ordinary income to the extent of accrued market discount. Also, all shareholders
required to file a Federal income tax return are required to report the receipt
of exempt interest dividends and other exempt interest on their returns.
Moreover, while such dividends and interest are exempt from regular Federal
income tax, they may be subject to alternative minimum tax (currently imposed at
the rate of 26% (28% on the taxable excess over $175,000) or 28% in the case of
non-corporate taxpayers and at the rate of 20% in the case of corporate
taxpayers) in two circumstances. First, exempt interest dividends derived from
certain "private activity" bonds issued after August 7, 1986, generally will
constitute an item of tax preference for both corporate and non-corporate
taxpayers. Second, exempt interest dividends derived from all bonds, regardless
of the date of issue, must be taken into account by corporate taxpayers in
determining certain adjustments for alternative minimum tax purposes. Receipt of
exempt interest dividends may result in collateral Federal income tax
consequences to certain other taxpayers, including financial institutions,
property and casualty insurance companies, individual recipients of Social
Security or Railroad Retirement benefits, and foreign
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corporations engaged in trade or business in the United States. Prospective
investors should consult their own tax advisors as to such consequences.
If a Money or Non-Money Market Municipal Portfolio distributes exempt
interest dividends during the shareholder's taxable year, no deduction generally
will be allowed for any interest expense on indebtedness incurred to purchase or
carry shares of such Portfolio.
Individuals and estates that are subject to Ohio personal income tax or
municipal or school district income taxes in Ohio will not be subject to such
taxes on distributions from the Ohio Municipal Money Market Portfolio or Ohio
Tax-Free Income Portfolio to the extent that such distributions are properly
attributable to interest on Ohio State-Specific Obligations or obligations
issued by the U.S. Government, its agencies, instrumentalities or territories if
the interest on such obligations is exempt from state income taxation under the
laws of the United States (collectively with Ohio State-Specific Obligations,
the "Obligations") if (a) the Portfolio continues to qualify as a regulated
investment company for Federal income tax purposes and (b) at all times at least
50% of the value of the total assets of the Portfolio consists of Ohio State-
Specific Obligations or similar obligations of other states or their
subdivisions. The Ohio Municipal Money Market and Ohio Tax-Free Income
Portfolios are not subject to the Ohio personal income tax, school district
income taxes in Ohio, the Ohio corporation franchise tax, or the Ohio dealer in
intangibles tax, provided that, with respect to the Ohio corporation franchise
tax and the Ohio dealer in intangibles tax, the Fund timely files the annual
report required by Section 5733.09 of the Ohio Revised Code. The Ohio Tax
Commissioner, however, has waived this annual filing requirement for each year
(and is expected to do so for 1998) since 1990, the first tax year to which such
requirement applied. Distributions with respect to shares of the Ohio Municipal
Money Market and Ohio Tax-Free Income Portfolios properly attributable to
proceeds of insurance paid to those Portfolios that represent maturing or
matured interest on defaulted Obligations held by those Portfolios and that are
excluded from gross income for Federal income tax purposes will not be subject
to Ohio personal income tax or municipal or school district income taxes in
Ohio, nor included in the net income base of the Ohio corporation franchise tax.
Distributions of exempt-interest dividends, to the extent attributable to
interest on North Carolina State-Specific Obligations and to interest on direct
obligations of the United
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States (including territories thereof), are not subject to North Carolina
individual or corporate income tax. Distributions of gains attributable to
certain obligations of the State of North Carolina and its political
subdivisions issued prior to July 1, 1995 are not subject to North Carolina
individual or corporate income tax; however, distributions of gains attributable
to such types of obligations that were issued after June 30, 1995 will be
subject to North Carolina individual or corporate income tax. An investment in
a Portfolio (including the North Carolina Municipal Money Market Portfolio) by a
corporation subject to the North Carolina franchise tax will be included in the
capital stock, surplus and undivided profits base in computing the North
Carolina franchise tax. Investors in a Portfolio including, in particular,
corporate investors which may be subject to the North Carolina franchise tax,
should consult their tax advisors with respect to the effects on such tax of an
investment in a Portfolio and with respect to their North Carolina tax situation
in general.
As a regulated investment company, the Virginia Municipal Money Market
Portfolio may distribute dividends that are exempt from the Virginia income tax
to its shareholders if the Portfolio satisfies all requirements for conduit
treatment under Federal law and, at the close of each quarter of its taxable
year, at least 50% of the value of its total assets consists of obligations the
interest on which is exempt from taxation under Federal law. If the Portfolio
fails to qualify, no part of its dividends will be exempt from the Virginia
income tax. To the extent any portion of the dividends are derived from taxable
interest for Virginia purposes or from net short-term capital gains, such
portion will be taxable to the shareholders as ordinary income. The character
of long-term capital gains realized and distributed by the Portfolio will follow
through to its shareholders regardless of how long the shareholders have held
their shares. Generally, interest on indebtedness incurred by shareholders to
purchase or carry shares of the Portfolio will not be deductible for Virginia
income tax purposes.
To be classified as a qualified investment fund for New Jersey personal
income tax purposes, at least 80% of the investments of the New Jersey Municipal
Money Market Portfolio and New Jersey Tax-Free Income Portfolio must consist of
New Jersey State-Specific Obligations or direct U.S. Government obligations
excluding financial options, futures, forward contracts, or other similar
financial instruments related to interest-bearing obligations, obligations
issued at a discount or bond indexes related thereto to the extent such
instruments are authorized by the regulated investment company rules of the
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Internal Revenue Code, cash and cash items, which cash items shall include
receivables; the Portfolios must have no investments other than interest-bearing
obligations, obligations issued at a discount, and cash and cash items
(including receivables and financial options, futures, forward contracts, or
other similar financial instruments related to interest-bearing obligations,
obligations issued at a discount or bond indexes related thereto; and the
Portfolios must satisfy certain reporting obligations and provide certain
information to shareholders.
So long as the Delaware Tax-Free Income Portfolio qualifies as a regulated
investment company under the Code, individuals, estates or trusts that are
subject to Delaware personal income tax will not be subject to such tax with
respect to (i) "exempt interest dividends" (as defined in the Code) attributable
to interest on Delaware State-Specific Obligations and (ii) dividends
attributable to interest paid on certain U.S. government obligations, provided
that the Delaware Tax-Free Income Portfolio sends shareholders a written
statement of the dollar amount or percentage of total distributions by the
Delaware Tax-Free Income Portfolio that are described in (i) and (ii). Other
distributions made by the Portfolio to its shareholders who are individuals,
estates or trusts subject to Delaware personal income tax will be includible in
the gross income of such shareholders for Delaware personal income tax purposes
to the same extent as such distributions are includible in the gross income of
such shareholders for Federal income tax purposes. Distributions made by the
Delaware Tax-Free Income Portfolio to its shareholders who are corporations or
other entities subject to Delaware corporate income tax will be excluded from
the Delaware taxable income of such shareholders to the same extent as such
distributions are excluded from the Federal taxable income of such
shareholders.
Exempt-interest dividends paid by the Kentucky Tax-Free Income Portfolio
that are attributable to Kentucky State-Specific Obligations will be excludible
from a shareholder's gross income for Kentucky income tax purposes. Further,
distributions attributable to interest on certain U.S. government obligations
will similarly be excluded from gross income for Kentucky income tax purposes.
All other distributions by the Kentucky Tax-Free Income Portfolio will be
included in a shareholder's gross income for Kentucky income tax purposes.
Kentucky taxes distributions of net capital gain at the same rates as ordinary
income. Under the laws of Kentucky relating to ad valorem taxation of property,
the shareholders rather than the Kentucky Tax-Free Income Portfolio are
considered the owners of the Portfolio's assets.
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Each shareholder will be deemed to be the owner of a pro-rata portion of the
Kentucky Tax-Free Income Portfolio's assets. According to the Kentucky Revenue
Cabinet, the portion of the Portfolio's assets that consists of Kentucky State-
Specific Obligations will be exempt from intangible property taxes, but the
portion that consists of cash on hand, cash in out-of-state banks, futures,
options and other nonexempt assets will be subject to intangible property
taxes.
Distributions of net investment income will be taxable (other than the
possible allowance of the dividends received deduction described below) to
shareholders as ordinary income, regardless of whether such distributions are
paid in cash or are reinvested in shares. Shareholders receiving any
distribution from a 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 Money and
Non-Money Market Municipal Portfolios may each purchase securities that do not
bear tax-exempt interest. Any income on such securities recognized by the
Portfolio will be distributed and will be taxable to its shareholders.
Each Portfolio intends to distribute to shareholders any 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 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.
In the case of corporate shareholders, distributions (other than capital
gain dividends) of a Non-Money Market Portfolio for any taxable year generally
qualify for the dividends received deduction to the extent of the gross amount
of "qualifying dividends" received by such Portfolio for the year. Generally, a
dividend will be treated as a "qualifying dividend" if it has been received from
a domestic corporation. Distributions attributable to net investment income
from debt securities and net realized short-term capital gain will be taxable to
shareholders as ordinary income and will not be treated as "qualifying
dividends" for purposes of the dividends received deduction.
Under current law, 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
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phase-out of personal exemptions, the maximum effective marginal rate of tax for
some taxpayers may be higher. Under recently enacted legislation, long-term
capital gains of individuals are taxed at a maximum rate of 28% with respect to
capital assets held for more than 12 months but less than 18 months and at a
maximum rate of 20% with respect to capital assets held for more than 18 months
(10% for gains otherwise taxed at 15%). 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. For shareholders of the Non-Money Market Portfolios,
any loss incurred on the sale or exchange of a Portfolio's shares, held six
months or less, will be disallowed to the extent of exempt interest dividends
paid with respect to such shares, and any loss not so disallowed will be treated
as a long-term capital loss to the extent of capital gain dividends received
with respect to such shares.
Each Non-Money Market 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 a Portfolio purchases shares in a "passive foreign investment company"
(a "PFIC"), such Portfolio may be subject to
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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, under recently enacted legislation, 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).
Investment income that may be received by certain of the Portfolios from
sources within foreign countries may be subject to foreign taxes withheld at the
source. The United States has entered into tax treaties with many foreign
countries which entitle any such Portfolio to a reduced rate of, or exemption
from, taxes on such income. If more than 50% of the value of the total assets at
the close of the taxable year of the International Equity Portfolio,
International Emerging Markets Portfolio, International Small Cap Equity
Portfolio and International Bond Portfolio consist of stock or securities of
foreign corporations, such Portfolio may elect to "pass through" to the
Portfolio's shareholders the amount of foreign taxes paid by such Portfolio. If
a Portfolio so elects, each shareholder would be required to include in gross
income, even though not actually received, his pro rata share of the foreign
taxes paid by the Portfolio, but would be treated as having paid his pro rata
share of such foreign taxes and would therefore be allowed to either deduct such
amount in computing taxable income or use such amount (subject to various Code
limitations) as a foreign tax credit against federal income tax (but not both).
For purposes of the foreign tax credit limitation rules of the Code, each
shareholder would treat as foreign source income his pro rata share of such
foreign taxes plus the portion of dividends received from the Portfolio
representing income derived from
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foreign sources. No deduction for foreign taxes could be claimed by an
individual shareholder who does not itemize deductions. In certain
circumstances, a shareholder that (i) has held shares of the 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. Additionally, such Portfolio must also meet this holding period
requirement with respect to its foreign stocks and securities in order for
"creditable" taxes to flow-through. Each shareholder should consult his own tax
adviser regarding the potential application of foreign tax credits.
Ordinary income dividends paid by a Portfolio will qualify for the 70%
dividends-received deduction generally available to corporations to the extent
of the amount of "qualifying dividends" received by a Portfolio from domestic
corporations for the taxable year. A dividend received by a Portfolio will not
be treated as a qualifying dividend (i) if it has been received with respect to
any share of stock that the Portfolio has held for less than 46 days (91 days in
the case of certain preferred stock) during the 90 day period beginning on the
date which is 45 days before the date on which such share becomes ex-dividend
with respect to such dividend (during the 180 day period beginning 90 days
before such date in the case of certain preferred stock), (ii) to the extent
that a Portfolio is under an obligation to make related payments with respect to
positions in substantially similar or related property or (iii) to the extent
the stock on which the dividend is paid is treated as debt-financed. Moreover,
the dividends-received deduction for a corporate shareholder may be disallowed
if the corporate shareholder fails to satisfy the foregoing requirements with
respect to its shares of a Portfolio.
If for any taxable year any 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 (including amounts derived from interest on Municipal Obligations)
will be taxable as ordinary dividends to the extent of such 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). Each
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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
each 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 when required to do so
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 Portfolios 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, each
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
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
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<PAGE>
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 shall continue to hold office and may
appoint successor trustees. The Fund's Declaration of Trust provides that
meetings of the shareholders of the Fund shall 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 each 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 that Portfolio. The underlying
assets of each Portfolio 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. As stated in the Prospectuses, certain
expenses of a Portfolio may be charged to a specific class of shares
representing interests in that Portfolio.
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<PAGE>
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 liquidation and
termination of any Portfolio or class of shares. Upon any liquidation of a
Portfolio, Shareholders of each class of the Portfolio are entitled to share pro
rata in the net assets belonging to that class available for distribution.
MISCELLANEOUS
Effective January 31, 1998, the Fund has changed its name from Compass
Capital Funds/SM/ to BlackRock Funds/SM/.
COUNSEL. The law firm of Simpson Thacher & Bartlett (a partnership which
includes professional corporations), 425 Lexington Avenue, New York, New York
10017, serves as the Fund's counsel. The law firm of Stradley, Ronon, Stevens &
Young, LLP, 2600 One Commerce Square, Philadelphia, Pennsylvania 19103, serves
as the Trust's counsel.
INDEPENDENT ACCOUNTANTS. Coopers & Lybrand L.L.P., with offices located at
2400 Eleven Penn Center, Philadelphia, Pennsylvania, serves as the Fund's and
the Trust's independent accountants.
FIVE PERCENT OWNERS. The name, address and percentage ownership of each
person that on ___________ __, 1998 owned of record or beneficially 5% or more
of the outstanding shares of a
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<PAGE>
Portfolio which had commenced operations as of that date was as follows:
Money Market Portfolio: PNC Bank, Airport Business Center/Int'l Court 2, 200
- ----------------------
Stevens Dr., Lester, PA 19113, 79.498%; BHC Securities Inc., One Commerce
Square, 2005 Market Street, Philadelphia, PA 19103-3212, 8.730%; U.S. Treasury
-------------
Money Market Portfolio: PNC Bank, Airport Business Center/Int'l Court 2, 200
- ----------------------
Stevens Dr., Lester, PA 19113, 81.731%; Large Cap Value Equity Portfolio: PNC
--------------------------------
Bank, Saxon & Co., Attn: Income Collections, 200 Stevens Dr., Suite 260, Lester,
PA 19113, 82.888%; Intermediate Government Bond Portfolio: PNC Bank, Saxon &
--------------------------------------
Co., Attn: Income Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113,
92.482%; Municipal Money Market Portfolio: PNC Bank, Airport Business
--------------------------------
Center/Int'l Court 2, 200 Stevens Dr., Lester, PA 19113, 75.728%; PNC Bank
Pittsburgh, Treas Management-32nd Fl., Two PNC Place, Pittsburgh, PA 15222,
12.721%; Small Cap Value Equity Portfolio: PNC Bank, Saxon & Co., Attn: Income
--------------------------------
Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 69.236%; National
City Bank Kentucky, Humana Retirement/Savings Tr., P.O. Box 94777, Cleveland, OH
44101, 8.418%; Large Cap Growth Equity Portfolio: PNC Bank, Saxon & Co., Attn:
---------------------------------
Income Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 88.882%;
Managed Income Portfolio: PNC Bank, Saxon & Co., Attn: Income Collections, 200
- ------------------------
Stevens Dr., Suite 260, Lester, PA 19113, 88.059%; Tax-Free Income Portfolio:
--------------------------
PNC Bank, Saxon & Co., Attn: Income Collections, 200 Stevens Dr., Suite 260,
Lester, PA 19113, 85.165%; Balanced Portfolio: PNC Bank, Saxon & Co., Attn:
------------------
Income Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 63.110%; BHC
Securities Inc., One Commerce Square, 2005 Market Street, Philadelphia, PA
19103-3212, 17.965%; International Equity Portfolio: PNC Bank, Saxon & Co.,
------------------------------
Attn: Income Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 91.267%;
Ohio Tax-Free Income Portfolio: PNC Bank, Saxon & Co., Attn: Income Collections,
- ------------------------------
200 Stevens Dr., Suite 260, Lester, PA 19113, 69.768%; BHC Securities Inc., One
Commerce Square, 2005 Market Street, Philadelphia, PA 19103-3212, 17.283%;
Pennsylvania Tax-Free Income Portfolio: PNC Bank, Saxon & Co., Attn: Income
- --------------------------------------
Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 44.933%; BHC
Securities Inc., One Commerce Square, 2005 Market Street, Philadelphia, PA
19103-3212, 30.190%; North Carolina Municipal Money Market Portfolio: North
-----------------------------------------------
Carolina Trust Co., 301 North Elm St., P.O. Box 1108, Greensboro, NC 27402,
54.766%; Branch Banking and Trust Company, Wilbranch & Company, Trust
Department, P.O. Box 1847, Wilson, NC 27893, 15.722%; First Citizens Bank,
McWood & Company, P.O. Box 29522, Raleigh, NC 27626, 7.951%; Central Carolina
Bank & Trust Co., P.O. Box 30010, Durham, NC 27702-3010, 12.051%; Ohio Municipal
--------------
Money Market
- ------------
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<PAGE>
Portfolio: PNC Bank, Airport Business Center/Int'l Court 2, 200 Stevens Dr.,
- ---------
Lester, PA 19113, 45.378%; BHC Securities, One Commerce Square, 2005 Market St,
Philadelphia, PA 19103-3212, 36.690%; Wayne County National Bank, Wayco & Co.,
P.O. Box 757/1776 Beall Avenue, Wooster, OH 44691, 10.632%; Low Duration Bond
-----------------
Portfolio: PNC Bank, Saxon & Co., Attn: Income Collections, 200 Stevens Dr.,
- ---------
Suite 260, Lester, PA 19113, 50.035%; BIT Acquisition Corporation, 9 Parker,
Irvine, CA 92718, 12.960%; U.S. Industries Inc., Master Trust, c/o Bank of New
York, One Wall Street, 12th Floor, New York, NY 10286, 11.437%; Vimrx
Pharmaceuticals Inc., 2751 Centerville Rd., Ste. 210, Wilmington, DE 19806,
5.234%; Intermediate Bond Portfolio: PNC Bank, Saxon & Co., Attn: Income
---------------------------
Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 96.631%; Select
------
Equity Portfolio: PNC Bank, Saxon & Co., Attn: Income Collections, 200 Stevens
- ----------------
Dr., Suite 260, Lester, PA 19113, 88.395%; Small Cap Growth Equity Portfolio:
---------------------------------
PNC Bank, Saxon & Co., Attn: Income Collections, 200 Stevens Dr., Suite 260,
Lester, PA 19113, 55.016%; Pennsylvania Municipal Money Market Portfolio: PNC
---------------------------------------------
Bank, Airport Business Center/Int'l Court 2, 200 Stevens Dr., Lester, PA 19113,
72.542%; Janney Montgomery Scott, 1801 Market Street, 9th Floor, Philadelphia,
PA 19103, 7.704%; BHC Securities, Inc., One Commerce Square, 2005 Market St,
Philadelphia, PA 19103-3212, 5.310%; Virginia Municipal Money Market Portfolio:
-----------------------------------------
First Virginia Bank Inc., Oldom & Company, 6400 Arlington Blvd., Falls Church,
VA 22042, 57.973%; American National Bank & Trust Co, Ambro and Company, 628
Main St, P.O. Box 191, Danville, VA 24543, 5.444%; Mentor Investment Group, as
advisor for Virginia State Non-Arbitrage Program, 901 East Byrd Street, 6th Fl.,
Richmond, VA 23219, 15.720%; F&M Bank-Peoples Warrtrust & Co., P.O. Box 93,
Warrenton, VA 22186, 6.799%; International Bond Portfolio: PNC Bank, Saxon &
----------------------------
Co., 200 Stevens Dr., Suite 260, Lester, PA 19113, 86.150%; International
-------------
Emerging Markets Portfolio: PNC Bank, Saxon & Co., Attn: Income Collections, 200
- --------------------------
Stevens Dr., Suite 260, Lester, PA 19113, 93.154%; Government Income Portfolio:
---------------------------
BHC Securities, Inc., One Commerce Square, 2005 Market St, Phila., PA 19103-
3212, 16.102%; New Jersey Municipal Money Market Portfolio: PNC Bank, Airport
-------------------------------------------
Business Center/Int'l Court 2, 200 Stevens Dr., Lester, PA 19113, 74.379%;
Janney Montgomery Scott, 1801 Market Street, 9th Fl., Phila., PA 19103, 14.569%;
New Jersey Tax-Free Income Portfolio: PNC Bank, Saxon & Co., Attn: Income
- ------------------------------------
Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 58.461%; BHC
Securities, Inc., One Commerce Square, 2005 Market Street, Suite 1200,
Philadelphia, PA 19103-3212, 7.731%; Core Bond Portfolio: PNC Bank, Saxon & Co.,
-------------------
Attn: Income Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 83.187%;
Mid-Cap Value Portfolio: PNC Bank, Saxon & Co., 200 Stevens Dr., Suite 260,
- -----------------------
Lester, PA 19113, 89.033%; Mid-Cap Growth Portfolio: PNC
------------------------
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<PAGE>
Bank, Saxon & Co., Attn: Income Collections, 200 Stevens Dr., Suite 260, Lester,
PA 19113, 92.342%; Index Equity Portfolio: PNC Bank, Saxon & Co., Attn: Income
----------------------
Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 73.274%;
International Small Cap Equity Portfolio: PNC Bank, Saxon & Co., Attn: Income
- ----------------------------------------
Collections, 200 Stevens Drive, Suite 260, Lester, PA 19113, 84.196%; Merrill
Lynch Pierce Fenner Financial Data Services, Attn: Stock Powers, 4800 E. Deer
Lake Dr., 3rd Fl., Jacksonville, FL 32246, 5.106%.
On February 4, 1998, PNC Bank, which has its principal offices at 1600
Market Street, Philadelphia, Pennsylvania 19103, held of record approximately
78% 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, 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, Inc., PIMC, BlackRock, PCM, PEAC,
CastleInternational, PNC Bank and other institutions that are banks or bank
affiliates are subject to such banking laws and regulations.
BlackRock, Inc., PIMC, BlackRock, PCM, PEAC, CastleInternational 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
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<PAGE>
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 normally be subject to shareholder
approval. It is not anticipated that any change in the Fund's method of
operations as a result of these occurrences would affect its net asset value per
share or result in a financial loss to any shareholder.
SHAREHOLDER APPROVALS. As used in this Statement of Additional Information
and in the Prospectuses, a "majority of the outstanding shares" of a class,
series or Portfolio means, with respect to the approval of an investment
advisory agreement, a distribution plan or a change in a fundamental investment
policy, the lesser of (1) 67% of the shares of the particular class, series or
Portfolio represented at a meeting at which the holders of more than 50% of the
outstanding shares of such class, series or Portfolio are present in person or
by proxy, or (2) more than 50% of the outstanding shares of such class, series
or Portfolio.
FINANCIAL STATEMENTS
BLACKROCK FUNDS. The audited financial statements and notes thereto in the
Fund's Annual Report to Shareholders for the fiscal year ended September 30,
1997 (the "1997 Annual Report") are incorporated in this Statement of Additional
Information by reference. No other parts of the 1997 Annual Report are
incorporated by reference herein. The financial statements included in the 1997
Annual Report have been audited by the Fund's independent accountants, Coopers &
Lybrand, L.L.P., except for the statements of changes in net assets for the year
ended June 30, 1995 for the Core Bond Portfolio and Short Government Bond
Portfolio (now known as Low Duration Bond Portfolio) and the financial
highlights for the periods ended June 30, 1995, 1994 and 1993 for those same
Portfolios which have been audited by other auditors. The reports of Coopers &
Lybrand L.L.P. are incorporated herein by reference. Such financial statements
have been incorporated herein in reliance upon such reports given upon their
authority as experts in accounting and auditing. Additional copies of the 1997
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.
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<PAGE>
The financial highlights included in the 1997 Annual Report for each of the
two years in the period ended June 30, 1995, and for the period from July 17,
1992 through June 30, 1993 for the Short Government Bond Portfolio (now known as
the Low Duration Bond Portfolio) and the period from December 9, 1992 through
June 30, 1993 for the Core Bond Portfolio, and the statements of changes in net
assets for the year ended June 30, 1995 for those same Portfolios have been
audited by the former independent accountants of the Predecessor BFM Portfolios,
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 Coopers & Lybrand L.L.P. and Deloitte & Touche,
L.L.P. given upon their authority as experts in accounting and auditing.
INDEX MASTER PORTFOLIO. The audited financial statements and notes thereto
for The U.S. Large Company Series of the Trust contained in the Trust's Annual
Report to Shareholders for the fiscal year ended November 30, 1997 (the "1997
Index Master Report") are incorporated by reference into this Statement of
Additional Information. No other parts of the 1997 Index Master Report are
incorporated by reference herein. The financial statements included in the 1997
Index Master Report have been audited by the Trust's independent accountants,
Coopers & Lybrand L.L.P., whose reports thereon are incorporated herein by
reference. Such financial statements have been incorporated herein by reference
in reliance upon such reports given upon their authority as experts in
accounting and auditing. Additional copies of the 1997 Index Master Report may
be obtained at no charge by telephoning the Trust at (310) 395-8005.
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<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 rating categories used by Standard and
Poor's for commercial paper:
"A-1" - Issue's degree of safety regarding timely payment is strong.
Those issues determined to possess extremely strong safety characteristics are
denoted "A-1+."
"A-2" - Issue's capacity for timely payment is satisfactory. However,
the relative degree of safety is not as high as for issues designated "A-1."
"A-3" - Issue has an adequate capacity for timely payment. It is,
however, somewhat more vulnerable to the adverse effects of changes in
circumstances than an obligation carrying a higher designation.
"B" - Issue has only a speculative capacity for timely payment.
"C" - Issue has a doubtful capacity for payment.
"D" - Issue is in payment default.
Moody's commercial paper ratings are opinions of the ability of
issuers to repay punctually promissory obligations not having an original
maturity in excess of 9 months. The following summarizes the rating categories
used by Moody's for commercial paper:
"Prime-1" - Issuer or related supporting institutions are considered
to have a superior capacity for repayment of short-term promissory obligations.
Prime-1 repayment capacity will normally be evidenced by the following
characteristics: leading market positions in well established industries; high
rates of return on funds employed; conservative capitalization structures with
moderate reliance on debt and ample asset protection; broad margins in earning
coverage of fixed financial charges and high internal cash generation; and well
established
A-1
<PAGE>
access to a range of financial markets and assured sources of alternate
liquidity.
"Prime-2" - Issuer or related supporting institutions are considered
to have a strong capacity for repayment of short-term promissory obligations.
This will normally be evidenced by many of the characteristics cited above but
to a lesser degree. Earnings trends and coverage ratios, while sound, will be
more subject to variation. Capitalization characteristics, while still
appropriate, may be more affected by external conditions. Ample alternative
liquidity is maintained.
"Prime-3" - Issuer or related supporting institutions have an
acceptable capacity for repayment of short-term promissory obligations. The
effects of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
"Not Prime" - Issuer does not fall within any of the Prime rating
categories.
The three rating categories of Duff & Phelps for investment grade
commercial paper and short-term debt are "D-1," "D-2" and "D-3." Duff & Phelps
employs three designations, "D-1+," "D-1" and "D-1-," within the highest rating
category. The following summarizes the rating categories used by Duff & Phelps
for commercial paper:
"D-1+" - Debt possesses highest certainty of timely payment. Short-
term liquidity, including internal operating factors and/or access to
alternative sources of funds, is outstanding, and safety is just below risk-free
U.S. Treasury short-term obligations.
"D-1" - Debt possesses very high certainty of timely payment.
Liquidity factors are excellent and supported by good fundamental protection
factors. Risk factors are minor.
"D-1-" - Debt possesses high certainty of timely payment. Liquidity
factors are strong and supported by good fundamental protection factors. Risk
factors are very small.
"D-2" - Debt possesses good certainty of timely payment. Liquidity
factors and company fundamentals are sound. Although ongoing funding needs may
enlarge total financing
A-2
<PAGE>
requirements, access to capital markets is good. Risk factors are small.
"D-3" - Debt possesses satisfactory liquidity, and other protection
factors qualify issue as investment grade. Risk factors are larger and subject
to more variation. Nevertheless, timely payment is expected.
"D-4" - Debt possesses speculative investment characteristics.
Liquidity is not sufficient to ensure against disruption in debt service.
Operating factors and market access may be subject to a high degree of
variation.
"D-5" - Issuer has failed to meet scheduled principal and/or interest
payments.
Fitch short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years. The
following summarizes the rating categories used by Fitch for short-term
obligations:
"F-1+" - Securities possess exceptionally strong credit quality.
Issues assigned this rating are regarded as having the strongest degree of
assurance for timely payment.
"F-1" - Securities possess very strong credit quality. Issues
assigned this rating reflect an assurance of timely payment only slightly less
in degree than issues rated "F-1+."
"F-2" - Securities possess good credit quality. Issues assigned this
rating have a satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as the "F-1+" and "F-1" categories.
"F-3" - Securities possess fair credit quality. Issues assigned this
rating have characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause these
securities to be rated below investment grade.
"F-S" - Securities possess weak credit quality. Issues assigned this
rating have characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial and
economic conditions.
"D" - Securities are in actual or imminent payment default.
A-3
<PAGE>
Fitch may also use the symbol "LOC" with its short-term ratings to
indicate that the rating is based upon a letter of credit issued by a commercial
bank.
Thomson BankWatch short-term ratings assess the likelihood of an
untimely or incomplete payment of principal or interest of unsubordinated
instruments having a maturity of one year or less which are issued by United
States commercial banks, thrifts and non-bank banks; non-United States banks;
and broker-dealers. The following summarizes the ratings used by Thomson
BankWatch:
"TBW-1" - This designation represents Thomson BankWatch's highest
rating category and indicates a very high degree of likelihood that principal
and interest will be paid on a timely basis.
"TBW-2" - This designation indicates that while the degree of safety
regarding timely payment of principal and interest is strong, the relative
degree of safety is not as high as for issues rated "TBW-1."
"TBW-3" - This designation represents the lowest investment grade
category and indicates that while the debt is more susceptible to adverse
developments (both internal and external) than obligations with higher ratings,
capacity to service principal and interest in a timely fashion is considered
adequate.
"TBW-4" - This designation indicates that the debt is regarded as non-
investment grade and therefore speculative.
IBCA assesses the investment quality of unsecured debt with an
original maturity of less than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for short-term debt ratings:
"A1+" - Obligations which posses a particularly strong credit feature
are supported by the highest capacity for timely repayment.
"A1" - Obligations are supported by the highest capacity for timely
repayment.
"A2" - Obligations are supported by a satisfactory capacity for timely
repayment.
A-4
<PAGE>
"A3" - Obligations are supported by a satisfactory capacity for timely
repayment.
"B" - Obligations for which there is an uncertainty as to the capacity
to ensure timely repayment.
"C" - Obligations for which there is a high risk of default or which
are currently in default.
A-5
<PAGE>
CORPORATE AND MUNICIPAL LONG-TERM DEBT RATINGS
- ----------------------------------------------
The following summarizes the ratings used by Standard & Poor's for
corporate and municipal debt:
"AAA" - This designation represents the highest rating assigned by
Standard & Poor's to a debt obligation and indicates an extremely strong
capacity to pay interest and repay principal.
"AA" - Debt is considered to have a very strong capacity to pay
interest and repay principal and differs from AAA issues only in small degree.
"A" - Debt is considered to have a strong capacity to pay interest and
repay principal although such issues are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt in
higher-rated categories.
"BBB" - Debt is regarded as having an adequate capacity to pay
interest and repay principal. Whereas such issues normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher-rated categories.
"BB," "B," "CCC," "CC" and "C" - Debt is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. "BB" indicates the
lowest degree of speculation and "C" the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
"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 principal repayments. Adverse
business, financial or economic conditions will likely impair capacity or
willingness to pay
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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" - This rating is typically applied to debt subordinated to senior
debt that is assigned an actual or implied "CCC" rating.
"C" - This rating is typically applied to debt subordinated to senior
debt which 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" - This rating is reserved for income bonds on which no interest
is being paid.
"D" - Debt is in payment default. This rating is used when interest
payments or principal payments are not made on the date due, even if the
applicable grace period has not expired, unless S & P believes that such
payments will be made during such grace period. "D" rating is also used upon
the filing of a bankruptcy petition if debt service payments are jeopardized.
PLUS (+) OR MINUS (-) - The ratings from "AA" through "CCC" may be
modified by the addition of a plus or minus sign to show relative standing
within the major rating categories.
"r" - This rating is attached to highlight derivative, hybrid, and
certain other obligations that S & P believes may experience high volatility or
high variability in expected returns due to non-credit risks. Examples of such
obligations are: securities whose principal or interest return is indexed to
equities, commodities, or currencies; certain swaps and options; and interest
only and principal only mortgage securities. The absence of an "r" symbol
should not be taken as an indication that an obligation will exhibit no
volatility or variability in total return.
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The following summarizes the ratings used by Moody's for corporate and
municipal long-term debt:
"Aaa" - Bonds are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
"Aa" - Bonds are judged to be of high quality by all standards.
Together with the "Aaa" group they comprise what are generally known as high-
grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in "Aaa" securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in "Aaa"
securities.
"A" - Bonds possess many favorable investment attributes and are to be
considered as upper medium-grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.
"Baa" - Bonds considered medium-grade obligations, i.e., they are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any great length of time.
Such bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
"Ba," "B," "Caa," "Ca," and "C" - Bonds that possess one of these
ratings provide questionable protection of interest and principal ("Ba"
indicates some speculative elements; "B" indicates a general lack of
characteristics of desirable investment; "Caa" represents a poor standing; "Ca"
represents obligations which are speculative in a high degree; and "C"
represents the lowest rated class of bonds). "Caa," "Ca" and "C" bonds may be
in default.
Con. (---) - Bonds for which the security depends upon the completion
of some act or the fulfillment of some condition are rated conditionally. These
are bonds secured by (a) earnings of projects under construction, (b) earnings
of projects
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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, Baa, Ba and B groups which Moody's
believes possess the strongest investment attributes are designated by the
symbols, Aa1, A1, Ba1 and B1.
The following summarizes the long-term debt ratings used by Duff &
Phelps for corporate and municipal long-term debt:
"AAA" - Debt is considered to be of the highest credit quality. The
risk factors are negligible, being only slightly more than for risk-free U.S.
Treasury debt.
"AA" - Debt is considered of high 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.
"BB," "B," "CCC," "DD," and "DP" - Debt that possesses one of these
ratings is considered to be below investment grade. Although below investment
grade, debt rated "BB" is deemed likely to meet obligations when due. Debt
rated "B" possesses the risk that obligations will not be met when due. Debt
rated "CCC" is well below investment grade and has considerable uncertainty as
to timely payment of principal, interest or preferred dividends. Debt rated
"DD" is a defaulted debt obligation, and the rating "DP" represents preferred
stock with dividend arrearages.
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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 economic conditions and
circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
"BB," "B," "CCC," "CC," "C," "DDD," "DD," and "D" -Bonds that possess
one of these ratings are considered by Fitch to be speculative investments. The
ratings "BB" to "C" represent Fitch's assessment of the likelihood of timely
payment of principal and interest in accordance with the terms of obligation for
bond issues not in default. For defaulted bonds, the rating "DDD" to "D" is an
assessment of the ultimate recovery value through reorganization or liquidation.
To provide more detailed indications of credit quality, the Fitch
ratings from and including "AA" to "BBB" may be
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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
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.
"BB," "B," "CCC," "CC," and "C" - Obligations are assigned one of
these ratings where it is considered that speculative characteristics are
present. "BB" represents the lowest degree of speculation and indicates a
possibility of investment risk developing. "C" represents the highest degree of
speculation and indicates that the obligations are currently in default.
IBCA may append a rating of plus (+) or minus (-) to a rating to
denote relative status within major rating categories.
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
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by United States commercial banks, thrifts and non-bank banks; non-United States
banks; and broker-dealers. The following summarizes the rating categories used
by Thomson BankWatch for long-term debt ratings:
"AAA" - This designation represents the highest category assigned by
Thomson BankWatch to long-term debt and indicates that the ability to repay
principal and interest on a timely basis is 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.
"BB," "B," "CCC," and "CC," - These designations are assigned by
Thomson BankWatch to non-investment grade long-term debt. Such issues are
regarded as having speculative characteristics regarding the likelihood of
timely payment of principal and interest. "BB" indicates the lowest degree of
speculation and "CC" the highest degree of speculation.
"D" - This designation indicates that the long-term debt is in
default.
PLUS (+) OR MINUS (-) - The ratings from "AAA" through "CC" may
include a plus or minus sign designation which indicates where within the
respective category the issue is placed.
MUNICIPAL NOTE RATINGS
- ----------------------
A Standard and Poor's rating reflects the liquidity concerns and
market access risks unique to notes due in three years or less. The following
summarizes the ratings used by Standard & Poor's Ratings Group for municipal
notes:
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"SP-1" - The issuers of these municipal notes exhibit very strong or
strong capacity to pay principal and interest. Those issues determined to
possess overwhelming safety characteristics are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit satisfactory
capacity to pay principal and interest.
"SP-3" - The issuers of these municipal notes exhibit speculative
capacity to pay principal and interest.
Moody's ratings for state and municipal notes and other short-term
loans are designated Moody's Investment Grade ("MIG") and variable rate demand
obligations are designated Variable Moody's Investment Grade ("VMIG"). Such
ratings recognize the differences between short-term credit risk and long-term
risk. The following summarizes the ratings by Moody's Investors Service, Inc.
for short-term notes:
"MIG-1"/"VMIG-1" - Loans bearing this designation are of the best
quality, enjoying strong protection by established cash flows, superior
liquidity support or demonstrated broad-based access to the market for
refinancing.
"MIG-2"/"VMIG-2" - Loans bearing this designation are of high quality,
with margins of protection ample although not so large as in the preceding
group.
"MIG-3"/"VMIG-3" - Loans bearing this designation are of favorable
quality, with all security elements accounted for but lacking the undeniable
strength of the preceding grades. Liquidity and cash flow protection may be
narrow and market access for refinancing is likely to be less well established.
"MIG-4"/"VMIG-4" - Loans bearing this designation are of adequate
quality, carrying specific risk but having protection commonly regarded as
required of an investment security and not distinctly or predominantly
speculative.
"SG" - Loans bearing this designation are of speculative quality and
lack margins of protection.
Fitch and Duff & Phelps use the short-term ratings described under
Commercial Paper Ratings for municipal notes.
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APPENDIX B
----------
As stated in the Prospectuses, certain Portfolios of the Fund 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, a Portfolio may use interest rate
futures contracts as a defense, or hedge, against anticipated interest rate
changes and not for speculation. As described below, this would include the use
of futures contract sales to protect against expected increases in interest
rates and futures contract purchases to offset the impact of interest rate
declines.
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
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until at or near that date. The determination would be in accordance with the
rules of the exchange on which the futures contract sale or purchase was made.
Although interest rate futures contracts by their terms call for
actual delivery or acceptance of securities, in most cases the contracts are
closed out before the settlement date without the making or taking of delivery
of securities. Closing out a futures contract sale is effected by the 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 stock index futures such as the
ALL-ORDS (Australia), CAC-40 (France), TOPIX (Japan) and the FTSE-100 (United
Kingdom).
II. Index Futures Contracts
-----------------------
General. A stock or bond index assigns relative values to the stocks
-------
or bonds included in the index, which fluctuates
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with changes in the market values of the stocks or bonds included. Some stock
index futures contracts are based on broad market indexes, such as Standard &
Poor's 500 or the New York Stock Exchange Composite Index. In contrast, certain
exchanges offer futures contracts on narrower market indexes, such as the
Standard & Poor's 100 or indexes based on an industry or market indexes, such as
Standard & Poor's 100 or indexes based on an industry or market segment, such as
oil and gas stocks. Futures contracts are traded on organized exchanges
regulated by the Commodity Futures Trading Commission. Transactions on such
exchanges are cleared through a clearing corporation, which guarantees the
performance of the parties to each contract. With regard to each Portfolio, to
the extent consistent with its investment objective, the Adviser anticipates
engaging in transactions, from time to time, in foreign stock index futures such
as the ALL-ORDS (Australia), CAC-40 (France), TOPIX (Japan) and the FTSE-100
(United Kingdom).
A Portfolio may sell index futures contracts in order to offset a
decrease in market value of its portfolio securities that might otherwise result
from a market decline. A Portfolio may do so either to hedge the value of its
portfolio as a whole, or to protect against declines, occurring prior to sales
of securities, in the value of the securities to be sold. Conversely, a
Portfolio may 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 may utilize index futures contracts in
anticipation of changes in the composition of its portfolio holdings. For
example, in the event that a Portfolio expects to narrow the range of industry
groups represented in its holdings it may, prior to making purchases of the
actual securities, establish a long futures position based on a more restricted
index, such as an index comprised of securities of a particular industry group.
A Portfolio may also sell futures contracts in connection with this strategy, in
order to protect against the possibility that the value of the securities to be
sold as part of the restructuring of the portfolio will decline prior to the
time of sale.
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
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Portfolio to hedge against exposure to fluctuations in exchange rates between
different currencies arising from multinational transactions.
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 in a
segregated account 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 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 as a hedging device. One risk arises because of the imperfect
correlation between movements in the price of the futures and movements in the
price of the
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instruments which are the subject of a hedge. The price of the future 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 futures, 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.
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 the
instruments being hedged, the price of futures may not correlate perfectly with
movement in the cash market due to certain market distortions. Rather than
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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 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
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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
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
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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. As an example, in anticipation of a decline in interest rates, a
Portfolio may purchase call options on futures contracts as a substitute for the
purchase of futures contracts to hedge against a possible increase in the price
of securities which the Portfolio intends to purchase. Similarly, if the value
of the securities held by a Portfolio is expected to decline as a result of an
increase in interest rates, the Portfolio might purchase put options or sell
call options on futures contracts rather than sell futures contracts.
Investments in futures options involve some of the same considerations
that are involved in connection with investments in futures contracts (for
example, the existence of a liquid secondary market). In addition, the purchase
or sale of an option also entails the risk that changes in the value of the
underlying futures contract will not 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 securities or
currencies being hedged, 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-8
<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, 1997, September 30,
1996, March 31, 1996 and June 30, 1995.
(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 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;
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 for the year or
period ended September 30, 1997;
Statements of Net Assets - September 30, 1997;
Statements of Operations for the year or period
ended September 30, 1997;
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<PAGE>
Statements of Changes in Net Assets for the years
or periods ended September 30, 1997 and 1996;
Financial Highlights;
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 (Coopers &
Lybrand L.L.P.) 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 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
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<PAGE>
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 (Coopers & Lybrand
L.L.P.) for the year ended September 30, 1997;
Schedule of Investments - September 30, 1997;
Statement of Assets and Liabilities - September
30, 1997;
Statement of Operations for the year ended
September 30, 1997;
Statement of Changes in Net Assets for the year
ended September 30, 1997 and the periods ended
September 30, 1996 and March 31, 1996;
Financial highlights for all periods presented;
Notes to Financial Statements.
(vi) With respect to The U.S. Large Company Series of The
DFA Investment Trust Company:
C-4
<PAGE>
Report of Independent Accountants (Coopers &
Lybrand L.L.P.) 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 year
ended November 30, 1997;
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").
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<PAGE>
(e) Amendment No. 4 to the Declaration of Trust dated
December 23, 1997 is incorporated herein by reference
to 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
C-6
<PAGE>
Amendment No. 27 to Registrant's Registration
Statement on Form N-1A filed on January 28, 1997.
(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
C-7
<PAGE>
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.
(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
C-8
<PAGE>
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.
(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.
C-9
<PAGE>
(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 Compass Distributors, Inc. is
incorporated herein by reference to Exhibit (6)(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 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
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.
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<PAGE>
(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. 33 to Registrant's
Registration Statement on Form N-1A filed on January
27, 1998.
(e) Sub-Custodian Agreement dated April 27, 1992 among the
Registrant, PNC Bank, National Association and The
Chase Manhattan Bank.
(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.
(h) Amendment No. 1 to Custodian Agreement between State
Street Bank and Trust Company and PNC Bank, National
Association dated November 21, 1989.
(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 Amended and Restated Administration Agreement
among Registrant, Compass Distributors,
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<PAGE>
Inc. and PFPC Inc. is incorporated herein by reference
to Exhibit 9(d) of Post-Effective Amendment No. 27 to
Registrant's Registration Statement on Form N-1A filed
on January 28, 1997.
(b) Forms of Appendix A and Appendix B to Amended and
Restated Administration Agreement between Registrant,
Compass Distributors, Inc. and PFPC Inc. are
incorporated herein by reference to Exhibit (9)(b) of
Post-Effective Amendment No. 33 to Registrant's
Registration Statement on Form N-1A filed on January
27, 1998.
(c) Form of Co-Administration Agreement between Registrant
and BlackRock, Inc. is incorporated herein by
reference to Exhibit (9)(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 A to Co-Administration Agreement
between Registrant and BlackRock, Inc. is incorporated
herein by reference to Exhibit (9)(c) of Post-
Effective Amendment No. 33 to Registrant's
Registration Statement on Form N-1A filed on January
27, 1998.
(e) 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.
(f) 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.
(g) Amendment No. 2 to Transfer Agency Agreement dated
October 4, 1989 between Registrant and PFPC Inc.
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
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<PAGE>
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.
(h) 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.
(i) 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.
(j) Form of Appendix C to Transfer Agency Agreement
between Registrant and PFPC Inc. is incorporated
herein by reference to Exhibit (9)(j) of Post-
Effective Amendment No. 33 to Registrant's
Registration Statement on Form N-1A filed on January
27, 1998.
(k) 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
Registration Statement on Form N-1A filed on January
28, 1997.
(10) None.
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<PAGE>
(11) Consent of Coopers & Lybrand L.L.P.
(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.
(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. 33 to Registrant's Registration
Statement on Form N-1A filed on January 27, 1998.
(16) Schedules for computation of performance quotations.
(17) None.
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<PAGE>
(18) Plan Pursuant to 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,
1997, is incorporated herein by reference to
Registrant's filing including such Annual Report filed
on November 26, 1997 (Accession No. 0000930413-97-
000628).
(c) 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-15
<PAGE>
(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
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 December 31, 1997:
<TABLE>
<CAPTION>
Portfolio Institutional Service Investor A Investor B Investor C
- --------- ------------- ------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Money Market 18 708 832 30 1
US Treasury Money Market 3 200 84 1 1
Municipal Money Market 2 63 8 1 2
Ohio Municipal Money Market 8 3 4 1 1
Pennsylvania Municipal Money Market 24 44 46 1 1
North Carolina Municipal 13 5 8 1 1
Money Market
New Jersey Municipal Money Market 9 113 21 1 1
</TABLE>
C-16
<PAGE>
<TABLE>
<CAPTION>
Portfolio Institutional Service Investor A Investor B Investor C
- --------- ------------- ------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Virginia Municipal Money Market 10 2 3 0 0
Managed Income 29 11 259 65 0
Tax-Free Income 10 121 139 54 2
Ohio Tax-Free Income 3 2 27 21 0
Pennsylvania Tax-Free Income 1 116 337 415 1
New Jersey Tax-Free Income 0 1,506 18 24 1
Low Duration Bond 28 953 62 5 2
Low Duration Bond/BlackRock Class 8 N/A N/A N/A N/A
Intermediate Bond 8 442 44 0 0
Core Bond 37 1,516 39 532 9
Core Bond/BlackRock Class 7 N/A N/A N/A N/A
Intermediate Government 13 3 152 4 1
Government Income 0 0 72 926 9
International Bond 6 92 62 92 36
International Emerging Markets 16 15 170 416 4
Large Cap Growth Equity 35 603 583 1,015 5
Index Equity 22 161 725 2,434 629
Small Cap Value Equity 56 13 814 1,639 71
International Equity 30 551 608 1,176 7
International Small Cap Equity 6 6 21 125 4
Balanced 14 123 1,674 2,601 5
Large Cap Value Equity 21 4,091 768 2,593 6
Small Cap Growth Equity 162 437 1,350 4,354 384
Select Equity 32 9 264 2,713 14
Mid-Cap Value Equity 10 14 60 844 6
Mid-Cap Growth Equity 14 6 39 616 14
Multi-Sector Mortgage 2 N/A N/A N/A N/A
Securities III
BlackRock Strategic I 12 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
C-17
<PAGE>
Exhibit (6)(a). Indemnification of PFPC Inc. and BlackRock Distributors, Inc. in
their capacity as co-administrators is provided for in Section 7 of the Amended
and Restated Administration Agreement incorporated by reference herein as
Exhibit 9(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(e).
Indemnification of BlackRock, Inc. in its capacity as co-administrator as
provided for in Section 7 of the Co-Administration 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 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
C-18
<PAGE>
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.
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, Inc. (formerly PNC Asset Management Group, Inc.) is an
indirect wholly-owned subsidiary for PNC Bank Corp. BlackRock, 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, 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, Inc. pursuant to the Investment Advisers
Act of 1940 (SEC File No. 801-47710).
(b) PNC Institutional Management Corporation ("PIMC") is an indirect
wholly-owned subsidiary of PNC Bank Corp. The list required by this Item 28 of
officers and directors of PIMC, 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 PIMC pursuant to the
Investment Advisers Act of 1940 (SEC File No. 801-13304).
(c) Provident Capital Management, Inc. ("PCM") is an indirect wholly-
owned subsidiary of PNC Bank Corp. PCM currently offers investment advisory
services to institutional investors such as pension and profit-sharing plans or
trusts, insurance companies
C-19
<PAGE>
and banks. The list required by this Item 28 of officers and directors of PCM,
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 PCM pursuant to the Investment Advisers Act of 1940 (SEC File
No. 801-1438).
(d) 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).
(e) PNC Equity Advisors Company ("PEAC") is an indirect wholly-owned
subsidiary of PNC Bank Corp. PEAC 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 PEAC, 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 PEAC pursuant to the Investment
Advisers Act of 1940 (SEC File No. 801-47711).
(f) CastleInternational Asset Management Limited
("CastleInternational") is an indirect wholly-owned subsidiary of PNC Bank Corp.
The list required by this Item 28 of officers and directors of
CastleInternational, 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 CastleInternational 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.
C-20
<PAGE>
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) Provident Capital Management, Inc., 30 South 17th Street,
Philadelphia, Pennsylvania 19103 (records relating to its
functions as investment sub-adviser).
(3) BlackRock Distributors, Inc., Four Falls Corporate Center,
6th Floor, West Conshohocken, PA 19428-2961 (records
relating to its functions as distributor and co-
administrator).
(4) BlackRock, Inc., 1600 Market Street, 29th Floor,
Philadelphia, PA 19103 (records relating to its functions
as investment adviser and co-administrator).
(5) PNC Institutional Management Corporation, Bellevue Corporate
Center, 103 Bellevue Parkway, Wilmington, Delaware 19809
(records relating to its functions as investment sub-
adviser).
(6) BlackRock Financial Management, Inc., 345 Park Avenue, New
York, New York 10154 (records relating to its functions as
investment adviser and sub-adviser).
(7) PNC Equity Advisors Company, 1600 Market Street, 29th Floor,
Philadelphia, Pennsylvania 19103 (records relating to its
functions as investment sub-adviser).
(8) 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).
(9) The Chase Manhattan Bank, N.A., 1285 Avenue of the Americas,
New York, New York 10019 (records relating to its function
as sub-custodian).
(10) State Street Bank and Trust Company, P.O. Box 1631, Boston,
Massachusetts (records relating to its function as sub-
custodian).
(11) Barclays Bank PLC, 75 Wall Street, New York, New York 10265
(records relating to its function as sub-custodian).
C-21
<PAGE>
(12) CastleInternational Asset Management Limited, 7 Castle
Street, Edinburgh, Scotland, EH2 3AH (records relating to
its functions as investment sub-adviser).
(13) Citibank, N.A., 111 Wall Street, 23rd Floor, Zone 6, New
York, NY 10043 (records relating to its functions as sub-
custodian).
(14) 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.
(b) (1) Registrant undertakes to file a post-effective amendment, using
reasonably current financial statements which need not be certified,
within four to six months from the effective date of Post-Effective
Amendment No. 30 to Registrant's 1933 Act Registration Statement
relating to shares of the International Small Cap Equity Portfolio or
the initial public offering thereof, whichever is later.
(2) Registrant undertakes to file a post-effective amendment, using
reasonably current financial statements which need not be certified,
within four to six months from the effective date of this Post-
Effective Amendment No. 33 to Registrant's 1933 Act Registration
Statement relating to shares of the Micro-Cap Equity Portfolio and
BlackRock Shares of the Intermediate Bond Portfolio, or the initial
public offering thereof, whichever is later.
(3) Registrant undertakes to file a post-effective amendment, using
reasonably current financial statements which need not be certified,
within four to six months from the effective date of this Post-
Effective Amendment No. 34 to Registrant's 1933 Act Registration
Statement relating to shares of the GNMA, Delaware Tax-Free Income and
Kentucky Tax-Free Income Portfolios, or the initial public offering
thereof, whichever is later.
C-22
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this Post-
Effective Amendment No. 34 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 13th day of February, 1998.
BLACKROCK FUNDS
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 No. 34 to the Registration Statement has been signed by the
following persons in the capacities and on the dates indicated:
Signature Title Date
--------- ----- ----
/s/ Raymond J. Clark Trustee, President and February 13, 1998
- ------------------------- Treasurer
(Raymond J. Clark)
/s/ David R. Wilmerding, Jr. Chairman of the Board February 13, 1998
- -------------------------
(David R. Wilmerding, Jr.)
/s/ Anthony M. Santomero Vice-Chairman of the February 13, 1998
- ------------------------- Board
(Anthony M. Santomero)
/s/ William O. Albertini Trustee February 13, 1998
- ------------------------
(William O. Albertini)
/s/ Robert M. Hernandez Trustee February 13, 1998
- -------------------------
(Robert M. Hernandez)
<PAGE>
EXHIBIT INDEX
-------------
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- -----------
<S> <C>
5(r) Form of Sub-Advisory Agreement between
BlackRock, Inc. and BlackRock Financial
Management, Inc. with respect to the GNMA
Portfolio, the Delaware Tax-Free Income Portfolio
and the Kentucky Tax-Free Income Portfolio.
8(e) Sub-Custodian Agreement dated April 27, 1992
among The Chase Manhattan Bank, N.A., The
PNC Fund and Provident National Bank.
8(g) Custodian Agreement dated June 13, 1983 between Provident
National Bank and State Street Bank and Trust Company.
8(h) Amendment No. 1 to Custodian Agreement.
11 Consent of Coopers & Lybrand L.L.P.
13(a) Form of Purchase Agreement.
16 Average Annual Total Return Computation.
</TABLE>
<PAGE>
EXHIBIT 5(r)
SUB-ADVISORY AGREEMENT
GNMA Portfolio
Delaware Tax-Free Income Portfolio
Kentucky Tax-Free Income Portfolio
AGREEMENT dated as of _______________, 1998, between BlackRock, Inc., a
Delaware corporation ("Adviser"), and BlackRock Financial Management, Inc., a
Delaware corporation ("Sub-Adviser").
WHEREAS, Adviser has agreed to furnish investment advisory services to the
GNMA Portfolio, the Delaware Tax-Free Income Portfolio and the Kentucky Tax-Free
Income Portfolio (each, a "Portfolio") of BlackRock Funds (the "Fund"), an open-
end, management investment company registered under the Investment Company Act
of 1940 ("1940 Act"); and
WHEREAS, Adviser wishes to retain the Sub-Adviser to provide it with sub-
advisory services as described below in connection with Adviser's advisory
activities on behalf of each Portfolio; and
WHEREAS, the advisory agreement between Adviser and the Fund dated January
4, 1996 (such Agreement or the most recent successor agreement between such
parties relating to advisory services to each Portfolio is referred to herein as
the "Advisory Agreement") contemplates that Adviser may sub-contract investment
advisory services with respect to each Portfolio to a sub-adviser pursuant to a
sub-advisory agreement agreeable to the Fund and approved in accordance with the
provisions of the 1940 Act; and
WHEREAS, this Agreement has been approved in accordance with the provisions
of the 1940 Act, and Sub-Adviser is willing to furnish such services upon the
terms and conditions herein set forth;
NOW, THEREFORE, in consideration of the premises and mutual covenants
herein contained, it is agreed between the parties hereto as follows:
1. Appointment. Adviser hereby appoints Sub-Adviser to act as sub-adviser
-----------
with respect to each Portfolio as provided in Section 2 of the Advisory
Agreement. Sub-Adviser accepts such appointment and agrees to render the
services herein set forth for the compensation herein provided.
<PAGE>
2. Services of Sub-Adviser. Subject to the oversight and supervision of
-----------------------
Adviser and the Fund's Board of Trustees, Sub-Adviser will supervise the day-to-
day operations of each Portfolio and perform the following services: (i)
provide investment research and credit analysis concerning each Portfolio's
investments, (ii) conduct a continual program of investment of each Portfolio's
assets, (iii) determine what portion of each Portfolio's assets will be invested
in cash, cash equivalents and money market instruments, (iv) place orders for
all purchases and sales of the investments made for each Portfolio, and (v)
maintain the books and records as are required to support Fund operations (in
conjunction with record-keeping and accounting functions performed by Adviser).
In addition, Sub-Adviser will keep the Fund and Adviser informed of developments
materially affecting the Fund and shall, on its own initiative, furnish to the
Fund from time to time whatever information Sub-Adviser believes appropriate for
this purpose. Sub-Adviser will communicate to Adviser on each day that a
purchase or sale of an instrument is effected for each Portfolio (i) the name of
the issuer, (ii) the amount of the purchase or sale, (iii) the name of the
broker or dealer, if any, through which the purchase or sale will be effected,
(iv) the CUSIP number of the instrument, if any, and (v) such other information
as Adviser may reasonably require for purposes of fulfilling its obligations to
the Fund under the Advisory Agreement. Sub-Adviser will provide the services
rendered by it under this Agreement in accordance with each Portfolio's
investment objectives, policies and restrictions as stated in each Portfolio's
Prospectus and Statement of Additional Information (as currently in effect and
as they may be amended or supplemented from time to time), and the resolutions
of the Fund's Board of Trustees.
3. Other Sub-Adviser Covenants. Sub-Adviser further agrees that it:
---------------------------
(a) will comply with all applicable Rules and Regulations of the Securities
and Exchange Commission (the "SEC") and will in addition conduct its activities
under this Agreement in accordance with other applicable law;
(b) will place orders either directly with the issuer or with any broker or
dealer. Subject to the other provisions of this paragraph, in placing orders
with brokers and dealers, Sub-Adviser will attempt to obtain the best price and
the most favorable execution of its orders. In placing orders, Sub-Adviser will
consider the experience and skill of the firm's securities traders as well as
the firm's financial responsibility and administrative efficiency. Consistent
with this obligation, Sub-Adviser may, subject to the approval of the Fund's
Board of Trustees, select brokers on the basis of the research, statistical and
pricing services they provide to the Portfolio and other clients of Adviser or
Sub-Adviser. Information and research received from such brokers will be in
addition to, and not in lieu of, the services required to be performed by Sub-
Adviser hereunder. A commission paid to such brokers may be higher than that
which another qualified broker would have charged for effecting the same
transaction, provided that Sub-Adviser determines in good faith that such
commission is reasonable in terms either of the transaction or the overall
responsibility of Adviser and Sub-Adviser to each Portfolio and their other
clients and that the total commissions paid by each Portfolio will be reasonable
in relation to the benefits to the
<PAGE>
Portfolio over the long-term. In addition, Sub-Adviser is authorized to take
into account the sale of shares of the Fund in allocating purchase and sale
orders for portfolio securities to brokers or dealers (including brokers and
dealers that are affiliated with Adviser, Sub-Adviser or the Fund's
distributor), provided that Sub-Adviser believes that the quality of the
transaction and the commission are comparable to what they would be with other
qualified firms. In no instance, however, will any Portfolio's securities be
purchased from or sold to the Adviser, Sub-Adviser, the Fund's distributor or
any affiliated person thereof, except to the extent permitted by the SEC or by
applicable law;
(c) will maintain or cause Adviser to maintain books and records with
respect to each Portfolio's securities transactions and will render to Adviser
and the Fund's Board of Trustees such periodic and special reports as they may
request;
(d) will maintain a policy and practice of conducting its investment
advisory services hereunder independently of the commercial banking operations
of its affiliates. When Sub-Adviser makes investment recommendations for a
Portfolio, its investment advisory personnel will not inquire or take into
consideration whether the issuer of securities proposed for purchase or sale for
the Portfolio's account are customers of the commercial department of its
affiliates; and
(e) will treat confidentially and as proprietary information of the Fund
all records and other information relative to the Fund, each Portfolio's and the
Fund's prior, current or potential shareholders, and will not use such records
and information for any purpose other than performance of its responsibilities
and duties hereunder, except after prior notification to and approval in writing
by the Fund, which approval shall not be unreasonably withheld and may not be
withheld where Sub-Adviser may be exposed to civil or criminal contempt
proceedings for failure to comply, when requested to divulge such information by
duly constituted authorities, or when so requested by the Fund.
4. Services Not Exclusive. Sub-Adviser's services hereunder are not
----------------------
deemed to be exclusive, and Sub-Adviser shall be free to render similar services
to others so long as its services under this Agreement are not impaired thereby.
5. Books and Records. In compliance with the requirements of Rule 31a-3
-----------------
under the 1940 Act, Sub-Adviser hereby agrees that all records which it
maintains for each Portfolio are the property of the Fund and further agrees to
surrender promptly to the Fund any such records upon the Fund's request. Sub-
Adviser further agrees to preserve for the periods prescribed by Rule 31a-2
under the 1940 Act the records required to be maintained by Rule 31a-1 under the
1940 Act.
6. Expenses. During the term of this Agreement, Sub-Adviser will pay all
--------
expenses incurred by it in connection with its activities under this Agreement
other than the cost of securities, commodities, and other investments (including
brokerage commissions and other transaction charges, if any) purchased or sold
for each Portfolio.
<PAGE>
7. Compensation. For the services which the Sub-Adviser will render to
------------
Adviser under this Agreement, Adviser will pay to Sub-Adviser a fee, computed
daily and payable monthly, at the following annual rates for each Portfolio:
.400% of the first $1 billion of each Portfolio's average daily net assets,
.350% of the next $1 billion of each Portfolio's average daily net assets, .325%
of the next $1 billion of each Portfolio's average daily net assets and .300% of
the average daily net assets of each Portfolio in excess of $3 billion.
If the Adviser waives any or all of its advisory fee payable under the
Advisory Agreement, or reimburses the Fund pursuant to Section 8(b) of that
Agreement, with respect to a Portfolio, the Sub-Adviser will bear its share of
the amount of such waiver or reimbursement by waiving fees otherwise payable to
it hereunder on a proportionate basis to be determined by comparing the
aggregate fees that would otherwise be paid to it hereunder with respect to the
Portfolio to the aggregate fees that would otherwise be paid by the Fund to the
Adviser under the Advisory Agreement with respect to the Portfolio. Adviser
shall inform Sub-Adviser prior to waiving any advisory fees.
8. Limitation on Liability. Sub-Adviser will not be liable for any error
-----------------------
of judgment or mistake of law or for any loss suffered by Adviser or by a
Portfolio in connection with the performance of this Agreement, except a loss
resulting from a breach of fiduciary duty with respect to the receipt of
compensation for services or a loss resulting from willful misfeasance, bad
faith or gross negligence on its part in the performance of its duties or from
reckless disregard by it of its obligations or duties under this Agreement.
9. Duration and Termination. This Agreement will become effective as of
------------------------
the date hereof and, unless sooner terminated with respect to a Portfolio as
provided herein, shall continue in effect with respect to each Portfolio until
March 31, 1999. Thereafter, if not terminated, this Agreement shall continue in
effect with respect to each Portfolio for successive annual periods ending on
March 31, provided such continuance is specifically approved at least annually
(a) by the vote of a majority of those members of the Fund's Board of Trustees
who are not interested persons of any party to this Agreement, cast in person at
a meeting called for the purpose of voting on such approval, and (b) by the
Fund's Board of Trustees or by a vote of a majority of the outstanding voting
securities of the Portfolio. Notwithstanding the foregoing, this Agreement may
be terminated with respect to a Portfolio at any time, without the payment of
any penalty, by the Fund (by vote of the Fund's Board of Trustees or by vote of
a majority of the outstanding voting securities of the Portfolio), or by Adviser
or Sub-Adviser on 60 days' written notice, and will terminate automatically upon
any termination of the Advisory Agreement between the Fund and Adviser. This
Agreement will also immediately terminate in the event of its assignment. (As
used in this Agreement, the terms "majority of the outstanding voting
securities," "interested person" and "assignment" shall have the same meanings
of such terms in the 1940 Act.)
10. Amendment of this Agreement. No provision of this Agreement may be
---------------------------
changed, waived, discharged or terminated orally, but only by an instrument in
writing
<PAGE>
signed by the party against which enforcement of the change, waiver, discharge
or termination is sought. Any amendment of this Agreement shall be subject to
the 1940 Act.
11. Miscellaneous. The captions in this Agreement are included for
-------------
convenience of reference only and in no way define or delimit any of the
provisions hereof or otherwise affect their construction or effect. If any
provision of this Agreement shall be held or made invalid by a court decision,
statute, rule or otherwise, the remainder of this Agreement shall not be
affected thereby. This Agreement shall be binding on, and shall inure to the
benefit of, the parties hereto and their respective successors and shall be
governed by Delaware law.
12. Counterparts. This Agreement may be executed in counterparts by the
------------
parties hereto, each of which shall constitute an original counterpart, and all
of which, together, shall constitute one Agreement.
[End of Text]
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this instrument to be
executed by their officers designated below as of the day and year first above
written.
BLACKROCK, INC.
By:______________________________
BLACKROCK FINANCIAL MANAGEMENT, INC.
By:______________________________
<PAGE>
EXHIBIT 8(e)
SUB-CUSTODIAN AGREEMENT
-----------------------
AGREEMENT dated as of April 27, 1992 among THE CHASE
MANHATTAN BANK, N.A. ("Bank"), THE PNC(R) FUND ("Fund") and PROVIDENT NATIONAL
BANK ("Company").
W I T N E S S E T H:
WHEREAS, Company has entered into a Custodian Agreement with the Fund,
a Massachusetts business trust, to provide certain custody services; and
WHEREAS, the company and the Fund wish to retain Bank to provide
certain Sub-custodian services to the Company and the Fund for the benefit of
the Fund, and Bank is willing to furnish such services;
NOW, THEREFORE, in consideration of the premises and mutual covenants
herein contained, it is agreed between the parties hereto as follows:
1. Custody Account. The bank agrees to establish and maintain (a) a
---------------
separate custody account for each investment portfolio of the Fund ("Custody
Account") for any and all stocks, shares, bonds, debentures, notes, mortgages or
other obligations for the payment of money and any certificates, receipts,
warrants or other instruments representing rights to receive, purchase or
subscribe for the same or evidencing or representing any other rights or
interests therein and other similar property (hereinafter called "Securities")
from time to time received by the Bank or any sub-custodian (as defined in the
second paragraph of Section 3 hereof) for the account of the particular
investment portfolio of the Fund; and (b) a separate deposit account or
<PAGE>
2
accounts in the name of each investment portfolio of the Fund ("Deposit
Account") for any and all cash equivalents in any currency received by the Bank
or any sub-custodian for the account of the particular investment portfolio of
the Fund, which cash shall not be subject to withdrawal by draft or check. The
term "Property" as used herein shall mean all securities, cash, cash equivalents
and other assets of the Fund.
2. Maintenance of Property Abroad. Securities in a Custody Account
------------------------------
shall be held in the country or other jurisdiction as shall be specified from
time to time in Instructions (as defined in section 9 hereof), provided that
such country or other jurisdiction shall be one in which the principal trading
market for such Securities is located or the country or other jurisdiction in
which such Securities are to be presented for payment or are acquired for the
Custody Account, and cash in a Deposit Account shall be credited to an account
in such country on other jurisdiction in which such cash may be legally
deposited or is the legal currency for the payment of public or private debts.
Cash may be held pursuant to Instructions in either interest or non-interest
bearing accounts as may be available for the particular currency. To the extent
Instructions are issued and the Bank can comply with such Instructions, the Bank
is authorized to maintain cash balances on deposit for the Fund with itself or
one of its affiliates at such reasonable rates of interest as may from time to
time be paid on such accounts, or in non-interest bearing accounts as the Fund
may direct, if acceptable to the Bank.
<PAGE>
3
3. Eligible Foreign Custodians and Securities Depositories.
-------------------------------------------------------
The Board of Trustees of the Fund authorizes the Bank to hold the Securities in
the Custody Account(s) and the cash in the Deposit Account(s) in custody and
deposit accounts, respectively, which have been established by the bank with one
of its branches, a branch of a qualified U.S. bank, an eligible foreign
custodian or an eligible foreign securities depository; provided, however, that
the Board of Trustees of the Fund has approved the use of, and the Bank's
contract with, such eligible foreign custodian or eligible foreign securities
depository by resolution, and Instructions to such effect have been provided to
the Bank. Furthermore, if a Bank's branch, a branch of a qualified U.S. bank or
an eligible foreign custodian is selected to act as the Bank's sub-custodian to
hold any Property, such entity is authorized to hold such Property in its
account with any eligible foreign securities depository in which it participates
so long as such foreign securities depository has been approved by the Board of
Trustees of the Fund. For purposes of this Agreement (a) "qualified U.S. bank"
shall mean a qualified U.S. bank as defined in Rule 17f-5 under the Investment
Company Act of 1940, as amended ("Rule 17f-5"); (b) "eligible foreign custodian"
shall seen (i) a banking institution or trust company incorporated or organized
under the laws of a country other than the United States that is regulated as
such by that country's government or an agency thereof and that has
shareholders' equity in excess of $200 million in U.S. currency or a foreign
currency equivalent thereto) or (ii) a
<PAGE>
4
majority-owned direct or indirect subsidiary of a qualified U.S. bank or bank
holding company that is incorporated or organized under the laws of a country
other than the United States and that has shareholders' equity in excess of $100
million in U.S. currency (or a foreign currency equivalent thereto), and (c)
"eligible foreign securities depository" shall mean a securities depository or
clearing agency, incorporated or organized under the laws of a country other
than the United States, which operates (i) the central system for handling of
securities or equivalent book-entries in that country or (ii) a transnational
system for the central handling of securities or equivalent book--entries.
Hereinafter the term "sub-custodian" will refer to any Bank branch,
any branch of a qualified U.S. bank, any eligible foreign custodian or any
eligible foreign securities depository with which the Bank has entered into an
agreement of the type contemplated hereunder regarding Securities and/or cash
held in or to be acquired for a Custody Account or a Deposit Account.
If, after the initial approval of the sub-custodians by the Board of
Trustees of the Fund in connection with this Agreement, the Bank wishes to
appoint other sub-custodians to hold the Fund's Property, it will so notify the
Company and the Fund and will provide them with information reasonably necessary
to determine any such new sub-custodian's eligibility under Rule 17f-5,
including a copy of the proposed agreement with such-custodian. The Fund shall
within 30 days after receipt of
<PAGE>
5
such notice give a written approval or disapproval of the proposed action.
If the Bank intends to remove any sub-custodian previously approved,
it shall so notify the Fund and the Company and shall move the Property
deposited with such sub-custodian to another sub-custodian previously approved
or to a new sub-custodian, provided that the appointment of any new sub-
custodian will be subject to the requirements set forth in the preceding
paragraph. The Bank shall take steps as may be required to remove any sub-
custodian which has ceased to meet the requirements of Rule 17f-5.
4. Use of Sub-Custodians. With respect to Property which is
---------------------
maintained by the Bank in the physical custody of a sub-custodian pursuant to
Section 3:
(a) The Bank will identify on its books as belonging to the
particular investment portfolio of the Fund any Property held by such sub-
custodian.
(b) In the event that a sub-custodian permits any of the Securities
placed in its care to be held in an eligible foreign securities depository, such
sub-custodian will be required by its agreement with the Bank to identify on its
books such Securities as being held for the account of the Bank as a custodian
for its customers.
(c) Any Securities in a Custody Account held by a sub-custodian of
the Bank will be subject only to the instructions of the Bank or its agents; and
any Securities held in an eligible
<PAGE>
6
foreign securities depository for the account of a sub-custodian will be subject
only to the instructions of such sub-custodian.
(d) The Bank will only deposit Property in an account with a sub-
custodian which includes exclusively the assets held by the Bank for its
customers, and the Bank will cause such account to be designated by such sub-
custodian as a special custody account for the exclusive benefit of customers of
the Bank.
(e) Any agreement the Bank shall enter into with a sub-custodian with
respect to the holding of property shall require that (i) the Property is not
subject to any right, charge, security interest, lien or claim of any kind in
favor of such sub-custodian or its creditors except for a claim of payment for
its safe custody or administration and (ii) beneficial ownership of such
Property is freely transferable without the payment of money or value other than
for safe custody or administration; provided, however, that the foregoing shall
not apply to the extent that any of the above-mentioned rights, charges, etc.
result from any compensation or other expenses arising with respect to the
safekeeping of Property pursuant to such agreement.
(f) The Bank shall allow independent public accountants of the Fund
such reasonable access to the records of the Bank relating to Property held in a
Custody Account and a Deposit Account as required by such accountants in
connection with their examination of the books and records pertaining to the
affairs of the Fund. The Bank shall, subject to restrictions
<PAGE>
7
under applicable law, also obtain from any sub-custodian with which the Bank
maintains the physical possession of any Property an undertaking to permit
independent public accountants of the Fund such reasonable access to the records
of such sub-custodian as may be required in connection with their examination of
the books and records pertaining to the affairs of the Fund or to supply a
verifiable confirmation of the contents of such records. The Bank shall furnish
the Fund and the Company such reports (or portions thereof) of the Bank's
external auditors as relate directly to the Bank's system of internal accounting
controls applicable to the Bank's duties under this Agreement.
(g) The Bank will supply to the Fund, care of its investment adviser,
and the Company at least monthly a statement in respect to any Property in a
Custody and a Deposit Account held by each sub-custodian, including an
identification of the entity having possession of such Property, and the Bank
will send to the Fund and the Company an advice or notification of any transfers
of Property to or from the Custody Account and Deposit Account, indicating, as
to Property acquired for an investment portfolio of the Fund, the identity of
the entity having physical possession of such Property. In the absence of the
filing in writing with the Bank by the Fund of exceptions or objections to any
such statement within sixty (60) days of the Fund's receipt of such statement,
or within sixty (60) days after the date that a material defect is reasonably
discoverable, the Fund shall be deemed to have approved such statement; and in
such case or upon written approval of the Fund of any such statement the Bank
<PAGE>
8
shall, to the extent permitted by law and provided the Bank has met the standard
of care in Section 12 hereof, be released, relieved and discharged with respect
to all matters and things set forth in such statement as though such statement
has been settled by the decree of a court of competent jurisdiction in an action
in which the Fund and all persons having any equity interest in the Fund were
parties.
(h) The Bank hereby warrants to the Fund and the Company that in its
opinion, after due inquiry, the established procedures to be followed by each of
its branches, each branch of a qualified U.S. bank, each eligible foreign
custodian and each eligible foreign securities depository holding Property of
the Fund pursuant to this Agreement afford protection for such Property at least
equal to that afforded by the Bank's established procedures with respect to
similar Property held by the Bank (and its securities depositories) in New York.
(i) The Bank hereby warrants to the Fund and the Company that as of
the date of this Agreement it is maintaining a Bankers Blanket Bond and hereby
agrees to notify the Fund and the Company in the event its Bankers Blanket Bond
is cancelled or otherwise lapses.
5. Deposit Account Payments. Subject to the provisions of Section 7,
------------------------
the Bank shall make, or cause its sub-custodian to make, payments of cash
credited to a Deposit Account only:
(a) in connection with the purchase of Securities for the particular
investment portfolio of the Fund involved and the
<PAGE>
9
delivery of such Securities to, or the crediting of such Securities to the
particular Custody Account of, the Bank or its sub-custodian, each such payment
to be made at prices as confirmed by Instructions from Authorized Parsons (as
defined in Section 10 hereof);
(b) for the purchase or redemption of shares of the capital stock of
the particular investment portfolio of the Fund involved and the delivery to, or
crediting to the account of, the Bank or its sub-custodian of such shares to be
so purchased or redeemed;
(c) for the payment for the account of the particular investment
portfolio of the Fund involved of dividends, interest, taxes, management or
supervisory fees, capital distributions or operating expenses;
(d) for the payments to be made in connection with the conversion,
exchange or surrender of Securities held in a Custody Account;
(e) for other proper corporate purposes of the particular investment
portfolio of the Fund involved; or
(f) upon the termination of this Custody Agreement as hereinafter set
forth.
All payments of cash for a purpose permitted by subsection (a), (b),
(c) or (d) of this Section 5 will be made only upon receipt by the Bank of
Instructions from Authorized Persons which shall specify the purpose for which
the payment is to be made and the applicable subsection of this Section 5. In
the case of any payment to be made for the purpose permitted by
<PAGE>
10
subsection (e) of this Section 5, the Bank must first receive a certified copy
of a resolution or the Board of Trustees of the Fund adequately describing such
payment, declaring such purpose to be a proper corporate purpose, and naming the
person or persons to whom such payment shall be made. Any payment pursuant to
subsection (f) of this Section 5 will be made in accordance with Section 17
hereof.
In the event that any payment for an investment portfolio of the Fund
made under this Section 5 exceeds the funds available in that investment
portfolio's Deposit Account, the Bank may, in its discretion, advance the Fund
on behalf of tax investment portfolio an amount equal to such excess and such
advance shall be deemed a loan from the Bank to that investment portfolio
payable on demand, bearing interest at the rate of interest customarily charged
by the Bank on similar loans. If the Bank causes a Deposit Account to be
credited on the payable date for interest, dividends or redemptions, the
particular investment portfolio of the Fund involved will promptly return to the
Bank any such amount or property so credited upon oral or written notification
that neither the Bank nor its sub-custodian can collect such amount or property
in the ordinary course of business. The Bank or its sub-custodian, as the case
may be, shall have no duty or obligation to institute legal proceedings, file a
claim or proof of claim in any insolvency proceeding or take any other action
with respect to the collection of such amount or property beyond its ordinary
collection procedures.
<PAGE>
11
6. Custody Account Transactions. Subject to the provisions of
----------------------------
Section 7, Securities in a Custody Account will be transferred, exchanged or
delivered by the Bank or its sub-custodians only:
(a) upon sale of such Securities for the particular
investment portfolio of the Fund involved and receipt by the Bank or its sub-
custodian of payment therefor, each such payment to be
in the amount confirmed by Instructions from Authorized Persons;
(b) when such Securities are called, redeemed or
retired, or otherwise become payable;
(c) in exchange for or upon conversion into other
Securities alone or other Securities and cash pursuant to any plan of merger,
consolidation, reorganization, recapitalization or readjustment;
(d) upon conversion of such Securities pursuant to their terms into
other Securities;
(e) upon exercise of subscription, purchase or other similar rights
represented by such Securities;
(f) for the purpose of exchanging interim receipts or temporary
Securities for definitive Securities;
(g) For the purpose of redeeming in kind shares of the capital stack
of the particular investment portfolio of the Fund involved against delivery to
the Bank or its sub-custodian of such shares to be redeemed;
(h) for other proper corporate purposes of the particular investment
portfolio of the Fund involved; or
<PAGE>
12
(i) upon the termination of this Custody Agreement as hereinafter set
forth.
All transfers, exchanges or deliveries of Securities in a Custody Account for a
purpose permitted by either subsection (a), (b), (c), (d), (e) of (f) of this
Section 6 will be made, except an provided in Section 8 hereof, only upon
receipt by the Bank of Instructions from Authorized Persons which shall specify
the purpose of the transfer, exchange or delivery to be made and the applicable
subsection of this Section 6. In the case of any transfer or delivery to be
made for the purpose permitted by subsection (g) of this Section 6, the Bank
must first receive Instructions from Authorized Persons specifying the shares
held by the Bank or its sub-custodian to be so transferred or delivered and
naming the person or persons to whom transfers or delivery of such shares shall
be made. In the case of any transfer, exchange or delivery to be made for the
purpose permitted by subsection (h) of this Section 6, the Bank must first
receive a certified copy of a resolution of the Board of Trustees of the Fund
adequately describing such transfer, exchange or delivery of declaring such
purpose to be a proper corporate purpose, and naming the person or persons to
whom delivery, of such Securities shall be made. Any transfer or delivery
pursuant to subsection (i) of this Section 6 will be made in accordance with
Section 17 hereof.
7. Custody Account Procedures. With respect to any transaction
--------------------------
involving Securities held in or to be acquired for a Custody Account, the Bank
in its discretion may cause the Deposit
<PAGE>
13
Account for the particular investment portfolio of the Fund involved to be
credited on the contractual settlement date with the proceeds of any sale or
exchange of Securities from the particular Custody Account and to be debited on
the contractual settlement date for the cost of Securities purchased or acquired
for the particular Custody Account. The Bank may reverse any such credit or
debit if the transaction with respect to which such credit or debit was made
fails to settle within a reasonable period, determined by the Bank in its
discretion, after the contractual settlement date, except that if any Securities
delivered pursuant to this Section 7 are returned by the recipient thereof, the
Bank may cause any such credits and debits to be reversed at any time. With
respect to any transactions as to which the Bank does not determine so to credit
or debit the particular Deposit Account, the proceeds from the sale or exchange
or Securities will be credited and the cost of such Securities purchased or
acquired will be debited to the particular Deposit Account on the date such
proceeds or Securities are received by the Bank.
Notwithstanding the preceding paragraph, settlement and payment for
Securities received for, and delivery of Securities out of, a Custody Account
may be effected in accordance with the customary or established securities
trading or securities processing practices and procedures in the jurisdiction or
market in which the transaction occurs, including, without limitation,
delivering Securities to the purchaser thereof or to a dealer therefor (or an
agent for such purchaser or dealer) against a
<PAGE>
14
receipt with the expectation of receiving later payment for such Securities from
such purchaser or dealer.
8. Actions of the Bank. Until the Bank receives Instructions from
-------------------
Authorized Persons to the contrary, the Bank will, or will instruct its sub-
custodian, to:
(a) present for payment any Securities in a Custody Account which are
called, redeemed or retired or otherwise become payable and all coupons and
other income items which call for payment upon presentation to the extent that
the Bank or sub-custodian is aware of such opportunities for payment, and hold
cash received upon presentation of such Securities in accordance with the
provisions of Sections 2, 3 and 4 hereof;
(b) in respect of Securities in a Custody Account, execute in the name
of the Fund on behalf of the particular investment portfolio involved such
ownership and other certificates as may be required to obtain payments in
respect thereof;
(c) exchange interim receipts or temporary Securities in a Custody
Account for definitive Securities;
(d) (if applicable) convert monies received with respect to
Securities of foreign issue into United States dollars or any other currency
necessary to effect any transaction involving the Securities whenever it is
practicable to do so through customary banking channels, using any method or
agency available, including, but not limited to, the facilities of the Bank, its
subsidiaries, affiliates or sub-custodians;
<PAGE>
15
(e) (if applicable) appoint brokers and agents for any transaction
involving the Securities in a Custody Account, including, without limitation,
affiliates of the Bank or any sub-custodian; and
(f) reclaim taxes withheld by foreign issuers where
reclaim is possible, provided that Bank has been provided with all documentation
it may require.
9. Instructions. As used in this Agreement, the term
------------
"Instructions" means instructions of the Fund or the Company received by the
Bank via telephone, telex, TWX, facsimile transmission, bank wire or other
teleprocess or electronic instruction system acceptable to the Bank which the
Bank believes in good faith to have been given by Authorized Persons or which
are transmitted with proper testing or authentication pursuant to terms and
conditions which the Bank may specify.
Any Instructions delivered to the Bank by telephone shall promptly
thereafter be confirmed in writing by an Authorized Person (which confirmation
may bear the facsimile signature of such Person), but the particular investment
portfolio of the Fund involved and the Company will hold the Bank harmless for
the Company's or the Fund's (i) failure to send such confirmation in writing, or
(ii) the failure of such confirmation to conform to the telephone Instructions
received. Unless otherwise expressly provided, all Instructions shall continue
in full force and effect until cancelled or superseded. If the Bank requires
test arrangements, authentication methods or other security devices to be used
with respect to Instructions, any
<PAGE>
16
Instructions given by the Fund or the Company thereafter shall be given and
processed in accordance with such terms and conditions for the use of such
arrangements, methods or devices as the Bank may put into effect and modify from
time to time. The Fund and the Company shall safeguard any testkeys,
identification codes or other security devices which the Bank shall make
available to them. The Bank may electronically record any Instructions given by
telephone, and any other telephone discussions, with respect to a Custody
Account.
10. Authorized Persons. As used in this Agreement, the term
------------------
"Authorized Parsons" means such officers or such agents of the Fund or the
Company as have been designated by a resolution of the Board of Trustees of the
Fund, a certified copy of which has been provided to the Bank, to act on behalf
of the Fund in the performance of any acts which Authorized Persons may do under
this Agreement. Such persons shall continue to be Authorized Persons until such
time as the Bank receives Instructions from Authorized Persons that any such
officer or agent is no longer an Authorized Person.
11. Nominees. Securities in a Custody Account which are ordinarily
--------
in registered form may be registered in the name of the Bank's nominee or, as to
any Securities in the possession of an entity other than the Bank, in the name
of such entity's nominee. The particular investment portfolio of the Fund
involved agrees to hold any such nominee harmless from any liability as a holder
of record of such Securities, but not if such liability is a result of such
nominee's negligence. The
<PAGE>
17
Bank may without notice to the Company or the Fund cause any such Securities to
cease to be registered in the name of any such nominee and to be registered in
the name of the Fund. In the event that any Securities registered in the name
of the Bank's nominee or held by one of its sub-custodians and registered in the
name of such sub-custodian's nominee are called for partial redemption by the
issuer of such Security, the Bank may allot, or cause to be allotted, the called
portion to the respective beneficial holders of such class of security in any
manner the Bank deems to be fair and equitable.
12. Standard of Care.
----------------
(a) The Bank shall be obligated to perform only such
duties as are set forth in this Agreement or expressly contained in instructions
given to Bank which are consistent with the provisions of this Agreement.
(i) The Bank will use reasonable care with respect to its
obligations under this Agreement and the safekeeping of
Property. The Bank shall be liable to the Fund and the
Company for any loss which shall occur as the result of the
failure of a sub-custodian or an eligible foreign securities
depository to exercise reasonable care with respect to the
safekeeping of such Property to the same extent that the Bank
would be liable to the Fund and the Company if the Bank were
holding such Property is New York. In the event of any loss
to the Fund or the Company by reason of the failure of the
Bank or its sub-custodian or an eligible foreign securities
depository to exercise reasonable care, the Bank shall be
liable to the Fund or the Company only to the extent of the
Fund's or Company's direct damages and expenses to be
determined based on, but not limited to, the market value of
the Property which is the subject of the loss at the date of
discovery of such loss and without reference to any special
conditions or circumstances.
<PAGE>
18
(ii) The Bank will not be responsible for any act, omission,
default or for the solvency of any broker or agent (other than
as provided herein) which it or a sub-custodian appoints and
uses unless such appointment and use were made or done
negligently or in bad faith.
(iii) The Bank shall be indemnified by, and without liability to
the particular investment portfolio of the Fund involved and
the Company for any action taken or omitted by the Bank
whether pursuant to Instructions or otherwise within the scope
of this Agreement if such act or omission was in good faith
and without negligence. In performing its obligations under
this Agreement, the Bank may rely on the genuineness of any
document which it believes in good faith and without
negligence to have been validly executed.
(iv) The Fund, on behalf of the particular investment portfolio
of the Fund involved, agrees to cause such investment
portfolio to pay for and hold the Bank harmless from any
liability or loss resulting from the imposition or assessment
of any taxes or other governmental charges, and any related
expenses with respect to income from or Property in such
investment portfolio's Custody Account and Deposit Account.
(v) The Bank shall be entitled to rely, and may act upon the
advice of counsel (who may be counsel for the Fund or the
Company) on all matters and shall be without liability for any
action reasonably taken or omitted in good faith and without
negligence pursuant to such advice.
(vi) The Bank need not maintain any insurance for the exclusive
benefit of the Fund or Company.
(vii) Without limiting the forgoing, the Bank shall not be
liable for any loss which results from:
1) the general risk of investing, or
2) subject to Section 12(a)(i) hereof, investing or holding
Property in a particular country including, but not
limited to, losses resulting from nationalization,
expropriation or other governmental actions; regulation of
the banking or securities industry; currency restrictions,
devaluations or fluctuations; and market conditions which
prevent the
<PAGE>
19
orderly execution of securities transactions or affect the
value of Property.
(viii) No party shall be liable to the other for any loss due to
forces beyond its control including but not limited to strikes
or work stoppages, acts of war or terrorism, insurrection,
revolution, nuclear fusion, fission or radiation, or acts of
God.
(b) Consistent with and without limiting the first paragraph of this
Section 12, it is specifically acknowledged that the Bank shall have no duty or
responsibility to:
(i) Question Instructions or make any suggestions to the Fund,
Company or an Authorized Person regarding such Instructions;
(ii) Supervise or make recommendations with respect to
investments or the retention of Securities;
(iii) Subject to Section 12(a)(ii) hereof, evaluate or report to
the Fund, Company or an Authorized Person regarding the
financial condition of any broker, agent or other party to
which Securities are delivered of payments are made pursuant
to this Agreement; or
(iv) Review or reconcile trade confirmations received from
brokers.
(c) The Bank shall provide to the Fund, on an annual basis, a report
confirming that the arrangements hereunder remain in compliance with the rules
of the Securities and Exchange Commission governing such arrangements.
13. Compliance with Securities and Exchange Commission Rules and
------------------------------------------------------------
Orders. Except to the extent the Bank has specifically
- ------
agreed pursuant to this Agreement or in an exemptive order to comply with a
condition of Rule 17f-5 or any interpretation or exemptive order promulgated
thereunder by or under the authority of the Securities and Exchange Commission,
the Fund shall be
<PAGE>
20
solely responsible to assure that the maintenance of Securities and cash under
this Agreement complies with such Rule 17f-5.
14. Corporate Action. Whenever the Bank or its sub-custodian
----------------
receives information concerning the Securities which requires discretionary
action by the beneficial owner of the Securities (other than a proxy), such as
subscription rights, bonus issues, stock repurchase plans and rights offerings,
or legal notices or other material intended to be transmitted to securities
holders ("Corporate Actions"), the Bank will give the Company notice of such
Corporate Actions to the extent that the Bank's central corporate actions
department has actual knowledge of a Corporate Action in time to notify its
customers.
When a rights entitlement or a fractional interest resulting from a
rights issue, stock dividend, stock split or similar Corporate Action is
received which bears an expiration date, the Bank or its sub-custodians will
endeavor to obtain Instructions from the Fund, Company or its Authorized Person,
but if Instructions are not received in time for the Bank to take timely action,
or actual notice of such Corporate Action was received too late to seek
Instructions, the Bank is authorized to sell such rights entitlement or
fractional interest and to credit the applicable Deposit Account with the
proceeds and to take any other action it deems, in good faith, to be appropriate
in which case, provided it has set the standard of care in Section 12 hereof, it
shall be held harmless by the particular investment portfolio of the Fund
involved for any such action.
<PAGE>
21
The Bank will deliver proxies to the Company or its designated agent
pursuant to special arrangements which may have been agreed to in writing
between the parties hereto. Such proxies shall be executed in the appropriate
nominee name relating to Securities in a Custody Account registered in the name
of such nominee but without indicating the manner in which such proxies are to
be voted; and where bearer Securities are involved, proxies will be delivered in
accordance with instructions from Authorized Persons.
15. Fees and Expenses. The Fund agrees to pay to the Bank from time
-----------------
to time such compensation for its services pursuant to this Agreement as may be
mutually agreed upon in writing from time to time and the Bank's out-of-pocket
or incidental expenses, including (but without limitation) reasonable legal
fees. The Fund hereby agrees on behalf of its respective investment portfolios
to cause the particular investment portfolio of the Fund involved to hold the
Bank harmless from any liability or loss resulting from any taxes or other
governmental charges, and any expenses related thereto, which may be imposed, or
assessed with respect to such investment portfolio's Custody Account and also
agrees on behalf of its respective investment portfolios to cause the particular
investment portfolio of the Fund involved to hold the Bank, its sub-custodians,
and their respective nominees harmless from any liability as a record holder of
Securities in such investment portfolio's Custody Account. The Bank is
authorized to charge any account for the particular investment portfolio of the
Fund
<PAGE>
22
involved for such items and the Bank shall have a lien on Securities in such
investment portfolio's Custody Account and on cash in such investment
portfolio's Deposit Account for any amount owing to the Bank in connection with
such investment portfolio from time to time under this Agreement.
16. Effectiveness. This Agreement shall be effective on the date
-------------
first noted above.
17. Termination. This Agreement may be terminated by the Fund, the
-----------
Company or the Bank by 60 days' written notice to the other, sent by registered
mail, provided that any termination by the Company shall be authorized by a
resolution of the Board of Trustees of the Fund, a certified copy of which shall
accompany such notice of termination, and provided further, that such resolution
shall specify the names of persons to whom the Bank shall deliver the Securities
in each Custody Account and to whom the cash in each Deposit Account shall be
paid. If notice of termination is given by the Bank, the Fund or the Company
shall, within 60 days following the giving of such notice, deliver to the Bank a
certified copy of a resolution of the Board of Trustees of the Fund specifying
the names of the persons to whom the Bank shall deliver such Securities and
cash, after deducting therefrom any amounts which the Bank determines to be owed
to it under Section 15 hereof. If within 60 days following the giving of a
notice of termination by the Bank, the Bank does not receive from the Fund or
the Company a certified copy of a resolution of the Board of Trustees of the
Fund specifying the names of the persons to whom the cash in each Deposit
Account
<PAGE>
23
shall be paid and to whom the Securities in each Custody Account shall be
delivered, the Bank, at its election, may deliver such Securities and pay such
cash to a bank or trust company doing business in the State of New York and
qualified as a custodian under the Investment Company Act of 1940 to be held and
disposed of pursuant to the provisions of this Agreement, or to Authorized
Persons, or may continue to hold such Securities and cash until a certified copy
of one or more resolutions as aforesaid is delivered to the Bank. The
obligations of the parties hereto regarding the use of reasonable care,
indemnities and payment of fees and expenses shall survive the termination of
this Agreement, and the obligations of each investment portfolio of the Fund to
indemnify and/or hold harmless other persons or entities under this Agreement
shall be the several (and not the joint or joint and several) obligation of each
investment portfolio of the Fund.
18. Notices. Any notice or other communication from the Fund or the
-------
Company to the Bank is to be sent to the office of the Bank at 1211 Avenue of
the Americas (33rd floor), New York, New York, 10036, Attention: Global Custody
Division, or such other address as may hereafter be given to the Fund or the
Company in accordance with the notice provisions hereunder, and any notice from
the Bank to the Fund on the Company is to be mailed postage prepaid, addressed
to the Fund and to the Company at the addresses appearing below, or as the same
may hereafter be changed on the Bank's records in accordance with notice
hereunder from the Fund or the Company.
<PAGE>
24
19. Governing Law and Successors and Assigns. This Agreement shall
----------------------------------------
be governed by the law of the State of New York and shall not be assignable by
any party, but shall bind the successors and assigns of the Fund, the Company
and the Bank.
20. Headings. The headings of the paragraphs hereof are included for
--------
convenience of reference only and do not form a part of this Agreement.
21. Counterpart Execution. This Agreement may be executed in any
---------------------
number of counterparts with the same effect as if all parties hereto had signed
the same document. All counterparts shall be construed together and shall
constitute one agreement.
22. Confidentiality. Bank agrees an behalf of itself and its
---------------
employees to treat confidentially all records and other information relative to
the Fund and its prior, present, or potential shareholders, and relative to the
Company and its prior, present, or potential customers, except, after prior
notification to and approval in writing by the Fund or the Company, which
approval shall not be unreasonably withheld and may not be withheld where Bank
way be exposed to civil or criminal contempt proceedings for failure to comply,
when requested to divulge such information by duly constituted authorities, or
when so requested by the Fund or the Company.
<PAGE>
25
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to
be executed by their officers designated below on the day and year first above
written.
PROVIDENT NATIONAL BANK
By:____________________________
Address for record:
Airport Business Center
200 Stevens Drive
Lester, PA 19113
THE CHASE MANHATTAN BANK, N.A.
By:_____________________________
Address for record:
1211 Avenue of the Americas
New York, NY 10036
THE PNC(R) FUND
By:_____________________________
Address for record:
Bellevue Park Corporate Center
103 Bellevue Parkway
Wilmington, DE 19809
<PAGE>
EXHIBIT 8(g)
CUSTODIAN AGREEMENT
AGREEMENT made as of this 13th day of June, 1983, between Provident
National Bank, a Pennsylvania corporation having a place of business at 17th &
Chestnut Street Phila., PA (hereinafter called the "Company"), and STATE STREET
BANK AND TRUST COMPANY, a Massachusetts banking corporation, having its
principal place of business at Boston, Massachusetts (hereinafter called "State
Street").
WITNESSETH THAT:
---------------
In consideration of the mutual agreements herein contained by the
Company and State Street hereby agree as follows:
1. The Company agrees to and does hereby appoint State Street its
Custodian and Agent, and agrees that State Street shall retain all
securities received from the Company at State Street Bank & Trust
Company, 12 Nicholas Lane, London, England.
2. All securities delivered to State Street (other than bearer
securities) shall be properly endorsed and in form for transfer or in
the name of a nominee of State Street.
3. State Street shall have the following powers and perform the following
duties:
A. To keep safely the securities of the Company and on behalf of the
Company, from time to time, to receive delivery of certificates
for safekeeping. Securities of the Company may be maintained by
State Street at its premises, or upon receipt of proper
instructions from the Company and a representation that no rule
or regulation applicable to
<PAGE>
2
the Company prohibits the safekeeping of the Company's securities
in a foreign depository or in a book-entry system, at a sub-
custodian bank or in a book-entry system for the central handling
of securities. State Street shall maintain records of all
receipts, deliveries and locations of such securities, together
with a current inventory thereof.
B. To register securities of the Company by State Street in the name
of the nominee of State Street.
C. Upon receipt of proper instructions, and insofar as cash is
available for the purpose, to pay for and receive all securities
purchased for the account of the Company and to collect all
dividends, interest, or other distributions of the issuer, due
the purchaser.
D. Upon receipt of proper instructions, to exchange securities held
by it for the account of the Company for other securities or for
other securities and cash, and to expend cash, in connection with
any merger, consolidation, reorganization, recapitalization
split-up of shares, changes of par value or conversion or in
connection with the exercise of subscription or purchase rights,
or otherwise.
E. Upon receipt of proper instructions to make delivery of
securities which have been sold for the account of the Company,
or which have been called, redeemed, retired, or otherwise become
payable, upon payment therefor. All such payments are to be made
in cash, by a certified check or a treasurer's or cashier's check
of a bank or in the case of
<PAGE>
3
delivery through a securities depository, by credit by the
securities depository, all in accordance with street custom.
F. Promptly to execute all proxies in favor of management unless
otherwise directed and to mail said proxies to the address
specified.
4. State Street shall have and perform the following additional powers
and duties:
A. To retain cash of the Company in the banking department of an
agent bank in a separate account or accounts in the name of State
Street for the account of the Company, subject only to draft or
order by State Street acting pursuant to the terms of this
Agreement. State Street reserves the right to reverse erroneous
entries to the Company's account and to charge the account for
the amount of securities for which payment has not been made.
B. To collect, receive and deposit in the bank account maintained
pursuant to Paragraph 4(A) all income and other payments with
respect to the securities held hereunder.
C. Except as otherwise agreed to in writing, any securities or other
property of the Company at any time in the possession of State
Street may at all times be held and treated as collateral for the
payment of securities for which payment has not been made.
D. To render reports as agreed upon from time to time between both
parties.
5. State Street shall be deemed to have received proper instructions upon
receipt of written instructions signed by a majority of the Board of
Directors of the
<PAGE>
4
Company or by one or more persons as the Board of Directors shall have
from time to time authorized to give the particular instructions in
question. Different persons may be authorized to give instructions
for different purposes. A certified copy of a resolution or action of
the Board of Directors of the Company may be received and accepted by
State Street as conclusive evidence of the authority of any such
person or persons to act and may be considered as in full force and
effect until receipt of written notice to the contrary. Such
instructions may be general or specific in terms, and unless specified
to the contrary, State Street is authorized to act upon such
instructions whether given orally, by telephone, telex or otherwise.
6. State Street shall be kept indemnified by the Company and be without
liability for any action taken or thing done by it in carrying out the
terms and provisions of this Agreement provided that State Street has
acted in good faith and has not been guilty of gross negligence.
State Street shall have no more or less responsibility or liability to
the Company on account of any action or omission of any subcustodian
employed by State Street than any such subcustodian has to State
Street.
7. The Company shall pay to State Street the compensation set forth in
Exhibit A hereto until a different compensation shall be agreed upon
in writing between the parties together with United Kingdom Value
Added Tax (if any) hereon and any other includable expenses incurred
in connection herewith.
<PAGE>
5
8. If State Street has issued to the Company a test key security system
in order that State Street may verify that certain transmission of
information has been originated by the Company, the Company hereby
agrees:
A. To indemnify State Street against and to save State Street
harmless from all liability, claims, loss and demands whatsoever,
including attorney's fees, howsoever arising or incurred because
of or in connection with State Street's relying on receipt of a
test key to authenticate previous transmission received by State
Street apparently from the Company.
B. To cause the Company's internal auditors to verify to State
Street from time to time that use of and access to the test key
system is restricted to authorized employees.
C. To cause the Company's independent auditors to certify to State
Street on an annual basis that use of, and access to, the test
key system is restricted to authorized employees.
9. These provisions may be altered in any manner and to any extent by
written agreement between the Company and State Street.
10. Either party may terminate this Agreement by notice in writing
delivered or mailed to the other party hereto not less than thirty
(30) days prior to the date on which such termination shall take place
and thereupon this Agreement shall terminate in accordance with such
notice and all property then held shall be delivered to the Company or
upon its order to its successor.
<PAGE>
6
IN WITNESS WHEREOF, each of the parties hereto has caused this
Agreement to be executed in its name on its behalf by a duly authorized officer
as of the day and year first above written.
STATE STREET BANK AND TRUST COMPANY
By:
------------------------------------
By:
------------------------------------
PROVIDENT NATIONAL BANK
<PAGE>
EXHIBIT 8(h)
AMENDMENT NO. 1 TO CUSTODIAN AGREEMENT
This Agreement made as of the 21st day of November, 1989 between
PROVIDENT NATIONAL BANK, a national banking association ("Provident") and STATE
STREET BANK AND TRUST COMPANY, a Massachusetts banking corporation, ("State
Street") amends a Custodian Agreement between Provident and State Street dated
as of June 13, 1983 (the "Agreement").
The parties hereto, intending to be legally bound, agree as follows:
1. That the phrase "State Street Bank & Trust Company, 12 Nicholas
Lane, London, England" in paragraph 1 of the Agreement be replaced with "State
Street London Limited and Euroclear."
2. That the following sentence be added as the last sentence of
paragraph 3(E) of the Agreement:
"Notwithstanding any provision of this Agreement to the contrary,
settlement and payment for securities received for the account of the
Company and delivery of securities maintained for the account of the
Company may be effected in accordance with the customary or
established securities trading or securities processing practices and
procedures in the jurisdiction or market in which the transaction
occurs, including, without limitation, delivering securities to the
purchaser thereof or to a dealer therefor (or an agent for such
purchaser or dealer) against a receipt with the expectation of
receiving later payment for such securities from such purchaser or
dealer. All collection and receipt of funds or securities and all
payment and delivery of funds or securities under this Agreement shall
be made by State Street, at Company's risk, including without
limitation the risk associated with such street delivery practices of
delivering securities against a receipt, before receiving payment."
3. That the phrase "in the banking department of an agent bank" in
the first sentence of paragraph 4(A) of the Agreement be deleted.
4. That paragraph 6 of the Agreement be deleted and replaced in its
entirety with the following:
<PAGE>
2
"State Street shall not be responsible for the title, validity or
genuineness of any security received by it or delivered by it pursuant
to this Agreement and shall be kept indemnified by the Company and be
without liability for any action taken or thing done by it in carrying
for the terms and provisions of this Agreement, including reasonable
attorney's fees, provided that State Street has acted in good faith
and has not been guilty of negligence. State Street shall have no
more or less responsibility or liability to the Company on account of
any action or omission of any subcustodian or securities depository
employed by State Street than any such subcustodian or securities
depository has to State Street.
In the event State Street delegates its duties and obligations to
State Street London Limited, State Street agrees that such delegation
shall not relieve State Street of any responsibility for loss due to
such delegation except such loss as may result from: (a) Political
(e.g., exchange control restrictions, confiscation, expropriation,
nationalization, insurrection, civil strife or armed hostilities) or
(b) other risk of loss (excluding a bankruptcy or insolvency of State
Street London Limited not caused by a political risk) for which
neither State Street nor State Street London Limited would be liable
(e.g., losses due to Acts of God, nuclear incident and the like,
despite the exercise of reasonable care).
In no event shall State Street be liable for indirect, special or
consequential damages even if advised of the possibility of such
damages."
5. That paragraphs 7, 8, 9 and 10 of the Agreement be renumbered as
paragraphs 9, 10, 11 and 12, respectively.
6. That a new paragraph 7 be added to the Agreement to read in full
as follows:
"State Street shall have no responsibility or liability for any
obligations now or hereafter imposed on the Company or State Street as
custodian of the Securities by the tax law of the United States of
America or any state or political subdivision thereof. State Street
shall be kept indemnified by and be without liability to the Company
for any such obligations including taxes, withholding and reporting
requirements, claims for exemption or refund, additions for late
payment, interest, penalties and other expenses (including legal
expenses) that may be assessed against the Company or State Street as
custodian of the Securities."
7. That a new paragraph 8 be added to the Agreement to read in full
as follows:
<PAGE>
3
"It shall be the responsibility of the Company to notify State Street
of the obligations imposed on the Company with respect to the
securities, by the tax law of jurisdictions other than those mentioned
in paragraph 7 hereof. State Street shall use its best efforts to
assist the Company with respect to any claim for exemption or refund
under the tax law of jurisdictions for which the Company has provided
such information. Nevertheless, State Street shall be kept
indemnified by and shall be without liability to the Company for any
such obligations including taxes, withholding and reporting
requirements, claims for exemptions or refund, additions for late
payment, interest, penalties and other expenses (including legal
expenses) that may be assessed against State Street or the Company as
custodian of the securities."
8. That a new paragraph 13 be added to the Agreement to read in full
as follows:
"State Street hereby represents and warrants to the Company that it or
an affiliate of State Street currently maintains a Banker's Blanket
Bond (the "Bond") in the principal amount of not less than fifty
million dollars ($50,000,000) and an all risk excess policy in an
amount of not less than two hundred million dollars ($200,000,000) and
that the terms of the Bond cover all securities received from the
Company and held by State Street or State Street London Limited.
State Street agrees to maintain the Bond during the term of the
Agreement and shall immediately notify the Company in the event that
the Bond terminates or otherwise lapses."
9. That a new paragraph 14 be added to the Agreement to read in full
as follows:
"If State Street has issued to the Company a data access security
system in order that the Company may have access to certain data and
functions, the Company hereby agrees:
(a) To access data and functions only in accordance with
the Data Access Operating Procedures annexed hereto as Exhibit A
and to regard and preserve as confidential all information
obtained with respect to the issuance to the Company of a data
access security system.
(b) To access data and functions solely for its own
internal use and benefit.
(c) To discontinue use of the data access security system
at any time for reasonable security reasons upon notice from
State Street.
<PAGE>
4
(d) Upon request, to cause the Company's internal auditors
to verify to State Street that data access is restricted to
authorized employees.
(e) To indemnify State Street against and to hold State
Street harmless from all liability, claims, loss and demands
whatsoever, including reasonable attorney's fees, howsoever
arising or incurred because of or in connection with the access
of data and functions by the Company and the use by the Company
or any of its employees, whether authorized or unauthorized, of
the data access security system, provided that State Street shall
not be so indemnified if any portion of such loss is attributed
to State Street's willful misfeasance, bad faith or negligence."
IN WITNESS WHEREOF, each of the parties hereto has caused this
amendment to be executed in its name on its behalf by a duly authorized officer
as of the day and year first above written.
STATE STREET BANK AND TRUST COMPANY
By:
----------------------------------
PROVIDENT NATIONAL BANK
By:
----------------------------------
<PAGE>
EXHIBIT 11
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference of the following reports in this
Post-Effective Amendment No. 34 under the Securities Act of 1933, as amended,
to this Registration Statement on Form N-1A (33-26305) of the BlackRock Funds,
formerly the Compass Capital Funds:
. Our report dated November 14, 1997 for the BlackRock Funds' Bond
Portfolios.
. Our report dated November 14, 1997 for the BlackRock Funds' Equity
Portfolios.
. Our report dated November 14, 1997 for the BlackRock Funds' Money
Market Portfolios.
. Our report dated November 14, 1997 for the Multi-Sector Mortgage
Securities Portfolio III.
. Our report dated January 16, 1998 for the U.S. Large Company Series of
the DFA Investment Trust Company.
We consent to the reference to our Firm under the heading "Miscellaneous -
Independent Accountants" in the Statement of Additional Information.
/s/ Coopers & Lybrand L.L.P.
Coopers & Lybrand L.L.P.
2400 Eleven Penn Center
Philadelphia, Pennsylvania
February 13, 1998
<PAGE>
EXHIBIT 13(a)
PURCHASE AGREEMENT
------------------
(Registrant) (the "Fund"), a Massachusetts business trust, and
_________ (the "Distributor"), hereby agree as follows:
1. The Fund hereby offers the Distributor and the Distributor hereby
purchases ___ shares (of each of the Investor A, Investor B, Investor C, Service
and Institutional classes) of the ______ Portfolio (collectively, the "Shares")
for $___ per Share. The Fund hereby acknowledges receipt from the Distributor
of funds in full payment for the foregoing Shares.
2. The Distributor represents and warrants to the Fund that the
foregoing Shares are being acquired for investment purposes and not with a view
to the distribution thereof.
3. "(Registrant)" and "Trustees of (Registrant)" refer respectively
to the trust created and the Trustees, as trustees but not individually or
personally, acting from time to time under a Declaration of Trust dated December
22, 1988 which is hereby referred to and a copy of which is on file at the
office of the State Secretary of the Commonwealth of Massachusetts and at the
principal office of the Fund. The obligations of "(Registrant)" entered into in
the name or on behalf thereof by any of the Trustees, officers, representatives
or agents are made not individually, but in such capacities, and are not binding
upon any of the Trustees, shareholders, officers, representatives or agents of
the Fund personally, but bind only the Trust Property (as defined in the
Declaration of Trust), and all persons dealing with any class of shares of the
Fund must look solely to the Trust Property belonging to such class for the
enforcement of any claims against the Fund.
IN AGREEMENT WHEREOF, and intending to be legally bound hereby, the
parties hereto have executed this Purchase Agreement as of ______________.
(REGISTRANT)
By:__________________________
Name:
Title:
(DISTRIBUTOR)
By:__________________________
Name:
Title:
<PAGE>
EXHIBIT 16
AVERAGE ANNUAL TOTAL RETURN COMPUTATION
PORTFOLIO: PNC MANAGED INCOME
FORMULA: P(1+T)to the power of n =ERV
WHERE: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = Ending Redeemable Value of a hypothetical $1,000
payment made at the beginning of the 1, 5, or 10 year (or
other) periods at the end of the 1, 5, or 10 year (or other)
periods (or fractional portion thereof).
<TABLE>
<CAPTION>
PERIOD DATES ENDING AVERAGE *FORMULA
COVERED REDEEMABLE ANNUAL RATE
VALUE OF RETURN
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1 Year 10/01/90 $1,095.46 9.55% @RATE(1,095.46,1,000,1.00)
to 09/30/91
FROM FUND 11/01/89 $1,137.54 6.96% @RATE(1,137.54,1,000,1.92)
INCEPTION** to 09/30/91
** Period = 1.92 Years
* LOTUS 123 @RATE function:
@RATE(fv,pv,term) The periodic interest rate
necessary for present value
"pv", to grow to future value
"fv", over the number of
compounding periods in "term".
fv to the power of 1 divided by n
-- =1
pv
</TABLE>
<PAGE>
AVERAGE ANNUAL TOTAL RETURN COMPUTATION
PORTFOLIO: TAX-FREE INCOME
FORMULA: P(1+T)to the power of n =ERV
WHERE: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = Ending Redeemable Value of a hypothetical $1,000
payment made at the beginning of the 1, 5, or 10 year (or
other) periods at the end of the 1, 5, or 10 year (or other)
periods (or fractional portion thereof).
<TABLE>
<CAPTION>
PERIOD DATES ENDING AVERAGE *FORMULA
COVERED REDEEMABLE ANNUAL RATE
VALUE OF RETURN
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1 Year 10/01/90 $1,063.59 6.36% @RATE(1,063.59,1,000,1.00)
to 09/30/91
FROM FUND 05/14/90 $1,078.89 5.64% @RATE(1,078.89,1,000,1.38)
INCEPTION** to 09/30/91
** Period = 1.38 Years
* LOTUS 123 @RATE function:
@RATE(fv,pv,term) The periodic interest rate
necessary for present value
"pv", to grow to future value
"fv", over the number of
compounding periods in "term".
fv to the power of 1 divided by n
-- =1
pv
</TABLE>
<PAGE>
AVERAGE ANNUAL TOTAL RETURN COMPUTATION
PORTFOLIO: PNC GROWTH EQUITY
FORMULA: P(1+T)to the power of n =ERV
WHERE: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = Ending Redeemable Value of a hypothetical $1,000
payment made at the beginning of the 1, 5, or 10 year (or
other) periods at the end of the 1, 5, or 10 year (or other)
periods (or fractional portion thereof).
<TABLE>
<CAPTION>
PERIOD DATES ENDING AVERAGE *FORMULA
COVERED REDEEMABLE ANNUAL RATE
VALUE OF RETURN
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1 Year 10/01/90 $1,140.60 14.06% @RATE(1,140.60,1,000,1.00)
to 09/30/91
FROM FUND 11/01/89 $1,145.29 7.34% @RATE(1,145.29,1,000,1.92)
INCEPTION** to 09/30/91
** Period = 1.92 Years
* LOTUS 123 @RATE function:
@RATE(fv,pv,term) The periodic interest rate
necessary for present value
"pv", to grow to future value
"fv", over the number of
compounding periods in "term".
fv to the power of 1 divided by n
-- = 1
pv
</TABLE>
<PAGE>
AVERAGE ANNUAL TOTAL RETURN COMPUTATION
PORTFOLIO: PNC BALANCED
FORMULA: P(1+T)to the power of n =ERV
WHERE: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = Ending Redeemable Value of a hypothetical $1,000
payment made at the beginning of the 1, 5, or 10 year (or
other) periods at the end of the 1, 5, or 10 year (or other)
periods (or fractional portion thereof).
<TABLE>
<CAPTION>
PERIOD DATES ENDING AVERAGE *FORMULA
COVERED REDEEMABLE ANNUAL RATE
VALUE OF RETURN
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1 Year 10/01/90 $1,184.63 18.46% @RATE(1,184.63,1,000,1.00)
to 09/30/91
FROM FUND 05/14/90 $1,094.24 6.73% @RATE(1,094.24,1,000,1.38)
INCEPTION** to 09/30/91
** Period = 1.38 Years
* LOTUS 123 @RATE function:
@RATE(fv,pv,term) The periodic interest rate
necessary for present value
"pv", to grow to future value
"fv", over the number of
compounding periods in "term".
fv to the power of 1 divided by n
-- = 1
pv
</TABLE>
<PAGE>
THE PNC* FUNDS
CALCULATION OF YIELDS ON MONEY MARKET PORTFOLIOS
AS OF SEPTEMBER, 1991
<TABLE>
<CAPTION>
GOVERNMENT TAX-FREE
MONEY MARKET MONEY MARKET MONEY MARKET
------------ ------------ ------------
<S> <C> <C> <C>
Total Dividends for 7 Day Period.............................. $ .001011331 $ .001018633 $ .000821078
Dividend by Number of Days in Period.......................... 7 7 7
Multiplied by: Number of Days in Year......................... 365 365 365
Dividend by Offering Price per Share.......................... $ 1.00 $ 1.00 $ 1.00
------------- ------------- -------------
7 Day Yield................................................... 5.27% 5.32% 4.28%
============= ============= =============
7 Day Yield................................................... 5.27% 5.32% 4.28%
Dividend by Number of 7 Day Period in Year.................... 52.142857 52.142857 52.142857
Plus 1........................................................ 1 1 1
------------- ------------- -------------
1.0010107 1.0010203 1.0008208
Raised to the Power of the Number of 7 Day Periods in a Year.. 52.142857 52.142857 52.142857
------------- ------------- -------------
1.05407 1.054613 1.043210
------------- ------------- -------------
Effective 7 Day Yield......................................... 5.41% 5.46% 4.37%
==== ==== ====
</TABLE>
