AUL American Series Fund, Inc.
One American Square
Indianapolis, Indiana 46282
(800) 249-6269
AUL American Series Fund, Inc. (the "fund") is an open-end investment
company consisting of eight separate portfolios:
<TABLE>
<S> <C>
AUL American Equity portfolio AUL American Tactical Asset Allocation portfolio
AUL American Bond portfolio AUL American Conservative Investor portfolio
AUL American Money Market portfolio AUL American Moderate Investor portfolio
AUL American Managed portfolio AUL American Aggressive Investor portfolio
</TABLE>
Each portfolio has its own investment objectives and policies, which are
described later in this prospectus.
Shares of common stock of the portfolios are sold only to separate accounts
of American United Life Insurance Company(R) (AUL) to fund investments in
variable life and annuity contracts issued by AUL. The separate accounts of AUL
buy and sell shares of the portfolios according to instructions given by owners
or participants in the contracts. The rights of owners and participants are
described in the contracts or the certificates for those contracts and in the
prospectus for the contracts.
This prospectus should be read in conjunction with the separate account's
prospectus describing the contracts. Please read both prospectuses and retain
them for future reference.
Neither the SEC nor any state securities commission has approved or
disapproved these securities or found that this prospectus is accurate or
complete. Any representation to the contrary is a criminal offense.
May 1, 2000
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TABLE OF CONTENTS
Description Page
The Portfolios............................................................ 3-9
The Equity Portfolio.................................................... 3
The Bond Portfolio...................................................... 4
The Money Market Portfolio.............................................. 5
The Managed Portfolio................................................... 6
The Tactical Asset Allocation Portfolio................................. 7
The Conservative Investor Portfolio..................................... 8
The Moderate Investor Portfolio......................................... 8
The Aggressive Investor Portfolio....................................... 8
Investment Strategy of the LifeStyle Portfolios....................... 8
Operating Ranges...................................................... 8
Financial Highlights...................................................... 10 15
General Information about the Fund........................................ 16-17
Management of the Fund.................................................. 16
The Investment Manager--American United Life Insurance Company(R)....... 16
The Portfolio Managers and the Sub-Advisers............................. 17
The Equity Portfolio.................................................. 17
The Bond Portfolio.................................................... 17
The Managed Portfolio................................................. 17
The Sub-Advisers...................................................... 17
The Tactical Asset Allocation Portfolio............................. 17
The LifeStyle Portfolios............................................ 17
Further Portfolio Information; Investments;
Investment Strategies and Risks.......................................... 18-21
Investments and Investment Strategies................................... 18
The Equity Portfolio................................................... 18
The Bond Portfolio..................................................... 18
The Money Market Portfolio............................................. 18
The Managed Portfolio.................................................. 18
The Tactical Asset Allocation Portfolio................................ 18
The LifeStyle Portfolios............................................... 19
General Risks........................................................... 19
Market Risk............................................................ 19
Interest Rate Risk..................................................... 19
Credit Risk............................................................ 20
Defensive Strategy...................................................... 20
Legal Proceedings......................................................... 20
Diversification........................................................... 20
Purchase and Redemption of Shares......................................... 20
Net Asset Value......................................................... 21
Taxation.................................................................. 21
Statement of Additional Information....................................... 21
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The Portfolios
The Equity Portfolio
The primary investment objective of the Equity portfolio is long-term
capital appreciation. The portfolio seeks current investment income as a
secondary objective. To do this, the portfolio primarily invests in equity
securities that the adviser selects based on fundamental investment research for
their long-term growth prospects. The portfolio uses a value-driven approach in
selecting portfolio securities.
Normally, at least 65% of the portfolio's assets will be common stocks
listed on a national securities exchange or traded over-the-counter. The
portfolio may invest up to 35% of its assets in other instruments and investment
techniques such as American Depository Receipts, preferred stock, debentures
that can be converted to common stock or that have rights to buy common stock in
the future, nonconvertible debt securities, U.S. Government securities,
commercial paper and other money market instruments, repurchase agreements and
reverse repurchase agreements.
An investment in the portfolio entails investment risk, including possible
loss of the principal amount invested. The portfolio is subject to market risk,
which is the risk that the market value of a portfolio security may move up and
down, sometimes rapidly and unpredictably. This risk may be particularly acute
for the portfolio's investments in common stocks and other types of equity
securities. The portfolio is also subject to interest rate risk, which is the
risk that changes in interest rates will affect the value of its investments. In
particular, the portfolio's investments (if any) in debt securities and other
fixed income securities generally will change in value inversely with changes in
interest rates. Also, an investment by the portfolio in fixed income securities
generally will expose the portfolio to credit risk, which is the risk that the
issuer of a security will default or not be able to meet its financial
obligations.
An investment in the portfolio is not a bank deposit and is not insured or
guaranteed by the Federal Deposit Insurance Corporation or any other government
agency.
The chart and table below provide some indication of the risks of investing
in the Equity portfolio by showing annual returns since 1991 and average returns
since inception compared to a broad measure of market performance. The
information does not reflect charges and fees associated with a separate account
that invests in the portfolio or any insurance contract for which the portfolio
is an investment option. These charges and fees will reduce returns. How the
portfolio has performed in the past is not an indication of its future
performance.
[Bar chart inserted with returns printed above each year's column.]
Numbers to be inserted are: for 1991: 25.6% for 1996: 19.2%
for 1992: 10.0% for 1997: 29.6%
for 1993: 14.8% for 1998: 7.1%
for 1994: 2.6% for 1999: (0.9%)
for 1995: 19.4%
During this period, the portfolio's highest return for any quarter was
15.87%, which occurred in the first quarter of 1991 and the lowest return for a
quarter was -13.23% in the third quarter of 1998.
The following table demonstrates the average annual return of the portfolio
as of December 31, 1999, compared to the Standard & Poor's 500 Index (the "S&P
500")for one year, five years, and since the inception of the portfolio on April
10, 1990. The S&P 500 Index is a market-value-weighted benchmark of common stock
performance. The S&P 500 Index includes 500 of the largest stocks (in terms of
market value) in the United States. Investors cannot directly invest in an index
and unlike the portfolio, an index is unmanaged and does not incur transaction
or other expenses.
Average Annual Average Annual Average Annual
Return for One Year Return for Five Years Return Since 4/10/90
------------------- --------------------- --------------------
Equity portfolio (0.9%) 14.4% 12.5%
S&P 500 21.0% 28.5% 19.0%
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The Bond Portfolio
The primary investment objective of the Bond portfolio is to provide a high
level of current income consistent with prudent investment risk. A secondary
investment objective is to provide capital appreciation to the extent consistent
with the primary objective. To do this, the portfolio buys mostly corporate
bonds and other debt securities. A predominant number of the corporate bonds in
the portfolio will be considered to be "investment grade". The portfolio may
also buy U.S. Government securities, convertible bonds, and mortgage-backed
securities.
The portfolio may invest in bonds of any maturity. The average maturity and
type of bonds in the portfolio changes based on the adviser's view of market
conditions and the chance for a change in the interest rates for the different
types of bonds the portfolio buys.
The adviser believes that having mostly investment grade bonds in the
portfolio protects investors from the risk of losing principal and interest.
However, if the adviser feels that it can take advantage of higher yields
offered by bonds that are not investment grade ("junk bonds"), the portfolio may
invest up to 10% of its assets in such bonds. Bonds that are not investment
grade have a higher risk of losing principal and interest than investment grade
bonds.
An investment in the portfolio entails investment risk, including possible
loss of the principal amount invested. The portfolio is subject to market risk,
which is the risk that the market value of a portfolio security may move up and
down, sometimes rapidly and unpredictably. The portfolio also is subject to
interest rate risk, which is the risk that changes in interest rates will affect
the value of its investments. In particular, the portfolio's investments in debt
securities and other fixed income securities generally will change in value
inversely with changes in interest rates. Longer term bonds typically
demonstrate the greatest changes in value in response to changes in interest
rates. Also, an investment by the portfolio in fixed income securities generally
will expose the portfolio to credit risk, which is the risk that the issuer of a
security will default or not be able to meet its financial obligations.
Investments in junk bonds are subject to credit risk to a greater degree than
more highly-rated, investment grade securities.
An investment in the portfolio is not a bank deposit and is not insured or
guaranteed by the Federal Deposit Insurance Corporation or any other government
agency.
The chart and table below provide some indication of the risks of investing
in the Bond portfolio by showing annual returns since 1991 and average returns
since inception compared to a broad measure of market performance. The
information does not reflect charges and fees associated with a separate account
that invests in the portfolio or any insurance contract for which the portfolio
is an investment option. These charges and fees will reduce returns. How the
portfolio has performed in the past is not an indication of its future
performance.
[Bar chart inserted with returns printed above each year's column.]
Numbers to be inserted are: for 1991: 16.4% for 1996: 2.2%
for 1992: 7.2% for 1997: 7.8%
for 1993: 10.7% for 1998: 8.8%
for 1994: -3.6% for 1999: (1.1%)
for 1995: 17.8%
During this period, the portfolio's highest return for any quarter was
7.06%, which occurred in the third quarter of 1991 and the lowest return for a
quarter was -3.19% in the first quarter of 1994.
The following table demonstrates the average annual return of the portfolio
as of December 31, 1999, compared to the Lehman Brothers Aggregate Index (the
"Lehman Index") for one year, five years, and since the inception of the
portfolio on April 10, 1990. The Lehman Brothers Aggregate Bond Index is a broad
market-value-weighted benchmark of U.S. investment-grade bond performance. The
Lehman Aggregate Index includes all investment-grade U.S. bond issues
(government, corporate, mortgage-backed and asset-backed) with a minimum of $100
million par value and that have at least one year remaining to maturity.
Investors cannot directly invest in an index and unlike the portfolio, an index
is unmanaged and does not incur transaction or other expenses.
Average Annual Average Annual Average Annual
Return for One Year Return for Five Years Return Since 4/10/90
------------------- --------------------- --------------------
Bond portfolio (1.1%) 6.9% 7.5%
Lehman Brothers
Aggregate Index (0.8%) 7.7% 8.0%
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The Money Market Portfolio
The investment objective of the Money Market portfolio is to provide a high
level of current income while preserving assets and maintaining liquidity and
investment quality. To do this, the portfolio invests in short-term money market
instruments of the highest quality that the adviser has determined present
minimal credit risk. The portfolio invests only in money market instruments
denominated in U.S. dollars that mature in 13 months or less from the date of
purchase.
The portfolio is subject to interest rate risk, which is the risk that
changes in interest rates will affect the value of its investments. Investments
in debt securities and other fixed income securities generally will change in
value inversely with changes in interest rates. However, fixed income securities
with shorter terms to maturity, like those in which the portfolio invests,
typically demonstrate smaller changes in value in response to changes in
interest rates than do longer term securities. Also, an investment by the
portfolio in money market instruments will expose the portfolio to credit risk,
which is the risk that the issuer of a security will default or not be able to
meet its financial obligations. However, the portfolio invests only in
instruments that the adviser has determined present minimal credit risk.
An investment in this portfolio is not a bank deposit and is not insured or
guaranteed by the Federal Deposit Insurance Corporation or any other
governmental agency. Although the portfolio seeks to preserve the value of its
investment at $1 per share, it is possible to lose money by investing in the
portfolio.
The chart and table below provide some indication of the risks of investing
in the Money Market portfolio by showing annual returns since 1991 and average
returns since inception compared to a broad measure of market performance. The
information does not reflect charges and fees associated with a separate account
that invests in the portfolio or any insurance contract for which the portfolio
is an investment option. These charges and fees will reduce returns. How the
portfolio has performed in the past is not an indication of its future
performance.
[Bar chart inserted with returns printed above each year's column.]
Numbers to be inserted are: for 1991: 5.5% for 1996: 4.6%
for 1992: 3.0% for 1997: 4.9%
for 1993: 2.3% for 1998: 4.9%
for 1994: 3.4% for 1999: 4.6%
for 1995: 5.1%
During this period, the portfolio's highest return for any quarter was
1.56%, which occurred in the first quarter of 1991 and the lowest return for a
quarter was 0.55% in the fourth quarter of 1993.
The following table demonstrates the average annual return of the portfolio
as of December 31, 1999, compared to the return on 90 Day Treasury Bills for one
year, five years, and since the inception of the portfolio on April 10, 1990.
Average Annual Average Annual Average Annual
Return for One Year Return for Five Years Return Since 4/10/90
------------------- --------------------- --------------------
Money Market 4.6% 4.8% 4.2%
Portfolio
90-Day Treasury 4.9% 5.4% 5.2%
Bill
For the seven day period ended December 31, 1999, the current yield for the
portfolio was 6.0294% and the effective yield was 6.2112%.
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The Managed Portfolio
The investment objective of the Managed portfolio is to provide a high
total return consistent with prudent investment risk. The investments of the
portfolio are not limited to one type of investment and it purchases publicly
traded common stocks, debt securities, and money market instruments. The makeup
of the portfolio changes, based on the adviser's evaluation of economic and
market trends and the expected total return from a particular type of security.
Therefore, up to 100% of the portfolio may be invested in any one type of
investment such as common stocks, debt securities, or money market instruments.
The portfolio may buy common stocks and debt securities which are eligible
for purchase by the Equity and Bond portfolios as described above. Therefore,
the portfolio can invest up to 10% of its assets in debt securities that are
rated below-investment grade ("junk bonds"). The portfolio also may buy high
quality money market instruments.
An investment in the portfolio entails investment risk, including possible
loss of the principal amount invested. The portfolio is subject to market risk,
which is the risk that the market value of a portfolio security may move up and
down, sometimes rapidly and unpredictably. This risk may be particularly acute
for the portfolio's investments in common stocks and other types of equity
securities. The portfolio also is subject to interest rate risk, which is the
risk that changes in interest rates will affect the value of its investments. In
particular, the portfolio's investments in debt securities and other fixed
income securities generally will change in value inversely with changes in
interest rates. Longer term bonds typically demonstrate the greatest changes in
value in response to changes in interest rates. Also, an investment by the
portfolio in fixed income securities generally will expose the portfolio to
credit risk, which is the risk that the issuer of a security will default or not
be able to meet its financial obligations. Investments in bonds that are not
investment grade are subject to credit risk to a greater degree than more
highly-rated, investment grade securities.
An investment in the portfolio is not a bank deposit and is not insured or
guaranteed by the Federal Deposit Insurance Corporation or any other government
agency.
The chart and table below provide some indication of the risks of investing
in the Managed portfolio by showing annual returns since 1991 and average
returns since inception compared to two broad measures of market performance.
The information does not reflect charges and fees associated with a separate
account that invests in the portfolio or any insurance contract for which the
portfolio is an investment option. These charges and fees will reduce returns.
How the portfolio has performed in the past is not an indication of its future
performance.
[Bar chart inserted with returns printed above each year's column.]
Numbers to be inserted are: for 1991: 16.7% for 1996: 11.8%
for 1992: 7.9% for 1997: 20.9%
for 1993: 13.0% for 1998: 8.3%
for 1994:(0.9%) for 1999: (0.7%)
for 1995: 19.1%
During this period, the portfolio's highest return for any quarter was
10.00%, which occurred in the second quarter of 1997 and the lowest return for a
quarter was -6.60% in the third quarter of 1998.
The following table demonstrates the average annual return of the portfolio
as of December 31, 1999, compared to the S&P 500 and the Lehman Index for one
year, five years, and since the inception of the portfolio on April 10, 1990.
Investors cannot directly invest in an index and unlike the portfolio, an index
is unmanaged and does not incur transaction or other expenses.
Average Annual Average Annual Average Annual
Return for One Year Return for Five Years Return Since 4/10/90
------------------- --------------------- --------------------
Managed portfolio (0.7%) 11.6% 10.3%
S&P 500 21.0% 28.5% 19.0%
Lehman Brothers
Aggregate Index (0.8%) 7.7% 8.0%
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<PAGE>
The Tactical Asset Allocation Portfolio
The investment objective of the Tactical Asset Allocation portfolio is
preservation of capital and competitive investment returns. To do this, the
portfolio invests primarily in stocks, United States Treasury bonds, notes and
bills, and money market instruments as well as by lending its portfolio
securities to brokers, dealers, and other financial institutions. When markets
are favorable, the portfolio concentrates on performance; in declining markets,
the portfolio will have less equities in its portfolio in an effort to protect
its assets.
In allocating the portfolio's investments among asset classes, the
portfolio's sub-adviser utilizes forecasting models which evaluate risk versus
reward relationships of different asset classes. These models enable the
sub-adviser to determine when to "tactically" adjust the asset allocation
through a gradual shifting of assets among the various categories of
investments. The portfolio will seek to achieve income in excess of the dividend
income yield of the S&P 500.
The portfolio will normally invest 80% of its equity assets in the common
or preferred stocks of companies that pay dividends and no more than 20% of its
assets in companies that do not pay dividends. Generally, the equity securities
that are bought are listed on a national securities exchange or are traded in
the U.S. over-the-counter market. The focus is generally on high quality,
liquid, undervalued, large capitalization stocks. When market conditions require
a more defensive position, the portfolio invests more of its assets in
investment grade corporate debt securities, U.S. Government securities and money
market instruments.
Because of the portfolio's flexible investment policy, portfolio turnover
may be greater than for a portfolio that does not allocate assets among various
types of securities, which may increase the portfolio's expenses.
An investment in the portfolio entails investment risk, including possible
loss of the principal amount invested. The portfolio is subject to market risk,
which is the risk that the market value of a portfolio security may move up and
down, sometimes rapidly and unpredictably. This risk may be particularly acute
for the portfolio's investments in common stocks and other types of equity
securities, particularly those of foreign issuers. The portfolio also is subject
to interest rate risk, which is the risk that changes in interest rates will
affect the value of its investments. In particular, the portfolio's investments
in debt securities and other fixed income securities generally will change in
value inversely with changes in interest rates. Longer term bonds typically
demonstrate the greatest changes in value in response to changes in interest
rates. Also, an investment by the portfolio in fixed income securities generally
will expose the portfolio to credit risk, which is the risk that the issuer of a
security will default or not be able to meet its financial obligations. However,
the portfolio will invest only in U.S. Government securities, investment grade
corporate debt securities, and high quality money market instruments.
An investment in the portfolio is not a bank deposit and is not insured or
guaranteed by the Federal Deposit Insurance Corporation or any other government
agency.
The chart and table below provide some indication of the risks of investing
in the Tactical Asset Allocation portfolio by showing annual returns since 1996
and average returns since inception compared to two broad measures of market
performance. The information does not reflect charges and fees associated with a
separate account that invests in the portfolio or any insurance contract for
which the portfolio is an investment option. These charges and fees will reduce
returns. How the portfolio has performed in the past is not an indication of its
future performance.
[Bar chart inserted with returns printed above each year's column.]
Numbers to be inserted are: for 1996: 15.7%
for 1997: 15.5%
for 1998: 7.2%
for 1999: (3.1%)
During this period, the portfolio's highest return for any quarter was
10.53%, which occurred in the third quarter of 1997 and the lowest return for a
quarter was -8.60% in the third quarter of 1998.
The following table demonstrates the average annual return of the portfolio
as of December 31, 1999, compared to the S&P 500 and the Lehman Brothers
Intermediate Government Index for one year and since the inception of the
portfolio on July 31, 1995. The Lehman Bothers Intermediate Government Bond
Index is a market-value-weighted benchmark of the performance of all
intermediate-maturity U.S. Government bonds (excluding mortgage-backed
securities) and includes all U.S. Treasury
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<PAGE>
and U.S. Agency bond issues (excluding mortgage-backed securities) with a
minimum of $100 million par value and that have between 1 and 10 years remaining
to maturity. Investors cannot directly invest in an index and unlike the
portfolio, an index is unmanaged and does not incur transaction or other
expenses.
Average Annual Average Annual
Return for One Year Return Since 7/31/95
------------------- --------------------
Tactical Asset
Allocation portfolio (3.1%) 9.3%
S&P 500 21.0% 26.5%
Lehman Brothers Intermediate
Government Index 0.5% 5.8%
The LifeStyle Portfolios
The Conservative Investor Portfolio
The investment objective of the Conservative Investor portfolio is high
current income, with opportunities for capital appreciation. To do this, the
portfolio invests in a strategically allocated portfolio, primarily of bond and
money market instruments, with the balance of the portfolio in equities. The
portfolio's investment in bonds and money market securities is intended to help
provide gains through income accumulation and a measure of principal protection
if the stock market is in decline.
The Moderate Investor Portfolio
The investment objective of the Moderate Investor portfolio is a blend of
capital appreciation and income. To do this, the portfolio invests in a
strategically allocated portfolio of equities, bonds and money market
instruments with a weighting that is normally slightly heavier in equities. The
asset mix for this portfolio is intended to provide long-term growth and some
regular income, while helping to limit losses in the event of stock market
declines.
The Aggressive Investor Portfolio
The investment objective of the Aggressive Investor portfolio is long-term
capital appreciation. To do this, the portfolio invests in a strategically
allocated portfolio consisting primarily of equities. Current income is not a
major consideration. The asset mix for this portfolio is intended to provide
long-term growth, with a small amount of income to cushion the volatility of the
equity securities.
Investment Strategy of the LifeStyle Portfolios
In diversifying investments among three major asset classes -- equity
securities, bonds and money market instruments, each LifeStyle portfolio has its
own ideal neutral mix that represents a "benchmark" as to how that portfolio's
investments should be allocated among the major asset classes over the long
term. Each LifeStyle portfolio's neutral mix is set forth below:
Neutral Mixes
LifeStyle Equity Money Market
Portfolio Securities Bonds Instruments
- --------- ---------- ----- ------------
Conservative 35% 50% 15%
Moderate 55% 35% 10%
Aggressive 80% 20% 0%
Although each LifeStyle portfolio has its own ideal neutral asset
allocation, this mix may be adjusted based on cash flow, market conditions, and
the expected returns and risks for various asset classes. The mix of a portfolio
will also change depending on the relative performance and relative value of the
various asset classes. However, each portfolio has an operating range that is
intended to limit fluctuations in the assets of each class. Therefore, an
investment in an asset class will not usually be made if it would cause the
investments in that asset class to fall below or rise above its operating range.
The allocation to an asset class may be higher or lower than the portfolio's
operating range. An example of this is when there is a large amount of cash
either coming into or going out of the portfolio. However, this is not normally
expected. The operating ranges are:
Operating Ranges
LifeStyle Equity Money Market
Portfolio Securities Bonds Instruments
- --------- ---------- ----- -----------
Conservative 25-50% 40-60% 5-25%
Moderate 45-65% 25-45% 0-20%
Aggressive 70-90% 10-30% 0-15%
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<PAGE>
An investment in each of the LifeStyle portfolios entails investment risk,
including possible loss of the principal amount invested. Each portfolio is
subject to market risk, which is the risk that the market value of a portfolio
security may move up and down, sometimes rapidly and unpredictably. Investments
in equity securities of foreign issuers may pose risks in addition to, or to a
greater degree than, the risks generally associated with an equity investment.
These risks may be particularly acute for the Aggressive Investor portfolio, as
it typically will focus its investments in common stocks and other types of
equity securities. Each LifeStyle portfolio also is subject to interest rate
risk, which is the risk that changes in interest rates will affect the value of
its investments. In particular, investments in debt securities and other fixed
income securities generally will change in value inversely with changes in
interest rates. Longer term bonds typically demonstrate the greatest changes in
value in response to changes in interest rates. Also, an investment by a
portfolio in fixed income securities generally will expose the portfolio to
credit risk, which is the risk that the issuer of a security will default or not
be able to meet its financial obligations. Investments in bonds that are not
investment grade are subject to credit risk to a greater degree than more
highly-rated, investment grade securities. Thus, the Conservative Investor
portfolio may be particularly subject to interest and credit risk, as it
concentrates its investments in fixed income securities. Of course, like the
other LifeStyle portfolios, the Moderate Investor portfolio also is subject to
these risks.
Each of the LifeStyle portfolios is designed to fit a different general
risk profile. Investors can choose the portfolio or a mix of the portfolios,
based on their individual circumstances, including the expected timing of major
investment goals, such as sending a child to college, retirement or purchasing a
home, as well as their own tolerance for risk. As investment goals change,
investors should re-evaluate their portfolio choices to determine if all or a
portion of their investment should be moved to a portfolio with a more
appropriate objective and asset mix.
Based on the historical performance of the three major asset classes
(equity securities, bonds, and money market instruments), the Aggressive
Investor portfolio, which has the most equities in its portfolio, has the
highest potential for the greatest long-term total return, but also has the most
potential for the highest volatility and losses. The Conservative Investor
portfolio, which has the most fixed income securities in its portfolio, has less
potential for long-term total return, but also has the lowest potential for
extended volatility or significant losses. The Moderate Investor portfolio is
designed to be a balance between the potential returns and volatility of the
Aggressive Investor and the Conservative Investor portfolios. Of course, there
is no assurance that any of the portfolios will meet their investment
objectives.
The charts and tables below provide some indication of the risks of
investing in the LifeStyle portfolios by showing annual returns since their
inception on March 31, 1998 and average returns since inception compared to two
broad measures of market performance. The information does not reflect charges
and fees associated with a separate account that invests in the portfolio or any
insurance contract for which the portfolio is an investment option. These
charges and fees will reduce returns. How the portfolio has performed in the
past is not an indication of its future performance.
[Bar charts inserted with returns printed above each year's column.]
For the Conservative Investor Portfolio:
Numbers to be inserted are: for 1999: 5.8%
For the Moderate Investor Portfolio:
Numbers to be inserted are: for 1999: 8.2%
For the Aggressive Investor Portfolio:
Numbers to be inserted are: for 1999: 11.7%
During this period, the Conservative Investor portfolio's highest return
for any quarter was 7.98%, which occurred in the fourth quarter of 1998 and the
lowest return for a quarter was -3.38% in the third quarter of 1998; for the
Moderate Investor portfolio, the highest return for any quarter was 11.03%,
which occurred in the fourth quarter of 1998 and the lowest return for a quarter
was -6.62% in the third quarter of 1998; and for the Aggressive Investor
portfolio, the highest return for any quarter was 14.89%, which occurred in the
fourth quarter of 1998 and the lowest return for a quarter was -9.96% in the
third quarter of 1998.
The following tables demonstrate the average annual returns of the
portfolios as of December 31, 1999, compared to the Russell 3000 and the Lehman
Brothers Aggregate Index for one year and since the inception of the portfolios
on March 31, 1998. The Russell 3000 Index is a broad based index composed of
3000 large U.S. companies, as
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<PAGE>
determined by market capitalization. This portfolio of securities represents
approximately 98% of the investable U.S. equity market. The Russell 3000 Index
is comprised of stocks within the Russell 1000 and Russell 2000 Indices. The
index was developed with a base value as of December 31, 1986. The Lehman
Brothers Aggregate Bond Index is a broad market-value-weighted benchmark of U.S.
investment-grade bond performance. The Lehman Aggregate Index includes all
investment-grade U.S. bond issues (government, corporate, mortgage-backed and
asset-backed) with a minimum of $100 million par value and that have at least
one year remaining to maturity. Investors cannot directly invest in an index and
unlike the portfolio, an index is unmanaged and does not incur transaction or
other expenses.
Average Annual Average Annual
Return for One Year Return Since 3/31/98
------------------- --------------------
Conservative Investor portfolio 5.8% 6.7%
Moderate Investor portfolio 8.2% 7.6%
Aggressive Investor portfolio 11.7% 9.5%
Russell 3000 20.9% 17.6%
Lehman Brothers Aggregate Index (0.8%) 3.5%
FINANCIAL HIGHLIGHTS
Per Share Data and Ratios through the Year Ended December 31, 1999
The following information is intended to help investors understand the
portfolios' financial performance for the past five years (or since inception,
if shown). Per share amounts presented are based on a share outstanding for the
periods shown. The total returns in the tables represent an investor's gain (or
loss) on an investment in a portfolio (assuming reinvestment of all dividends
and distributions). The information in the tables has been audited by
PricewaterhouseCoopers LLP, the fund's independent accountants, whose report,
along with the fund's financial statements, are included in the fund's Annual
Report as of December 31, 1999. The Annual Report is available free of charge
upon request.
-10-
<PAGE>
<TABLE>
<CAPTION>
Equity Portfolio
----------------
1999 1998 1997 1996 1995
-------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Net Asset Value $ 20.27 $ 21.03 $ 16.65 $ 14.21 $ 12.27
Beginning of Period -------- ------- ------- ------- -------
Income from Investment
Operations
Net Investment Income 0.32 0.35 0.29 0.28 0.28
Net Realized and Unrealized
gains(losses) on securities (0.55) 1.23 4.64 2.44 2.12
-------- ------- ------- ------- -------
Total from Investment
Operations (0.23) 1.58 4.93 2.72 2.40
-------- ------- ------- ------- -------
Less Distributions
Dividends (from net
investment income) 0.32 0.35 0.30 0.28 0.27
Distributions (from capital
gains) 3.66 1.99 0.25 0.00 0.19
-------- ------- ------- ------- -------
Total Distributions 3.98 2.34 0.55 0.28 0.46
-------- ------- ------- ------- -------
Net Asset Value,
End of Period $ 16.06 $ 20.27 $ 21.03 $ 16.65 $ 14.21
======== ======= ======= ======= =======
Total Return (0.90%) 7.10% 29.59% 19.17% 19.45%
Ratios/Supplemental Data
Net Assets, end of
period (in thousands) $ 88,619 $95,485 $80,276 $50,652 $35,299
Ratio of expenses to
average net assets 0.63% 0.62% 0.66% 0.70% 0.70%
Ratio of net investment
income to average
net assets 1.54% 1.61% 1.52% 1.81% 2.08%
Portfolio Turnover Rate 32% 23% 9% 11% 10%
<CAPTION>
Bond Portfolio
--------------
1999 1998 1997 1996 1995
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Net Asset Value $ 10.83 $ 10.68 $ 10.65 $ 11.06 $ 9.99
Beginning of Period ------- ------- ------- ------- -------
Income from Investment
Operations
Net Investment Income 0.61 0.60 0.60 0.62 0.67
Net Realized and Unrealized
gains(losses) on securities (0.74) 0.36 0.25 (0.39) 1.07
------- ------- ------- ------- -------
Total from Investment
Operations (0.13) 0.96 0.85 0.23 1.74
------- ------- ------- ------- -------
Less Distributions
Dividends (from net
investment income) 0.61 0.60 0.59 0.63 0.66
Distributions (from capital
gains) --- 0.21 0.23 0.01 0.01
------- ------- ------- ------- -------
Total Distributions 0.61 0.81 0.82 0.64 0.67
------- ------- ------- ------- -------
Net Asset Value,
End of Period $ 10.09 $ 10.83 $ 10.68 $ 10.65 $ 11.06
======= ======= ======= ======= =======
Total Return (1.10%) 8.80% 7.85% 2.23% 17.79%
Ratios/Supplemental Data
Net Assets, end of
period (in thousands) $49,828 $50,089 $34,718 $28,188 $25,429
Ratio of expenses to
average net assets 0.62% 0.62% 0.67% 0.71% 0.70%
Ratio of net investment
income to average
net assets 5.68% 5.48% 5.53% 5.85% 6.28%
Portfolio Turnover Rate 93% 132% 107% 62% 55%
</TABLE>
-11-
<PAGE>
Money Market Portfolio
----------------------
<TABLE>
<CAPTION>
1999 1998 1997 1996 1995
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Net Asset Value $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
Beginning of Period ------- ------- ------- ------- -------
Income from Investment
Operations
Net Investment Income 0.05 0.05 0.05 0.05 0.05
Net Realized and Unrealized
gains(losses) on securities -- -- -- -- --
------- ------- ------- ------- -------
Total from Investment
Operations 0.05 0.05 0.05 0.05 0.05
------- ------- ------- ------- -------
Less Distributions
Dividends (from net
investment income) 0.05 0.05 0.05 0.05 0.05
Distributions (from capital
gains) -- -- -- -- --
------- ------- ------- ------- -------
Total Distributions 0.05 0.05 0.05 0.05 0.05
------- ------- ------- ------- -------
Net Asset Value,
End of Period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
======= ======= ======= ======= =======
Total Return 4.60% 4.86% 4.85% 4.63% 5.09%
Ratios/Supplemental Data
Net Assets, end of
period (in thousands) $126,532 $82,055 $55,757 $40,227 $24,290
Ratio of expenses to
average net assets 0.55% 0.61% 0.66% 0.70% 0.73%
Ratio of net investment
income to average
net assets 4.60% 4.82% 4.83% 4.64% 5.13%
Portfolio Turnover Rate -- -- -- -- --
</TABLE>
Managed Portfolio
-----------------
<TABLE>
<CAPTION>
1999 1998 1997 1996 1995
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Net Asset Value $ 15.13 $ 15.33 $ 13.40 $ 12.42 $ 11.00
Beginning of Period ------- ------- ------- ------- -------
Income from Investment
Operations
Net Investment Income 0.49 0.51 0.48 0.44 0.46
Net Realized and Unrealized
gains(losses) on securities (0.71) 0.79 2.34 1.01 1.62
------- ------- ------- ------- -------
Total from Investment
Operations (0.22) 1.30 2.82 1.45 2.08
------- ------- ------- ------- -------
Less Distributions
Dividends (from net
investment income) 0.50 0.51 0.48 0.44 0.46
Distributions (from capital
gains) 1.60 0.99 0.41 0.03 0.20
------- ------- ------- ------- -------
Total Distributions 2.10 1.60 0.89 0.47 0.66
------- ------- ------- ------- -------
Net Asset Value,
End of Period $ 12.81 $ 15.13 $ 15.33 $ 13.40 $ 12.42
======= ======= ======= ======= =======
Total Return (0.80%) 8.30% 20.95% 11.79% 19.13%
Ratios/Supplemental Data
Net Assets, end of
period (in thousands) $68,816 $73,112 $60,477 $43,092 $30,844
Ratio of expenses to
average net assets 0.62% 0.62% 0.67% 0.70% 0.70%
Ratio of net investment
income to average
net assets 3.25% 3.27% 3.27% 3.43% 3.86%
Portfolio Turnover Rate 49% 63% 27% 34% 35%
</TABLE>
-12-
<PAGE>
Tactical Asset Allocation Portfolio
-----------------------------------
<TABLE>
<CAPTION>
July 31, 1995
(commencement)
1999 1998 1997 1996 to Dec.31, 1995
------- ------- ------- ------- ---------------
<S> <C> <C> <C> <C> <C>
Net Asset Value $ 12.93 $ 12.44 $ 11.65 $ 10.44 $ 10.00
Beginning of Period ------- ------- ------- ------- -------
Income from Investment
Operations
Net Investment Income 0.34 0.34 0.28 0.28 0.16
Net Realized and Unrealized
gains(losses) on securities (0.81) 0.58 1.75 1.38 0.49
------- ------- ------- ------- -------
Total from Investment
Operations (0.45) 0.92 2.03 1.66 0.65
------- ------- ------- ------- -------
Less Distributions
Dividends (from net
investment income) 0.36 0.34 0.28 0.28 0.16
Distributions (from capital
gains) -- 0.09 0.96 0.17 0.05
------- ------- ------- ------- -------
Total Distributions 0.36 0.43 1.24 0.45 0.21
------- ------- ------- ------- -------
Net Asset Value,
End of Period $ 12.12 $ 12.93 $ 12.44 $ 11.65 $ 10.44
======= ======= ======= ======= =======
Total Return ** (3.10%) 7.20% 15.48% 15.67% 6.49%
Ratios/Supplemental Data
Net Assets, end of
period (in thousands) $ 5,155 $ 6,468 $ 4,452 $ 2,145 $ 1,139
Ratio of expenses to
average net assets 0.99% 1.00% 1.00% 1.00% 1.00%
Ratio of net investment
income to average
net assets 2.78% 2.64% 2.24% 2.62% 3.70%
Portfolio Turnover Rate 77% 41% 52% 25% 4%
</TABLE>
** Total returns for periods less than one year are not annualized. Total return
assumes reinvestment of dividends and capital gain distributions, if any.
-13-
<PAGE>
<TABLE>
Conservative Investor Moderate Investor
Portfolio Portfolio
--------------------------- ---------------------------
For the period For the period
3/31/98 to 3/31/98 to
1999 12/31/98 1999 12/31/98
--------- -------------- --------- --------------
<S> <C> <C> <C> <C>
Net Asset Value, $ 10.30 $ 10.00 $ 10.32 $ 10.00
Beginning of Period --------- -------------- --------- --------------
Income from Investment
Operations
Net Investment Income 0.34 0.22 0.25 0.16
Net Realized and Unrealized
gains (losses) on securities 0.27 0.37 0.65 0.36
--------- -------------- --------- --------------
Total from Investment
Operations 0.61 0.59 0.88 0.52
--------- -------------- --------- --------------
Less Distributions
Dividends (from net
investment income) 0.34 0.22 0.25 0.16
Distributions (from capital
gains) 0.42 0.07 0.46 0.04
--------- -------------- --------- --------------
Total Distributions 0.76 0.29 0.71 0.20
--------- -------------- --------- --------------
Net Asset Value,
End of Period $ 10.15 $ 10.30 $ 10.49 $ 10.32
========= ============== ========= ==============
Total Return ** 5.80% 5.84% 8.20% 5.09%
Ratios/Supplemental Data
Net Assets, end of
period (in thousands) $ 6,507 $ 6,281 $ 7,812 $ 6,803
Ratio of expenses to
average net assets 0.95% 0.95% 1.00% 0.94%
Ratio of net investment
income to average
net assets 3.23% 2.21% 2.33% 1.62%
Portfolio Turnover Rate 72% 82% 74% 60%
** Total returns for periods less than one year are not annualized.
</TABLE>
-14-
<PAGE>
Aggressive Investor
Portfolio
--------------------------
For the period
3/31/98 to
1999 12/31/98
--------- -------------
Net Asset Value, $ 10.37 $ 10.00
Beginning of Period --------- -------------
Income from Investment
Operations
Net Investment Income 0.16 0.09
Net Realized and Unrealized
gains (losses) on securities 1.09 0.41
--------- -------------
Total from Investment
Operations 1.25 0.50
--------- -------------
Less Distributions
Dividends (from net
investment income) 0.16 0.09
Distributions (from capital
gains) 0.59 0.04
--------- -------------
Total Distributions 0.75 0.13
--------- -------------
Net Asset Value,
End of Period $ 10.87 $ 10.37
========= =============
Total Return ** 11.70% 4.96%
Ratios/Supplemental Data
Net Assets, end of
period (in thousands) $ 7,902 $ 6,680
Ratio of expenses to
average net assets 0.96% 0.95%
Ratio of net investment
income to average
net assets 1.50% 0.94%
Portfolio Turnover Rate 76% 50%
** Total returns for periods less than one year are not annualized.
-15-
<PAGE>
General Information about the Fund
Management of the Fund
The business and affairs of the fund are managed under the direction of its
Board of Directors according to laws of the State of Maryland and the fund's
Articles of Incorporation and Bylaws. Information about the directors and the
fund's executive officers may be found in the statement of additional
information (SAI) under the heading "Management of the Fund."
The Investment Adviser--American United Life Insurance Company(R)
AUL is a legal reserve mutual life insurance company existing under the
laws of the State of Indiana. It was originally incorporated as a fraternal
society on November 7, 1877, under the laws of the federal government, and
reincorporated under the laws of the State of Indiana in 1933. It is qualified
to do business in 49 states and the District of Columbia. As a mutual company,
it is owned by and operated exclusively for the benefit of its policyowners. The
adviser has its principal business office located at One American Square,
Indianapolis, IN 46282.
At a meeting of the AUL Board of Directors held on February 17, 2000, the
Board approved the concept of changing the corporate structure of AUL. During
the second quarter of 2000, the Board of Directors of AUL is expected to
formally approve a plan of conversion ("Plan") under which AUL will convert from
a mutual life insurance company to a stock life insurance company ultimately
controlled by a mutual holding company ("Mutual Holding Company"). This
transaction is intended to result in a corporate structure that provides, among
other things, better access to external sources of capital. Under the Plan, upon
the conversion, the insurance company would issue voting stock to a newly-formed
stock holding company ("Stock Holding Company"). It is anticipated that the
Stock Holding Company could, subsequent to the conversion, offer shares of its
stock publicly or privately; however, the Mutual Holding Company must always
hold at least 51% of the voting stock of the Stock Holding Company. The Stock
Holding Company would always own 100% of the voting stock of AUL. No plans have
been formulated to issue any shares of capital stock or debt securities of the
Stock Holding Company at this time.
Since AUL currently is a mutual life insurance company, owners
("policyholders") of AUL's annuity contracts and life insurance policies
("policies") have certain membership interests in AUL consisting principally of
the right to vote on the election of the Board of Directors and on other matters
and certain rights upon liquidation or dissolution of AUL. Under the Plan,
policyholders continue to be policyholders in the same insurance company, but
would no longer have a membership interest in the insurance company; rather,
policyholders would have membership interests in the Mutual Holding Company.
These interests in the Mutual Holding Company would be substantially the same as
the membership interests that policyholders have in AUL prior to the conversion,
consisting principally of the right to vote on the election of the Board of
Directors and on other matters and certain rights upon liquidation or
dissolution of the Mutual Holding Company. After the conversion, persons who
acquire policies from AUL would automatically be members in the Mutual Holding
Company. The conversion will not, in any way, increase premium payments or
reduce policy benefits, values, guarantees or other policy obligations to
policyholders. The Plan is subject to the approval by AUL policyholders and the
consent of the Insurance Commissioner of Indiana, among other approvals and
conditions. If the necessary approvals are obtained and conditions met, the
conversion could occur in 2000. Under the Plan, the insurance company name will
not change.
Subject to overall supervision of the Board of Directors, the adviser
exercises overall responsibility for the investment and reinvestment of the
fund's assets. In so doing, the adviser manages the day-to-day investment
operations and the composition of the investment portfolio of each portfolio
(except the Tactical Asset Allocation portfolio and a portion of each LifeStyle
portfolio). These duties include the purchase, retention, and disposition of the
investments, securities, and cash in accordance with the portfolios' investment
objectives and policies as stated in the fund's current prospectus.
AUL has engaged sub-advisers to manage the assets of the Tactical Asset
Allocation portfolio and a portion of the assets of the LifeStyle portfolios as
described below.
Under the Investment Advisory agreement, the adviser is compensated for its
services, by a monthly fee based on an annual percentage of the average daily
net assets of each portfolio. The fees paid by the fund to AUL (by portfolio)
are:
Equity portfolio: .50% Tactical Asset Allocation portfolio: .80%
Bond portfolio: .50% Conservative Investor portfolio: .70%
Managed portfolio: .50% Moderate Investor portfolio: .70%
Money Market portfolio: .40%* Aggressive Investor portfolio: .70%
*The fee for the Money Market portfolio was reduced on May 1, 1999 from .50% to
the present level of .40%.
From the fees paid to AUL by the fund, AUL pays all of the sub-advisers for
their services.
-16-
<PAGE>
The Portfolio Managers and the Sub-Advisers
The Equity Portfolio
The day-to-day management of the Equity portfolio is the responsibility of
Kathryn Hudspeth, CFA, Vice President, Equities. Ms. Hudspeth has been the
portfolio manager of the Equity portfolio since its inception and has been with
AUL since 1989. Previously, Ms. Hudspeth has held positions with AUL which
include Assistant Vice President, Equities; Equity Portfolio Manager, and
Director of Equity Investments. Before coming to AUL, she was employed by Bank
One, Indianapolis, as a Vice President and Trust Officer in the Personal Trust
Division.
The Bond Portfolio
The day-to-day management of the Bond portfolio is the responsibility of
Kent Adams, CFA, Vice President, Fixed Income Securities. Mr. Adams has been the
portfolio manager of the Bond portfolio since its inception and has been with
AUL since 1977. Previously, Mr. Adams has held positions with AUL which include
Assistant Vice President, Investment Officer, Securities, and Senior Securities
Analyst.
The Managed Portfolio
The day-to-day management of the Managed portfolio is the joint
responsibility of Kathryn Hudspeth, Vice President, Equities and Kent Adams,
Vice President, Fixed Income Securities, AUL.
The Sub-Advisers
Dean Investment Associates is the sub-adviser to the Tactical Asset
Allocation portfolio. Credit Suisse Asset Management is the sub-adviser to a
portion of the assets of each LifeStyle portfolio. Subject to the supervision of
AUL and the fund's Board of Directors, the sub-advisers are responsible for the
actual management of their respective portfolio or portion of a portfolio, for
making decisions to buy, sell or hold any particular security, and for placing
orders to buy or sell securities on behalf of their respective portfolio or
portions of a portfolio managed by them.
The Tactical Asset Allocation Portfolio
Dean Investment Associates, a Division of C.H. Dean and Associates, Inc. is
located at 2480 Kettering Tower, Dayton, Ohio 45423-2480 and is a registered
investment adviser with the SEC. Dean Investment Associates is wholly-owned by
C.H. Dean and Associates, Inc. Founded in 1972,
Dean Investment Associates manages portfolios for individuals and institutional
clients worldwide. Dean Investment Associates provides a full range of
investment advisory services and currently has over $3 billion of assets under
management.
The portfolio is managed by a team of 10 senior investment professionals
(the Central Investment Committee). John C. Riazzi, CFA, serves as the Senior
Portfolio Manager of the portfolio. Mr. Riazzi joined Dean in March of 1989.
From 1989 through January, 1992, Mr. Riazzi was manager of Dean's Client
Services and Trading Operations. From January, 1992 to August, 1993, his role
expanded to include Assistant Manager of Consulting Services and Institutional
Portfolio Manager. In August, 1993, Mr. Riazzi was promoted to Vice President,
Director of Consulting Services, and was made a member of Dean's Central
Investment Committee. In October, 1999, he was promoted to Senior Vice President
responsible for Dean's Portfolio Management Group. He received a B.A. with
honors in Economics from Kenyon College in 1985, was awarded the Chartered
Financial Analyst designation in 1993, and has been a member of the Cincinnati
Society of Financial Analysts since January, 1994. Prior to joining Dean, Mr.
Riazzi spent four years in the commercial banking and brokerage industries.
The LifeStyle Portfolios
Credit Suisse is located at One Citicorp Center, 153 East 53rd Street, New
York, New York 10022, and is a registered investment adviser with the SEC.
Credit Suisse is responsible for managing the growth-oriented equity and
international equity portions of the LifeStyle portfolios. AUL manages the
portfolios' investments in all other asset classes. Credit Suisse is a
diversified investment adviser managing global equity, fixed-income and
derivative securities accounts for corporate pension and profit-sharing plans,
state pension funds, union funds, endowments and other charitable institutions.
As of December 31, 1999, Credit Suisse managed approximately $202 billion in
assets. Credit Suisse currently acts as investment adviser for 57 other
investment companies registered under the 1940 Act, and acts as sub-adviser to
certain portfolios of 17 other registered investment companies.
The portfolio manager for the growth-oriented equity securities in the
LifeStyle portfolios is Eric N. Remole. Mr. Remole joined Credit Suisse in 1997
as a Managing Director and Portfolio Manager and is responsible for the
management of structured equity products. Mr. Remole began his career in 1978 as
a systems analyst at Jaycor, Inc. He joined Bankers Trust in 1980 as an internal
management consultant in securities operations. In 1984 he joined Citicorp
Investment Management, Inc., Chancellor Capital Management, Inc.'s predecessor
and was appointed Managing Director in April of 1993. Mr. Remole received a B.A.
from Dartmouth College in 1978 and an M.S. in Operations Research from Stanford
University in 1981.
The portfolio manager for the international equity securities in the
LifeStyle portfolios is Steven Bleiberg. Mr. Bleiberg joined Credit Suisse in
1991 as a Vice President on the management and research team for international
equities, specializing in the application of quantitative techniques for risk
control and security selection. Mr. Bleiberg manages the Japanese portion of
Credit Suisse's international portfolios. He also contributes to the asset
allocation process for international and global portfolios. Mr.
-17-
<PAGE>
Bleiberg spent two years as a portfolio manager at Matrix Capital Management,
where he was responsible for all of the firm's active equity assets. Prior to
Matrix, he spent 5 years at Credit Suisse in the equity research department. He
received a B.A. from Harvard University and an M.S. from the Sloan School of
Management at MIT.
Further Portfolio Information; Investments; Investment Strategies and Risks
Investments and Investment Strategies
Many of the investment strategies and techniques described in this
prospectus are discretionary, and portfolio managers can decide whether or not
to use them at any particular time. Other techniques, strategies and investments
may be made that are not part of a portfolio's principal investment strategy or
strategies. The investment objectives of a portfolio may not be changed without
the approval of the shareholders. However, a portfolio's investment policies may
be changed by the fund's Board of Directors. All of the portfolios are
diversified and will not concentrate their securities purchases in a particular
industry or group of industries.
The Equity Portfolio
The Equity Portfolio invests primarily in equity securities selected on the
basis of fundamental investment research for their long-term growth prospects.
Using a bottom-up approach, the Portfolio concentrates on companies which appear
undervalued compared to the market and their own historic valuation levels. Both
quantitative and qualitative tools are utilized focusing on a "value" based
equity strategy.
Important valuation criteria include price to sales, price to cash flow,
price to adjusted earnings, profitability, and growth potential. The Portfolio
also focuses on high quality companies that have been able to produce profits
for shareholders over the long term. Other important considerations include
management ability, insider ownership and industry position.
In addition to extensive fundamental analysis, the adviser also uses
technical analysis. Its purpose is not to make investment decisions, but rather
to assist in the timing of trading decisions.
When the adviser believes that financial, economic, or market conditions
require a defensive strategy, the portfolio may buy more nonconvertible debt
securities, U.S. Government securities, commercial paper and other money market
instruments, repurchase agreements and reverse repurchase agreements. To meet
its secondary objective of current income, the portfolio may also buy and sell
options on securities and securities indices, although it will do so only for
purposes of trying to generate current income or to hedge portfolio risks, and
not for speculative purposes.
The Bond Portfolio
The bond portfolio may also invest in money market instruments and
repurchase and reverse repurchase agreements. The bond portfolio may invest in
dollar-denominated foreign securities including corporate bonds or other debt
securities that satisfy the portfolio's standards for quality.
The Money Market Portfolio
The adviser determines whether a money market instrument has the required
minimal credit risk under procedures adopted by the fund's Board of Directors.
An instrument is of the highest quality when:
*it is a U.S. Government security;
*it (or a similar short-term obligation from the same issuer) is rated
-in the highest rating category by two nationally recognized
statistical rating organizations, or
-if rated by only one such organization, if the Board ratifies or
approves the purchase; or
*it is not rated, but the adviser has determined the security to be of
comparable quality and the purchase is approved or ratified by the
Board.
If the rating of an instrument bought by the portfolio is lowered, the adviser
will follow procedures approved by the Board of Directors to determine if the
security still presents minimal credit risk. If it does not, it will be sold.
Examples of money market instruments that may be bought by the portfolio
include: U.S. Government securities, repurchase agreements that mature in seven
days or less with Federal Reserve System banks or with dealers in U.S.
Government securities, reverse repurchase agreements, certificates of deposit
and other obligations of banks or depositories, debt securities, commercial
paper, and variable amount floating rate notes and master notes.
The Managed Portfolio
In pursuing its investment objective, the portfolio may engage in the
writing of covered call and secured put options on equity and debt securities,
and may purchase call options on debt securities. The portfolio may enter into
repurchase agreements and reverse repurchase agreements.
The Tactical Asset Allocation Portfolio
The principles by which the portfolio's sub-adviser makes its stock
selection are based on "value investing" which attempts to preserve principal
while seeking above average returns. The sub-adviser seeks to identify companies
whose stocks are reasonably priced and that the sub-adviser believes will
perform better than the current expectations over the next several years.
The selection process starts with a "bottoms up" screening of the market to
identify stocks that are statistically
-18-
<PAGE>
undervalued based on financial characteristics. This process, however, is
balanced against a policy to preserve capital. The sub-adviser believes that
investors' expectations and the company's operating performance ultimately
determine which statistically "undervalued" stocks make good investments. The
sub-adviser's research staff tries to evaluate stocks that appear likely to
provide investors with positive surprises, while avoiding negative surprises, by
taking into account projected future cash flows, earnings, and dividends. The
sub-adviser's goal is to choose stocks which the market has undervalued based on
an "over reaction" to perceived risks. A stock's fundamentals dominate the
selection process. However, technical analysis is used to improve the timeliness
of the sub-adviser's trading decisions.
The portfolio may invest up to 25% of its total assets in equity securities
of foreign issuers. It is anticipated that most of the portfolio's investments
in securities of foreign issuers will be American Depositary Receipts (ADRs).
See "Foreign Securities" in the SAI for a discussion of some of the risks
involved in foreign investment.
The portion of the portfolio not invested in equity securities, which
varies, will be invested in debt obligations, including U.S. Government
securities, investment-grade corporate bonds and debentures, high-grade
commercial paper, convertible securities, and certificates of deposit. The
portfolio may increase its investment in such securities when the sub-adviser
determines that equity investment opportunities with desirable risk/reward
characteristics are unavailable, or for temporary defensive purposes.
The LifeStyle Portfolios
The LifeStyle portfolios are "strategic" rather than "tactical" allocation
funds, which means that AUL and the sub-adviser do not try to time the market to
identify the exact time when a major reallocation should be made. Instead, AUL
and the sub-adviser utilize a longer-term "risk/return" approach in pursuing the
portfolios' investment objectives.
Within each asset class, each LifeStyle portfolio's holdings are invested
across a diversified group of industries and issuers based upon AUL's and the
sub-adviser's investment criteria. AUL and the sub-adviser regularly review each
LifeStyle portfolio's investments and allocations and may make changes in the
particular securities or in the asset mix (within the defined operating ranges)
to favor investments that it believes will help achieve a portfolio's objective.
The LifeStyle portfolios invest directly in equities, bonds and money
market instruments. In the future, each portfolio may seek its investment
objective by investing primarily in other mutual funds and closed-end investment
companies.
General Risks
Each portfolio, of course, is subject to the general risk that its
investment objective or objectives will not be achieved, or that a portfolio
manager will make investment decisions or use strategies that do not accomplish
their intended goals. In addition, the portfolios' investment strategies may
subject them to a number of risks, including the following:
Market Risk
Although equities historically have outperformed other asset classes over
the long term, their prices tend to fluctuate more dramatically over the shorter
term. These movements may result from factors affecting individual companies, or
from broader influences like changes in interest rates, market conditions,
investor confidence or announcements of economic, political or financial
information. While potentially offering greater opportunities for capital growth
than larger, more established companies, the equities of smaller companies may
be particularly volatile, especially during periods of economic uncertainty.
These companies may face less certain growth prospects, or depend heavily on a
limited line of products and services or the efforts of a small number of key
management personnel. Portfolios that may invest primarily in equities, such as
the Equity, Managed, Tactical Asset Allocation, Aggressive Investor and Moderate
Investor portfolios may be particularly subject to the potential risks (and
rewards) and volatility of investing in equities.
The Tactical Asset Allocation portfolio and each LifeStyle portfolio may
invest in equities issued by foreign companies. The equities of foreign
companies may pose risks in addition to, or to a greater degree than, the risks
described above. Foreign companies may be subject to disclosure, accounting,
auditing and financial reporting standards and practices that are different from
those to which U.S. issuers are subject. Accordingly, these portfolios may not
have access to adequate or reliable company information. In addition, political,
economic and social developments in foreign countries and fluctuations in
currency exchange rates may affect the operations of foreign companies or the
value of their securities. Risks posed by investing in the equities of foreign
issuers may be particularly acute with respect to issuers located in lesser
developed, emerging market countries. Each LifeStyle portfolio may invest in
this type of issuer.
The adviser and/or sub-adviser of the Tactical Asset Allocation tries to
manage market risk by primarily investing in relatively large capitalization
"value" equities. Equities of larger companies tend to be less volatile than
those of smaller companies, and value equities in theory limit downside risk
because they are underpriced. Of course, the adviser's or sub-adviser's success
in moderating market risk cannot be assured. In addition, these portfolios may
produce more modest gains than equity funds with more aggressive investment
profiles.
Interest Rate Risk
Each portfolio may invest in debt securities and other types of fixed
income securities. Generally, the value of these securities will change
inversely with changes in interest rates. In addition, changes in interest rates
may affect the operations of the issuers of stocks or other equity securities
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in which the portfolios invest. Rising interest rates, which may be expected to
lower the value of fixed income instruments and negatively impact the operations
of many issuers, generally exist during periods of inflation or strong economic
growth.
Credit Risk
The portfolios' investments, and particularly investments in convertible
securities and debt securities, may be affected by the creditworthiness of
issuers in which the portfolios invest. Changes in the financial strength, or
perceived financial strength, of a company may affect the value of its
securities and, therefore, impact the value of a portfolio's shares if it
invests in the company's securities.
The portfolios, except for the Money Market portfolio, may invest in lower
rated debt obligations, and the Bond and Managed portfolios may invest in fixed
income securities that are not "investment grade", which are commonly referred
to as "junk bonds". To a greater extent than more highly rated securities, lower
rated securities tend to reflect short-term corporate, economic and market
developments, as well as investor perceptions of the issuer's credit quality.
Lower rated securities may be especially susceptible to real or perceived
adverse economic and competitive industry conditions. In addition, lower rated
securities may be less liquid than higher quality investments. Reduced liquidity
may prevent a portfolio from selling a security at the time and price that would
be most beneficial to the portfolio.
The adviser and sub-advisers attempt to reduce the credit risk associated
with lower rated securities through diversification of portfolio investments,
credit analysis of issuers in which the portfolios invest, and monitoring broad
economic trends and corporate and legislative developments. However, there is no
assurance that they will successfully or completely reduce credit risk.
Please see the Statement of Additional Information for more detailed
information about the portfolios, their investment strategies, and their risks.
Defensive Strategy
If the adviser believes that economic or other market conditions, such as
excessive volatility or sharp market declines, require taking a defensive
position to preserve or maintain the assets of a portfolio, then a portfolio may
purchase securities of a different type or types than it ordinarily would
purchase, even if such purchases are contrary to the investment objective or
objectives of a portfolio. Taking such a defensive position could prevent a
portfolio from attaining its investment objectives, or cause it to miss out on
some or all of an upswing in the securities market.
Legal Proceedings
There are currently no legal proceedings involving the fund.
Diversification
To comply with regulations under Section 817(h) of the Internal Revenue
Code (the "Code"), each portfolio will be required to diversify its investments.
Generally, to meet the requirements, on the last day of each calendar quarter,
no more than 55% of the total assets may be represented by any one investment,
no more than 70% may be represented by any two investments, no more than 80% may
be represented by any three investments, and no more than 90% may be represented
by any four investments. All securities of a given issuer generally are regarded
for this purpose as one investment and, in the case of U.S. Government
securities, each U.S. Government agency or instrumentality is treated as a
separate issuer. Other tax-related diversification requirements apply to each
portfolio in connection with qualifying as a regulated investment company.
Reference is made to the prospectus for the separate account or accounts
that invest in the fund and/or the applicable contract for information regarding
the federal income tax treatment of distributions to the separate account or
accounts.
Purchase and Redemption of Shares
As of the date of this prospectus, shares of the fund are offered only for
purchase by one or more separate accounts of AUL to serve as an investment
medium for the contracts issued by AUL. Shares of each portfolio may be offered
in the future to separate accounts of other affiliated or unaffiliated insurance
companies to serve as the underlying investments for variable life and annuity
contracts. Owners of the contracts do not deal directly with the fund with
respect to acquisition, redemption, or transfer of shares, and should refer to
the contract (or certificate), or, if applicable, the prospectus for the
separate account for information on allocation of premiums and on transfers of
account value.
Shares of a portfolio may be purchased or redeemed on any day that AUL is
open for business. Shares of each portfolio are sold at their respective net
asset values (without a sales charge) next computed after receipt of a purchase
order by AUL at its home office, on behalf of a separate account. The separate
accounts invest in shares of the fund in accordance with allocation instructions
received from
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owners and participants of the contracts offered by AUL. Redemptions will be
effected by the separate accounts to meet obligations under the contracts.
Redemptions are made at the per share net asset value next determined after
receipt of the redemption request by AUL at its home office, on behalf of a
separate account. Redemption proceeds normally will be paid within seven days
following receipt of instructions in proper form. The right of redemption may be
suspended by the fund (1) when the New York Stock Exchange (the "NYSE") is
closed (other than customary weekend and holiday closings) or for any period
during which trading is restricted; (2) because an emergency exists, as
determined by the SEC, making disposal of portfolio securities or valuation of
new assets not reasonably practicable; and (3) whenever the SEC has by order
permitted such suspension or postponement for the protection of shareholders.
Net Asset Value
The net asset value per share of each portfolio is determined by dividing
the value of each portfolio's net assets by the number of its shares
outstanding. That determination is made once each business day, Monday through
Friday, at or about 4 p.m., eastern standard time (EST). The determination may
be made earlier than 4 p.m. EST if the NYSE closes earlier than 4 p.m. EST and
it is possible to determine the net asset value at that time. Net asset value
will not be determined on days that the NYSE is closed, on any federal holidays
or on days when AUL is not open for business. Traditionally, in addition to
federal holidays, AUL is not open for business on the day after Thanksgiving and
either the day before or after Christmas or Independence Day. The value of the
assets of each portfolio other than the Money Market portfolio is based on their
market prices, with special provisions for assets not having readily available
market quotations and for short-term debt securities.
The net asset value per share of each portfolio, except the Money Market
portfolio, will fluctuate in response to changes in market conditions and other
factors. The Money Market portfolio will attempt to maintain a constant net
asset value per share of $1.00, which will not fluctuate in response to changes
in market conditions, although there can be no assurance that this will be
achieved. The Money Market portfolio attempts to maintain a constant net asset
value per share by using the amortized cost method of valuation for its
portfolio securities. This involves valuing a security at cost on the purchase
date and thereafter assuming a constant accretion of a discount or amortization
of a premium to maturity. See the SAI for a description of certain conditions
and procedures followed by the portfolios in connection with amortized cost
valuation.
TAXATION
Distributions of any net investment income and of any net realized
short-term capital gains are treated as ordinary income for tax purposes in the
hands of the shareholder (separate account). The excess of any net long-term
capital gains over the short-term capital losses will, to the extent
distributed, be treated as long-term capital gains in the hands of the separate
account regardless of the length of time the separate account may have held the
shares. Such income and capital gains distributions are automatically reinvested
in additional shares of the portfolio unless the shareholder (separate account)
elects otherwise. The purchase of shares of the fund has no direct effect on
purchasers of the Contracts through the separate account.
STATEMENT OF ADDITIONAL INFORMATION
The statement of additional information contains more specific information
relating to the AUL American Series Fund, Inc.
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We have not authorized anyone to provide you with information that is
different from the information in this prospectus. You should only rely on the
information in this prospectus or in other information provided to you by us.
There is a statement of additional information that has more information
about the fund. The fund also files annual and semi-annual reports with the SEC.
These reports provide more information about the fund's investments. The annual
report also discusses market conditions and investment strategies that
significantly affected the fund's performance in 1999.
You may request a free copy of the statement of additional information or a
copy of the annual or semi-annual reports by writing to us at One American
Square, Indianapolis, Indiana 46282 or by calling us at (800) 249-6269. If you
have other questions, call or write us.
Information about the fund can also be reviewed and copied at the SEC's
Public Reference Room in Washington, D.C. or may be obtained by calling the SEC
at (800) SEC-0330. Reports and other information is also available on the SEC's
Internet site at http://www.sec.gov. Copies of this information can be ordered
by writing the Public Reference Section of the SEC, Washington, D.C. 2054906009.
The SEC will charge a duplicating fee for this service.
The fund has filed a registration statement with the SEC under the
Securities Act of 1933 and the Investment Company Act of 1940, as amended, that
provides information about the fund's securities. This information is
incorporated by reference.
AUL AMERICAN SERIES FUND, INC.
Variable Life and Annuity Contracts
Sold By
AMERICAN UNITED
LIFE INSURANCE COMPANY(R)
One American Square
Indianapolis, Indiana 46282
PROSPECTUS
Dated: May 1, 2000
Investment Company Filing No.: 811-05850
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Statement of Additional Information
AUL American Series Fund, Inc.
May 1, 2000
This is a statement of additional information (sai) and not a prospectus.
It contains more detailed information about the fund than the prospectus. You
may request a free copy of the prospectus by writing to us at One American
Square, Indianapolis, Indiana 46282 or by calling us at (800) 249-6269. The date
of the current prospectus is May 1, 2000.
The annual report of the fund for the year ending December 31, 1999, and
the notes in the annual report are incorporated by reference in the statement of
additional information. A free copy of the annual report may be obtained by
writing or calling the fund at the address or telephone number given above.
A table of contents for this statement of additional information is found below.
<TABLE>
<CAPTION>
TABLE OF CONTENTS
<S> <C>
Description Page
- ----------- ----
Introduction................................................................ 2
The Fund.................................................................. 2
Description of the Fund's Investments and the Investment Risks.............. 2-3
Description of Investments for the LifeStyle Portfolios................... 2
General Description of Securities and Investment Techniques................. 3-14
U.S. Government Securities................................................ 3
Corporate Bonds and Debt Securities Generally............................. 3
Mortgage-Related Securities............................................... 5
GNMA Certificates....................................................... 5
FNMA and FHLMC Obligations.............................................. 6
Collateralized Mortgage Obligations (CMOs).............................. 6
Other Mortgage-Backed Securities........................................ 6
Risks of Mortgage-Related Securities.................................... 7
Repurchase Agreements..................................................... 7
Reverse Repurchase Agreements............................................. 7
Banking Industry and Savings Industry Obligations......................... 8
Forward Foreign Currency Contracts........................................ 8
Options................................................................... 9
Risks Associated with Options........................................... 10
Futures Contracts......................................................... 10
Limitations............................................................. 11
Risks Associated with Futures........................................... 12
Foreign Securities........................................................ 12
Risks of Foreign Securities............................................. 13
Other Investment Companies................................................ 13
Zero Coupon and Step Coupon Securities.................................... 13
Illiquid and Restricted Securities........................................ 14
Lending of Portfolio Securities........................................... 14
Investment Restrictions..................................................... 14-15
Management of the Fund...................................................... 15-17
Directors and Officers.................................................... 15
Compensation of Directors................................................. 16
The Investment Adviser.................................................... 16
The Sub-Advisers.......................................................... 17
Fund Expenses............................................................... 17-18
General Expenses of the Fund.............................................. 17
Portfolio Expenses........................................................ 18
Organizational Expenses of the Portfolios................................. 18
Portfolio Transactions and Brokerage........................................ 18-19
Brokerage and Research Services........................................... 18
Portfolio Turnover........................................................ 19
Performance Information..................................................... 20-21
Taxation.................................................................... 21
Federal Income Tax Status................................................. 21
Shareholder Information..................................................... 21-22
Description of the Fund Shares............................................ 21
Voting Rights............................................................. 21
Net Asset Value of the Fund Shares. ..................................... 22
Purchases and Redemptions................................................. 22
Custodian, Transfer Agent, and Dividend Disbursing Agent.................. 22
Independent Accountants................................................... 22
Legal Counsel............................................................. 22
Code of Ethics............................................................ 22
Financial Statements....................................................... 22
Appendix I.................................................................. 23
</TABLE>
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INTRODUCTION
This statement of additional information is designed to provide a more
detailed discussion of certain securities and investment techniques which are
described in the prospectus. This information is intended only for investors who
have read the prospectus and are interested in a more detailed explanation of
certain aspects of the fund's securities and investment techniques. Captions and
defined terms in this statement of additional information generally correspond
to like captions and terms in the prospectus.
The Fund
AUL American Series Fund, Inc. (the fund) is an open-end, diversified
management investment company, commonly referred to as a mutual fund. It's eight
portfolios are the:
<TABLE>
<S> <C>
AUL American Equity portfolio AUL American Tactical Asset Allocation portfolio
AUL American Bond portfolio AUL American Conservative Investor portfolio
AUL American Money Market portfolio AUL American Moderate Investor portfolio
AUL American Managed portfolio AUL American Aggressive Investor portfolio
</TABLE>
Each portfolio has its own investment objectives, which are described in
the prospectus.
The fund was incorporated under the laws of Maryland on July 26, 1989, and
is registered under the Investment Company Act of 1940 (the 1940 Act) as an
open-end, diversified management investment company.
As a "series" type of mutual fund, the fund issues shares of common stock
relating to separate investment portfolios (portfolios). More portfolios may be
added in the future. An interest in the fund is limited to the assets of the
particular portfolio in which shares are held. Shareholders of each portfolio
are entitled to a pro rata share of all dividends and distributions paid by the
portfolio.
Description of the Fund's Investments and the Investment Risks
Description of Investments for the LifeStyle Portfolios
Equity Securities. The equity portion of each LifeStyle portfolio may be
invested in any type of domestic or foreign equity security, primarily common
stocks, that meet certain standards of selection. In addition to investing in
common stocks, the LifeStyle portfolios may invest in preferred stock,
convertible preferred stock, convertible debt securities, warrants, depository
receipts, and other securities believed to have equity characteristics. The
equity portion of each portfolio may be diversified among small, medium and
large companies. Both growth and value investment disciplines are normally
utilized in managing the equity portion of each portfolio. The growth discipline
attempts to identify companies whose earnings and revenue trends are believed by
the sub-adviser to demonstrate, or have the prospects for demonstrating,
accelerating earnings and revenues as compared to prior periods, competitors, or
market expectations. The value investment discipline attempts to identify
companies that are believed by AUL to be temporarily undervalued. It is believed
that value investing tends to provide less volatile results over the long term.
Bonds. The bond portion of each LifeStyle portfolio may be invested in U.S.
Treasury securities, securities issued or guaranteed by the U.S. Government or a
foreign government, or an agency or instrumentality of the U.S. or a foreign
government, and non-convertible debt obligations issued by U.S. or foreign
corporations. The LifeStyle portfolios may also invest in mortgage-backed and
other mortgage-related securities as described below under "Mortgage-Related
Securities" and in other asset-backed securities. The bond portion of a
portfolio may be diversified among the various types of fixed income investment
categories described above. The sub-adviser's strategy is to actively manage the
LifeStyle portfolio by investing the portfolio's assets in sectors it believes
are undervalued (relative to the other sectors) and which represent better
relative long-term investment opportunities.
For the fixed income portion of its assets, each portfolio invests primarily in
debt securities that, at the time of investment, are "investment grade." These
include bonds rated BBB or better by S&P or Baa or better by Moody's or, if not
rated, of equivalent quality in the judgment of AUL. See "Corporate Bonds and
Debt Securities Generally" below for more information on debt securities. In
addition, 30% of each portfolio's fixed income assets may be invested in "high
yield" securities which are debt securities rated, at the time of investment,
lower than Baa by Moody's or BBB by S&P or of equivalent quality as deemed by
the adviser or the sub-adviser. "High Yield" bonds are not considered to be
investment grade and are regarded as predominantly speculative with respect to
the issuer's continuing ability to meet principal and interest payments. See
"Corporate Bonds and Debt Securities Generally" and Appendix I below for further
information concerning bond ratings.
Money Market Instruments. The cash equivalent portion of a LifeStyle portfolio's
securities may be invested in money market instruments (denominated in U.S.
dollars or
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foreign currencies), including U.S. Government obligations, obligations of
domestic and foreign banks, short-term corporate debt instruments and repurchase
agreements. The LifeStyle portfolios may only invest in money market instruments
that are rated AAA or A-1 by S&P, Aaa or P-1 by Moody's, or AAA or D-1 by Duff &
Phelps, Inc., or, if not rated, are of equivalent investment quality as
determined by AUL.
Foreign Securities. Each of the portfolios may invest in the securities of
foreign issuers. In determining the allocation of assets among U.S. and foreign
issuers, AUL and the sub-adviser consider the condition and growth potential of
the various economies; the relative valuations of the markets; and social,
political, and economic factors that may affect the markets. The Conservative
Investor portfolio will generally invest not more than 20% of its assets in
foreign securities; the Moderate Investor portfolio will generally invest not
more than 30% of its assets in foreign securities; and the Aggressive Investor
portfolio will generally invest not more than 35% of its assets in foreign
securities. These percentages are measured at the time of investment.
The LifeStyle portfolios may make investments in foreign securities either
directly or indirectly by purchasing depository receipts or depository shares of
similar instruments ("depository receipts"). Depository receipts are securities
that are listed on exchanges or quoted in the domestic over-the-counter markets
in one country but represent shares of issuers domiciled in another country.
Direct investments in foreign securities may be made either on foreign
securities exchanges or in the over-the-counter markets. Subject to its
investment objective and policies, each portfolio may invest in common stocks,
convertible securities, preferred stocks, bonds, notes and other debt securities
of foreign issuers and debt securities of foreign governments and their
agencies. The credit quality standards applicable to domestic securities
purchased by each LifeStyle portfolio are also applicable to its foreign
securities investments. The LifeStyle portfolios may also invest a portion of
their international holdings in securities of issuers in emerging market
(developing) countries. See "Foreign Securities" below for more information. In
connection with investments in securities denominated in foreign currencies, AUL
and the sub-adviser may seek to hedge all or a part of a portfolio's foreign
currency exposure through the use of forward foreign currency contracts. See
"Forward Foreign Currency Contracts" below.
GENERAL DESCRIPTION OF SECURITIES AND INVESTMENT TECHNIQUES
U.S. GOVERNMENT SECURITIES
All of the portfolios may invest in U.S. Government securities. U.S.
Government securities are obligations of, or obligations guaranteed by, the U.S.
Government, its agencies or instrumentalities. Securities guaranteed by the U.S.
Government include: (1) direct obligations of the U.S. Treasury (such as
Treasury bills, notes, and bonds) and (2) federal agency obligations guaranteed
as to principal and interest by the U.S. Treasury (such as GNMA certificates).
Direct obligations of the U.S. Government include a variety of Treasury
securities which differ with respect to coupons, maturities, and dates of issue.
Treasury bills have a maturity of one year or less. Treasury notes have
maturities of one to 10 years, and Treasury bonds generally have a maturity of
greater than 10 years. Securities guaranteed by the U.S. Government include
federal agency obligations guaranteed as to principal and interest by the U.S.
Treasury (such as Government National Mortgage Association ("GNMA") certificates
and Federal Housing Administration debentures). The payment of principal and
interest of these securities is unconditionally guaranteed by the U.S.
Government. They are thus of the highest credit quality. Such securities are
subject to variations in market value due to fluctuations in interest rates but,
if held to maturity, the United States is directly obligated or guarantees to
pay them in full.
Securities issued by U.S. Government instrumentalities and certain federal
agencies are neither direct obligations of, nor obligations guaranteed by, the
U.S. Treasury. However, they involve federal sponsorship in one way or another:
some are supported by the issuer's right to borrow from the U.S. Government;
others are supported only by the credit of the issuing government agency or
instrumentality. These agencies and instrumentalities include, but are not
limited to, Federal National Mortgage Association ("FNMA"), Federal Home Loan
Banks, Federal Land Banks, Central Bank for Cooperatives, Federal Intermediate
Credit Banks, Farmers Financing Bank, Farmers Home Administration, Farm Credit
Banks, and the Tennessee Valley Authority.
CORPORATE BONDS AND DEBT SECURITIES GENERALLY
The Bond, Money Market, Managed, Tactical Asset Allocation, and the
LifeStyle portfolios may invest in U.S. dollar or foreign currency-denominated
corporate bonds or debt securities of domestic or foreign issuers, which may
include, without limit, debentures, notes and other similar corporate debt
instruments, including convertible securities. Debt securities may be acquired
with warrants attached. Corporate income-producing securities also may include
forms of preferred or preference stock. These instruments must meet the minimum
ratings criteria set forth for the portfolio, or, if unrated, be deemed to be
comparable in quality to corporate debt securities in which the portfolio may
invest. The rate of return or return of principal on some debt obligations may
be linked or indexed to the level of exchange rates between the U.S. dollar and
a foreign currency or currencies.
The investment return on a debt security reflects interest earnings and
changes in the market value of the security. The market value of each
portfolio's securities may be affected by, among other things, changes in
interest rates,
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and the price of debt obligations will generally rise and fall inversely with
interest rates. Longer term debt obligations will normally have greater price
volatility than shorter term obligations.
A debt security also presents the risk that the issuer of the security may
not be able to meet its obligations on interest or principal payments at the
time called for by the instrument. Bonds rated BBB or Baa, which are considered
medium-grade category bonds, do not have economic characteristics that provide
the same degree of security with respect to payment of principal and interest
associated with higher rated bonds, and generally have some speculative
characteristics. A bond will be placed in this rating category where interest
payments and principal security appear adequate for the present, but economic
characteristics that provide longer-term protection may be lacking. Any bond,
and particularly those rated BBB or Baa, may be susceptible to changing
conditions, particularly to economic downturns, which could lead to a weakened
capacity to pay interest and principal. In the event that ratings decline after
the portfolio's investment in debt securities, the adviser or sub-adviser will
consider all such factors as it deems relevant to the advisability of retaining
such securities. See Appendix I below for further information concerning bond
ratings.
Among the corporate debt securities in which the portfolios may invest are
convertible securities. A convertible debt security is a bond, debenture, note,
or other security that entitles the holder to acquire common stock or other
equity securities of the same or a different issuer. A convertible security
generally entitles the holder to receive interest paid or accrued until the
convertible security matures or is redeemed, converted or exchanged. Before
conversion, convertible securities have characteristics similar to
non-convertible debt securities. Convertible securities rank senior to common
stock in a corporation's capital structure and, therefore, generally entail less
risk than the corporation's common stock, although the extent to which such risk
is reduced depends in large measure upon the degree to which the convertible
security sells above its value as a fixed income security.
A convertible security may be subject to redemption at the option of the
issuer at a predetermined price. If a convertible security held by a portfolio
is called for redemption, the portfolio would be required to permit the issuer
to redeem the security and convert it to underlying common stock, or would sell
the convertible security to a third party. A portfolio generally would invest in
convertible securities for their favorable price characteristics and total
return potential.
Certain portfolios may invest in or acquire warrants to purchase equity or
fixed income securities. Bonds with warrants attached to purchase equity
securities have many characteristics of convertible bonds and their prices may,
to some degree, reflect the performance of the underlying stock. Bonds also may
be issued with warrants attached to purchase additional fixed income securities
at the same coupon rate. A decline in interest rates would permit a portfolio to
buy additional bonds at the favorable rate or to sell the warrants at a profit.
If interest rates rise, the warrants would generally expire with no value.
Securities rated Baa and BBB are the lowest which are considered
"investment grade" obligations. Moody's Investors Service, Inc. ("Moody's")
describes securities rated Baa as "medium-grade" obligations; they are "neither
highly protected nor poorly secured . . . [i]nterest 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." Standard & Poor's ("S&P") describes
securities rated BBB as "regarded as having an adequate capacity to pay interest
and repay principal . . . [w]hereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal . . .
than in higher rated categories."
The Bond portfolio may invest up to 10% of its assets, measured at the time
of investment, the Managed portfolio may invest up to 10% of its fixed income
assets, measured at the time of investment, and each of the LifeStyle portfolios
may invest up to 30% of its fixed income assets, measured at the time of
investment, in securities rated below investment grade. These securities are
described as "speculative" by both Moody's and S&P. Investment in lower rated
corporate debt securities ("high yield securities" or "junk bonds") generally
provides greater income and increased opportunity for capital appreciation than
investments in higher quality securities, but they also typically entail greater
price volatility and principal and income risk. These high yield securities are
regarded as predominantly speculative with respect to the issuer's continuing
ability to meet principal and interest payments. Analysis of the
creditworthiness of issuers of debt securities that are high yield may be more
complex than for issuers of higher quality debt securities. Debt securities
rated lower than investment grade by either S&P or Moody's, but not the other,
are not considered to be high yield securities for purposes of the portfolios'
limits on investments in high yield securities.
High yield securities may be more susceptible to real or perceived adverse
economic and competitive industry conditions than investment grade securities.
The prices of high yield securities have been found to be less sensitive to
interest-rate changes than higher-rated investments, but more sensitive to
adverse economic downturns or individual corporate developments. A projection of
an economic downturn or of a period of rising interest rates, for example, could
cause a decline in high yield security prices because the advent of a recession
could lessen the ability of a highly leveraged company to make principal and
interest payments on its debt securities. If an issuer of high yield securities
defaults, in addition to risking payment of all or a
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portion of interest and principal, the portfolios investing in such securities
may incur additional expenses to seek recovery. In the case of high yield
securities structured as zero coupon or pay-in-kind securities, their market
prices are affected to a greater extent by interest rate changes, and therefore,
tend to be more volatile than securities which pay interest periodically and in
cash.
The secondary market on which high yield securities are traded may be less
liquid than the market for higher grade securities. Less liquidity in the
secondary trading market could adversely affect the price at which the
portfolios could sell a high yield security, and could adversely affect the
daily net asset value of the shares. Adverse publicity and investor perceptions,
whether or not based on fundamental analysis, may decrease the values and
liquidity of high yield securities, especially in a thinly-traded market. When
secondary markets for high yield securities are less liquid than the market for
higher grade securities, it may be more difficult to value the securities
because such valuation may require more research, and elements of judgment may
play a greater role in the valuation because there is less reliable, objective
data available.
The use of credit ratings as the sole method of evaluating high yield
securities can involve certain risks, as credit ratings evaluate the safety of
principal and interest payments, not the market value risk of high yield
securities. Also, credit rating agencies may fail to change credit ratings in a
timely fashion to reflect events since the security was last rated. Accordingly,
analysis of the creditworthiness of issuers of high yield securities may be more
complex than for issuers of higher quality debt securities, and the ability of a
portfolio to achieve its investment objective may, to the extent of its
investments in high yield securities, be more dependent upon such
creditworthiness analysis than would be the case if the portfolio were investing
in higher quality securities.
MORTGAGE-RELATED SECURITIES
The Bond, Managed, Tactical Asset Allocation, and the LifeStyle portfolios,
may invest in GNMA certificates, FNMA and Federal Home Loan Mortgage Corporation
("FHLMC") mortgage-backed obligations, and privately issued mortgage-backed
securities. Mortgage-related securities are interests in pools of mortgage loans
made to residential home buyers, including mortgage loans made by savings and
loan institutions, mortgage bankers, commercial banks, and others. Pools of
mortgage loans are assembled as securities for sale to investors by various
governmental and government-related organizations.
GNMA Certificates
Government National Mortgage Association (GNMA) certificates are
mortgage-backed securities representing part ownership of a pool of mortgage
loans on which timely payment of interest and principal is guaranteed by the
full faith and credit of the U.S. Government. GNMA is a wholly-owned U.S.
Government corporation within the Department of Housing and Urban Development.
GNMA is authorized to guarantee, with the full faith and credit of the U.S.
Government, the timely payment of principal and interest on securities issued by
institutions approved by GNMA (such as savings and loan institutions, commercial
banks, and mortgage bankers) and backed by pools of FHA-insured or VA-guaranteed
mortgages.
Interests in pools of mortgage loans differ from other forms of debt
securities, which normally provide for periodic payment of interest in fixed
amounts with principal payments at maturity or specified call dates. Instead,
these securities provide a periodic payment which consists of both interest and
principal payments. In effect, these payments are a "pass-through" of the
periodic payments made by the individual borrowers on the residential mortgage
loans, net of any fees paid to the issuer or guarantor of such securities.
Additional payments are caused by repayments of principal resulting from the
refinancing, foreclosure or sale of the underlying residential property, net of
fees or costs which may be incurred. Mortgage-related securities issued by GNMA
are described as "modified pass-through" securities. These securities entitle
the holder to receive all interest and principal payments owed on the mortgage
pool, net of certain fees, at the scheduled payment dates, regardless of whether
or not the mortgagor actually makes the payment. Although GNMA guarantees timely
payment even if homeowners delay or default, tracking the "pass-through"
payments may, at times, be difficult. Expected payments may be delayed due to
the delays in registering the newly traded paper securities. The Custodian's
policies for crediting missed payments while errant receipts are tracked down
may vary.
Although the mortgage loans in the pool will have maturities of up to 30
years, the actual average life of the GNMA certificates typically will be
substantially less because the mortgages will be subject to normal principal
amortization and may be prepaid prior to maturity. Early repayments of principal
on the underlying mortgages may expose a portfolio to a lower rate of return
upon reinvestment of principal. Prepayment rates vary widely and may be affected
by changes in market interest rates. In periods of falling interest rates, the
rate of prepayment tends to increase, thereby shortening the actual average life
of the GNMA certificates. Conversely, when interest rates are rising, the rate
of prepayment tends to decrease, thereby lengthening the actual average life of
the GNMA certificates. Accordingly, it is not possible to accurately predict the
average life of a particular pool. Reinvestment of prepayments may occur at
higher or lower rates than the original yield on the certificates. Due to the
prepayment feature and the need to reinvest prepayments of principal at current
rates, GNMA certificates can be less effective than typical bonds of similar
maturities at "locking in" yields during periods of declining interest rates,
although they may have comparable risks of decline in value during periods of
rising interest rates.
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FNMA and FHLMC Obligations
The Federal National Mortgage Association (FNMA), a federally-chartered and
privately-owned corporation, issues pass-through securities representing
interests in a pool of conventional mortgage loans. FNMA guarantees the timely
payment of principal and interest but this guarantee is not backed by the full
faith and credit of the U.S. Government. FNMA is a government sponsored
corporation owned entirely by private stockholders. It is subject to general
regulation by the Secretary of Housing and Urban Development. FNMA purchases
conventional (i.e., not insured or guaranteed by any government agency)
residential mortgages from a list of approved seller/servicers which include
state and federally-chartered savings and loan associations, mutual savings
banks, commercial banks, credit unions, and mortgage bankers.
The Federal Home Loan Mortgage Corporation (FHLMC), a corporate
instrumentality of the United States, was created by Congress in 1970 for the
purpose of increasing the availability of mortgage credit for residential
housing. Its stock is owned by the 12 Federal Home Loan Banks. FHLMC issues
Participation Certificates ("PCs") which represent interests in a pool of
conventional mortgages from FHLMC's national portfolio. FHLMC guarantees the
timely payment of interest and ultimate collection of principal and maintains
reserves to protect holders against losses due to default, but PCs are not
backed by the full faith and credit of the U.S. Government. As is the case with
GNMA certificates, the actual maturity of and realized yield on particular FNMA
and FHLMC pass-through securities will vary based on the prepayment experience
of the underlying pool of mortgages.
Collateralized Mortgage Obligations (CMOs)
A CMO is a hybrid between a mortgage-backed bond and a mortgage
pass-through security. Similar to a bond, interest and prepaid principal are
paid, in most cases, semi-annually. CMOs may be collateralized by whole mortgage
loans, but are more typically collateralized by portfolios of mortgage
pass-through securities guaranteed by GNMA, FHLMC, or FNMA, and their income
streams.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral. CMOs provide for a modified form of call
protection through a de facto breakdown of the underlying pool of mortgages
according to how quickly the loans are repaid. Monthly payment of principal
received from the pool of underlying investors, including prepayments, is first
returned to investors holding the shortest maturity class. Investors holding the
longer maturity classes receive principal only after the first class has been
retired. An investor is partially guarded against a sooner-than-desired return
of principal because of the sequential payments.
In a typical CMO transaction, a corporation ("issuer") issues multiple
portfolios (e.g., A, B, C, Z) of CMO bonds ("Bonds"). Proceeds of the Bond
offering are used to purchase mortgages or mortgage pass-through certificates
("Collateral"). The Collateral is pledged to a third party trustee as security
for the Bonds. Principal and interest payments from the Collateral are used to
pay principal on the Bonds in the order A, B, C, Z. The portfolio A, B, and C
Bonds all bear current interest. Interest on the portfolio Z Bond is accrued and
added to the principal; a like amount is paid as principal on the portfolio A,
B, or C Bond currently being paid off. When the portfolio A, B, and C Bonds are
paid in full, interest and principal on the portfolio Z Bond begin to be paid
currently. With some CMOs, the issuer acts as a conduit to allow loan
originators (usually builders or savings and loan associations) to borrow
against their loan portfolios.
Certain classes of CMOs pay the holders only the interest paid on the
underlying mortgages or mortgage pass-through securities ("interest-only
class"). Other classes pay the holders only the principal paid on the underlying
mortgages or mortgage pass-through securities ("principal-only class").
Interest-only and principal-only classes of CMOs purchased by a portfolio are
currently considered to be illiquid securities subject to the 10% limitation on
investment in illiquid securities. See "Investment Restrictions" in this SAI.
Other Mortgage-Backed Securities
Commercial banks, savings and loan institutions, private mortgage insurance
companies, mortgage bankers, and other secondary market issuers also create
pass-through pools of conventional residential mortgage loans. In addition, such
issuers may be the originators and/or servicers of underlying mortgage loans as
well as the guarantors of the mortgage-backed securities. Payments are passed
through to the holders, although not necessarily on a pro rata basis, on the
same schedule as they are received. Mortgage-backed bonds are general
obligations of the issuer fully collateralized directly or indirectly by a pool
of mortgages. The mortgages serve as collateral for the issuer's payment
obligations on the bonds, but interest and principal payments on the mortgages
are not passed through either directly (as with GNMA certificates and FNMA and
FHLMC pass-through securities) or on a modified basis (as with CMOs).
Accordingly, a change in the rate of prepayments on the pool of mortgages could
change the effective maturity of a CMO but not that of a mortgage-backed bond
(although, like many bonds, mortgage-backed bonds can provide that they are
callable by the issuer prior to maturity). Pools created by such
non-governmental issuers generally offer a higher rate of interest than
government and government-related pools, because there are no direct or indirect
government or agency guarantees of payments in the former pools. Timely payment
of interest and principal of these pools may be supported by various forms of
insurance or guarantees, including individual loan, title, pool and hazard
insurance, and letters of credit. The insurance and guarantees are issued by
governmental entities, private insurers, and the mortgage poolers. Such
insurance, guarantees, and the
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creditworthiness of the issuers thereof will be considered in determining
whether a mortgage-backed security meets a portfolio's investment quality
standards. There can be no assurance that the private insurers or guarantors can
meet their obligations under the insurance policies or guarantee arrangements.
All portfolios that may buy mortgage-backed securities may purchase such
securities without insurance or guarantees, if the adviser or sub-adviser
determines that the securities meet a portfolio's quality standards. Although
the market for such securities is becoming increasingly liquid, securities by
certain private organizations may not be readily marketable. It is expected that
governmental, government-related, or private entities may create mortgage loan
pools and other mortgage-backed securities offering mortgage pass-through and
mortgage-collateralized investments in addition to those described above. As new
types of mortgage-backed securities are developed and offered to investors, the
adviser and the sub-advisers will, consistent with a portfolio's investment
objectives, policies, and quality standards, consider making investments in such
new types of mortgage-backed securities.
Risks of Mortgage-Related Securities
In the case of mortgage pass-through securities such as GNMA certificates
or FNMA and FHLMC mortgage-backed obligations, early repayment of principal
arising from prepayments of principal on the underlying mortgage loans due to
the sale of the underlying property, the refinancing of the loan, or foreclosure
may expose a portfolio to a lower rate of return upon reinvestment of principal.
Prepayment rates vary widely and may be affected by changes in market interest
rates. In periods of falling interest rates, the rate of prepayment tends to
increase, thereby shortening the actual average life of the mortgage-related
security. Conversely, when interest rates are rising, the rate of prepayment
tends to decrease, thereby lengthening the actual average life of the
mortgage-related security. Accordingly, it is not possible to accurately predict
the average life of a particular pool. Reinvestment of prepayments may occur at
higher or lower rates than the original yield on the certificates. Therefore,
the actual maturity and realized yield on pass-through or modified pass-through
mortgage-related securities will vary based upon the prepayment experience on
the underlying pool of mortgages.
REPURCHASE AGREEMENTS
All portfolios may invest in repurchase agreements. If a portfolio acquires
a security from a bank or broker-dealer, it may simultaneously enter into a
repurchase agreement with the seller wherein the seller agrees at the time of
sale to repurchase the security at a mutually agreed upon time and price. The
term of such an agreement is generally quite short, possibly overnight or for a
few days, although it may extend over a number of months (up to one year) from
the date of delivery. The resale price is in excess of the purchase price by an
amount which reflects an agreed upon market rate of return, effective for the
period of time the portfolio is invested in the security. This results in a
fixed rate of return protected from market fluctuations during the term of the
agreement. This rate is not tied to the coupon rate on the security subject to
the repurchase agreement. Such transactions afford an opportunity for a
portfolio to maintain liquidity and earn income over periods of time as short as
overnight.
The underlying securities on repurchase agreements are ordinarily U.S.
Government securities, but may be other securities in which the portfolio might
otherwise invest. A portfolio will enter into repurchase agreements only if they
are fully collateralized. The market value of the collateral, including accrued
interest, will equal or exceed the repurchase price, and the collateral will be
in the actual or constructive possession of the portfolio. Under the Investment
Company Act of 1940 (the "1940 Act"), repurchase agreements are considered to be
loans by the purchaser collateralized by the underlying securities. The adviser
or sub-adviser, as appropriate, will monitor the value of the underlying
securities at the time a repurchase agreement is entered into and at all times
during the term of the agreement to ensure that its value always equals or
exceeds the agreed upon repurchase price to be paid to the portfolio. The
adviser or sub-adviser will also evaluate the creditworthiness and financial
responsibility of the banks and broker-dealers with which the portfolios enter
into repurchase agreements.
A portfolio may not enter into a repurchase agreement having more than
seven days remaining to maturity if, as a result, such agreements together with
any other securities which are not readily marketable, would exceed applicable
limits on the portfolio's investments in illiquid securities.
A repurchase agreement subjects a portfolio to the risk of the inability of
the seller to pay the repurchase price on the delivery date; however, the
underlying security constitutes the collateral for the seller's obligation. In
addition, a portfolio will enter into repurchase agreements only with parties
that the adviser or sub-adviser considers creditworthy. In the event the seller
does default, the portfolio may incur (1) a loss if the value of the collateral
declines and (2) disposition costs in connection with liquidating the
collateral. In the event bankruptcy proceedings are commenced with respect to
the seller, realization of the collateral by the portfolio may be delayed or
limited and a loss may be incurred if the collateral securing the repurchase
agreement declines in value during the bankruptcy proceedings.
REVERSE REPURCHASE AGREEMENTS
All of the portfolios may invest in reverse repurchase agreements. Reverse
repurchase agreements involve the sale of a security by a portfolio and its
agreement to repurchase the instrument at a specified time and price.
A portfolio will use the proceeds of a reverse repurchase agreement to
purchase other money market instruments
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which either mature at a date simultaneous with or prior to the expiration of
the reverse repurchase agreement or which are held under an agreement to resell
maturing as of that time. A portfolio will enter into a reverse repurchase
agreement only when the interest income to be earned from the investment of the
proceeds of the transaction is greater than the interest expense of the
transaction. However, reverse repurchase agreements involve the risk that the
market value of securities retained by the portfolio may decline below the
repurchase price of the securities sold by the portfolio which it is obligated
to repurchase.
Under the 1940 Act, reverse repurchase agreements may be considered to be
borrowings by the seller. A portfolio will maintain a segregated account
consisting of liquid assets to cover its obligations under reverse repurchase
agreements. To the extent that positions in reverse repurchase agreements are
not covered through the maintenance of a segregated account consisting of liquid
assets at least equal to the amount of any forward purchase commitment, a
portfolio will limit its investments in such reverse repurchase agreements and
other borrowings to no more than one-third of the current market value of the
portfolio's total assets. The use of reverse repurchase agreements by a
portfolio creates leverage which increases a portfolio's investment risk. If the
income and gains on securities purchased with the proceeds of reverse repurchase
agreements exceed the cost of the agreements, the portfolio's earnings or net
asset value will increase faster than otherwise would be the case; conversely,
if the income and gains fail to exceed the costs, earnings or net asset value
would decline faster than otherwise would be the case.
A portfolio may enter into reverse repurchase agreements with banks or
broker-dealers. Entry into such agreements with broker-dealers requires the
creation and maintenance of a segregated account consisting of U.S. Government
securities or cash or cash equivalents equal to its obligations under reverse
repurchase agreements.
BANKING INDUSTRY AND SAVINGS INDUSTRY OBLIGATIONS
All portfolios may invest in certificates of deposit, time deposits,
bankers' acceptances, and other short-term debt obligations issued by commercial
banks; and in certificates of deposit, time deposits, and other short-term
obligations issued by savings and loan associations ("S&L").
Certificates of deposit are negotiable certificates issued against funds
deposited in a commercial bank or S&L for a definite period of time and earning
a specified return. Bankers' acceptances are negotiable drafts or bills of
exchange, which are normally drawn by an importer or exporter to pay for
specific merchandise, and which are "accepted" by a bank, meaning, in effect,
that the bank unconditionally agrees to pay the face value of the instrument on
maturity. Fixed-time deposits are bank obligations payable at a stated maturity
date and bearing interest at a fixed rate. Fixed-time deposits may be withdrawn
on demand by the investor, but may be subject to early withdrawal penalties
which vary depending upon market conditions and the remaining maturity of the
obligation. There are no contractual restrictions on the right to transfer a
beneficial interest in a fixed-time deposit to a third party, because there is
no market for such deposits. A portfolio will invest in fixed-time deposits (1)
which are not subject to prepayment or (2) which provide for withdrawal
penalties upon prepayment (other than overnight deposits), consistent with
applicable limits on its investments in illiquid securities.
The portfolios will not invest in obligations issued by a commercial bank
or S&L unless the bank or S&L has total assets of at least $1 billion, or the
equivalent in other currencies, and the institution has outstanding securities
rated A or better by S&P or Moody's, or, if the institution has no outstanding
securities rated by S&P or Moody's, such institution, in the determination of
the adviser or sub-adviser, has creditworthiness similar to institutions having
outstanding securities so rated.
The Money Market, Managed, Tactical Asset Allocation and LifeStyle
portfolios may invest in U.S. dollar-denominated obligations of foreign branches
of U.S. banks and foreign banks. Obligations of foreign banks involve somewhat
different investment risks than those affecting obligations of U.S. banks, which
include: (1) the possibility that their liquidity could be impaired because of
future political and economic developments; (2) their obligations may be less
marketable than comparable obligations of U.S. banks; (3) a foreign jurisdiction
might impose withholding taxes on interest income payable on those obligations;
(4) foreign deposits may be seized or nationalized; (5) foreign governmental
restrictions, such as exchange controls, may be adopted which might adversely
affect the payment of principal and interest on those obligations; and (6) the
selection of those obligations may be more difficult because there may be less
publicly available information concerning foreign banks and/or because the
accounting, auditing, and financial reporting standards, practices, and
requirements applicable to foreign banks may differ from those applicable to
U.S. banks. Foreign banks are not generally subject to examination by any U.S.
Government agency or instrumentality.
FORWARD FOREIGN CURRENCY CONTRACTS
Foreign currency exchange rates may fluctuate significantly over short
periods of time. They generally are determined by the forces of supply and
demand in the foreign exchange markets and the relative merits of investments in
different countries, actual or perceived changes in interest rates and other
complex factors, as seen from an international perspective. Currency exchange
rates also can be affected unpredictably by intervention (or the failure to
intervene) by U.S. or foreign governments or central banks, by currency controls
or political developments in the U.S. or abroad. Currencies in which the
portfolios' assets are
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denominated may be devalued against the U.S. dollar, resulting in a loss to the
portfolios.
The Tactical Asset Allocation and LifeStyle portfolios may invest in
forward foreign currency contracts to reduce the risks of adverse changes in
foreign exchange rates. A forward foreign currency contract involves an
obligation to purchase or sell a specific currency at a future date, which may
be any fixed number of days from the date of the contract agreed upon by the
parties, at a price set at the time of the contract. By entering into a forward
foreign currency contract, a portfolio "locks in" the exchange rate between the
currency it will deliver and the currency it will receive for the duration of
the contract. As a result, a portfolio reduces its exposure to changes in the
value of the currency it will deliver and increases its exposure to changes in
the value of the currency it will exchange into. The effect on the value of a
portfolio is similar to selling securities denominated in one currency and
purchasing securities denominated in another. Contracts to sell foreign currency
would limit any potential gain which might be realized by a portfolio if the
value of the hedged currency increases. A portfolio may enter into these
contracts for the purpose of hedging against foreign exchange risk arising from
the portfolio's investment or anticipated investment in securities denominated
in foreign currencies. A portfolio also may enter into these contracts for
purposes of increasing exposure to a foreign currency or to shift exposure to
foreign currency fluctuations from one country to another. Although forward
foreign currency contracts typically will involve the purchase or sale of a
foreign currency against the dollar, a portfolio also may purchase or sell one
foreign currency forward against another foreign currency. A portfolio may use
one currency (or a basket of currencies) to hedge against adverse changes in the
value of another currency (or a basket of currencies) (proxy) when exchange
rates between the two currencies are positively correlated. There are certain
markets where it is not possible to engage in effective foreign currency
hedging. This may be true, for example, for the currencies of various Latin
American countries in which the foreign exchange markets are not sufficiently
developed to permit hedging activity to take place.
Under applicable tax law, the portfolios may be required to limit their
gains from hedging in forward foreign currency contracts. Although the
portfolios are expected to comply with such limits, the extent to which these
limits apply is subject to tax regulations as yet unissued. Hedging may also
result in the application of the marked-to-market and straddle provisions of the
Internal Revenue Code of 1986, as amended (the "Code"). Those provisions could
result in an increase (or decrease) in the amount of taxable dividends paid by
the portfolios and could affect whether dividends paid by the portfolios are
classified as capital gains or ordinary income. Position hedging is the sale of
forward foreign currency with respect to portfolio security positions
denominated in a foreign currency. A portfolio will not speculate in forward
foreign exchange.
A portfolio's dealings in forward foreign exchange will be limited to
hedging involving either specific transactions or portfolio positions.
Transaction hedging is the purchase or sale of forward foreign currency to "lock
in" the U.S. dollar price of a security purchased or sold by a portfolio.
Position hedging is the sale of forward foreign currency with respect to
portfolio security positions denominated in a foreign currency. A portfolio will
not speculate in forward foreign exchange.
Employing hedging strategies with forward currency contracts does not
eliminate fluctuations in the prices of portfolio securities or prevent losses
if the prices of such securities decline. Forward foreign currency contracts
involve some transactional expense for a portfolio. Although forward foreign
currency contracts will be used primarily to protect a portfolio from adverse
currency movements, they also involve the risk that anticipated currency
movements will not be accurately predicted, and a portfolio's total return could
be adversely affected as a result.
OPTIONS
In pursuing their investment objectives, the Equity, Bond, Managed, and
LifeStyle portfolios may engage in the writing (i.e., selling) of call options
("calls") in furtherance of its respective investment objective or objectives if
(1) after any sale, not more than 25% of that portfolio's total assets are
subject to calls; (2) the calls are traded on a domestic securities exchange or
board of trade; and (3) the calls are "covered."
The Equity, Bond, Managed and LifeStyle portfolios may also write put
options ("puts") if (1) after any sale, the aggregate of the exercise prices of
all outstanding puts written by the portfolio do not exceed 25% of the
portfolio's total assets; (2) the puts are traded on a domestic securities
exchange or board of trade; and (3) the puts are "secured." Each of these
portfolios may purchase a put only in a closing purchase transaction to
terminate an obligation on a put which it has written.
A portfolio may write calls and puts only if they are "covered" or
"secured." In the case of a call on a security, the option is "covered" if the
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, cash or cash equivalents in such
amount are placed in a segregated account by its Custodian) upon conversion or
exchange of other securities held by the portfolio. A put is secured if the
portfolio maintains cash, cash equivalents or U.S. Government securities with a
value equal to the exercise price in a segregated account or holds a put on the
same underlying security at an equal or greater exercise price.
The Equity portfolio may purchase a call only in a closing purchase
transaction to terminate its obligation on a call which it has written. The
Bond, Managed, and LifeStyle portfolios may also purchase calls on securities to
protect against substantial increases in prices of securities the
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portfolio intends to purchase pending its ability to invest in such securities
in an orderly manner. A portfolio may sell calls it has previously purchased,
which could result in a net gain or loss depending on whether the amount
realized on the sale is more or less than the premium and other transaction
costs paid on the call which is sold.
An option on a security is a contract that gives the holder of the option,
in return for a premium, the right to buy from (in the case of a call) or sell
to (in the case of a put) the writer of the option the underlying security at a
specified exercise price at any time during the term of the option. The writer
of an option on a security has the obligation upon exercise of the option to
deliver the underlying security (in the case of a call) upon payment of the
exercise price or to pay the exercise price (in the case of a put) upon delivery
of the underlying security.
If an option written by a portfolio expires unexercised, the portfolio
realizes a capital gain equal to the premium received at the time the option was
written. If an option purchased by a portfolio expires unexercised, the
portfolio realizes a capital loss equal to the premium paid. Prior to the
earlier of exercise or expiration of a call, it may be closed out by an
offsetting purchase of a call option of the same series (type, exchange,
underlying security, exercise price and expiration).
The principal factors affecting the market value of a call include supply
and demand, interest rates, the current market price of the underlying security
in relation to the exercise price of the option, the volatility of the
underlying security, and the time remaining until the expiration date.
The premium received for an option written by a portfolio is recorded as a
deferred credit. The value of the option is marked-to-market daily and is valued
at the closing price on the exchange or board of trade on which it is traded,
or, if no closing price is available, at the mean between the last bid and asked
prices.
Risks Associated with Options
The purchase and writing of options involves certain risks. During the
option period, the covered call writer has, in return for the premium on the
option, given up the opportunity to profit from a price increase in the
underlying securities above the exercise price, but, as long as its obligation
as a writer continues, has retained the risk of loss should the price of the
underlying security decline. The writer of an option has no control over the
time when it may be required to fulfill its obligation as a writer of the
option. If a call option purchased by a portfolio is not sold when it has
remaining value, and if the market price of the underlying security remains less
than or equal to the exercise price, the portfolio will lose its entire
investment in the option.
There can be no assurance that a liquid market will exist when a portfolio
seeks to close out an option position. If a portfolio were unable to close out a
covered call option it had written on a security due to trading restrictions or
suspensions are imposed on the options markets, it would not be able to sell the
underlying security. If a portfolio cannot effect a closing transaction, it will
not be able to sell the underlying security while the previously written option
remains outstanding, even if it might otherwise be advantageous to do so. As a
writer of a covered call option, a portfolio forgoes, during the option's life,
the opportunity to profit from increases in the market value of the security
covering the call option above the sum of the premium and the exercise price of
the call.
Since option premiums paid or received by a portfolio, as compared to
underlying investments, are small in relation to the market value of such
investments, buying call options offers large amounts of leverage, which could
result in the portfolios' net asset value being more sensitive to changes in the
value of the underlying securities.
FUTURES CONTRACTS
The Bond and Managed portfolio may invest in interest rate futures
contracts which are standardized and traded on a U.S. exchange or board of
trade. The LifeStyle portfolios may invest in interest rate and stock index
futures contracts. These investments may be made solely for the purpose of
hedging against changes in the value of a portfolio's securities or securities
intended to be purchased due to anticipated changes in interest rates, market
conditions, stock or currency prices and not for purposes of speculation. A
futures contract provides for the future sale by one party and purchase by
another party of a specified quantity of a financial instrument or the cash
value of an index at a specified price and time. A futures contract on an index
is an agreement pursuant to which two parties agree to take or make delivery of
an amount of cash equal to the difference between the value of the index at the
close of the last trading day of the contract and the price at which the index
contract originally was written. Although the value of an index might be a
function of the value of certain specified securities, no physical delivery of
these securities is made. A public market exists in futures contracts covering
various financial instruments including U.S. Treasury bonds, U.S. Treasury
notes, GNMA certificates, three-month U.S. Treasury bills, 90-day commercial
paper, bank certificates of deposit, and Eurodollar certificates of deposit.
The LifeStyle portfolios may also invest in futures contracts on exchanges
located outside of the United States. Foreign markets may offer advantages such
as trading in indices that are not currently traded in the United States.
Foreign markets, however, may have greater risk potential than domestic markets.
Unlike trading on domestic commodity exchanges, trading on foreign commodity
exchanges is not regulated by the Commodity Futures Trading Commission ("CFTC").
Foreign exchanges generally are principal markets so that no common clearing
facility exists, and a portfolio might be able to look only to the broker for
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performance of the contract. Amounts received for foreign futures may not be
provided the same protection as funds received in respect of transactions on
United States futures exchanges. Trading in foreign futures contracts may not be
afforded certain of the protective measures provided by U.S. law and regulation,
including the right to use reparations proceedings before the CFTC and
arbitration proceedings provided by the National Futures Association or any
domestic futures exchange. In addition, any profits that a portfolio might
realize in trading could be eliminated by adverse changes in the exchange rate
of the currency in which the transaction is denominated. Transactions on foreign
exchanges may include both commodities that are traded on domestic exchanges or
boards of trade and those that are not.
As a hedging strategy, a portfolio might purchase an interest rate futures
contract when it is not fully invested in long-term debt securities but wishes
to defer their purchase for some time until it can invest in such securities or
because short-term yields are higher than long-term yields. Such purchase would
enable a portfolio to earn the income on a short-term security while at the same
time minimizing the effect of all or part of an increase of the market price of
the long-term debt security which the portfolio intended to purchase in the
future. A portfolio would sell an interest rate futures contract in order to
continue to receive the income from a long-term debt security while endeavoring
to avoid part or all of the decline in market value of that security which would
accompany an increase in interest rates. Although other techniques could be used
to reduce a portfolio's exposure to interest rate fluctuations, a portfolio may
be able to hedge its exposure more effectively and perhaps at a lower cost by
using futures contracts.
The LifeStyle portfolios may purchase and sell stock index futures
contracts to hedge their securities portfolios. A LifeStyle portfolio may engage
in transactions in futures contracts only in an effort to protect it against a
decline in the value of the portfolio's securities or an increase in the price
of securities that the portfolio intends to acquire. For example, a LifeStyle
portfolio may sell stock index futures to protect against a market decline in an
attempt to offset partially or wholly a decrease in the market value of
securities that the LifeStyle portfolio intends to sell. Similarly, to protect
against a market advance when the LifeStyle portfolio is not fully invested in
the securities market, the LifeStyle portfolio may purchase stock index futures
that may partly or entirely offset increases in the cost of securities that the
portfolio intends to purchase.
A portfolio will only enter into futures contracts which are standardized
and traded on an exchange, board of trade, or similar entity. A portfolio will
not enter into a futures contract if immediately thereafter the initial margin
deposits for futures contracts held by the portfolio plus premiums paid by it
for open futures option positions, less the amount by which any such positions
are "in-the-money," would exceed 5% of the portfolio's total assets.
If a purchase or sale of a futures contract is made by a portfolio, the
portfolio is required to deposit with its Custodian (or broker, if legally
permitted) a specified amount of cash or U.S. Government securities ("initial
margin"). The margin required for a futures contract is set by the exchange on
which the contract is traded and may be modified during the term of the
contract. The initial margin is in the nature of a performance bond or good
faith deposit on the futures contract which is returned to the portfolio upon
termination of the contract, assuming all contractual obligations have been
satisfied. Each investing portfolio expects to earn interest income on its
initial margin deposits. A futures contract held by a portfolio is valued daily
at the official settlement price of the exchange on which it is traded. Each day
the portfolio pays or receives cash, called "variation margin," equal to the
daily change in value of the futures contract. This process is known as
"marking-to-market." Variation margin does not represent a borrowing or loan by
a portfolio but is instead settlement between the portfolio and the broker of
the amount one would owe the other if the futures contract expired. In computing
daily net asset value, each portfolio will mark-to-market its open futures
positions.
When purchasing a futures contract, a portfolio must maintain with its
Custodian (or broker, if legally permitted) cash, U.S. Government securities, or
other liquid high grade debt obligations (including any margin) equal to the
market value of such contract. When writing a futures contract, a portfolio must
maintain with its Custodian cash, U.S. Government securities, or other liquid
high grade debt obligations that, when added to the amounts deposited with a
futures commission merchant or broker as margin, are equal to the market value
of the instruments underlying the contract. Alternatively, a portfolio may
"cover" its position by owning the instruments underlying the contract, or
holding a call permitting the portfolio to purchase the same futures contract at
a price no higher than the price of the contract written by the portfolio (or at
a higher price if the difference is maintained in liquid assets with its
Custodian).
Generally, under futures contracts obligations are closed out prior to
delivery by offsetting purchases or sales of matching futures contracts (same
exchange, underlying index, and delivery month). If an offsetting purchase price
is less than the original sale price, the portfolio realizes a capital gain, or
if it is more, the portfolio realizes a capital loss. Conversely, if an
offsetting sale price is more than the original purchase price, the portfolio
realizes a capital gain, or if it is less, the portfolio realizes a capital
loss. The transaction costs must also be included in these calculations.
Limitations
A portfolio will not enter into a futures contract if, immediately
thereafter, the initial margin deposits for futures contracts held by that
portfolio would exceed 5% of the portfolios' total assets.
A portfolio may not maintain open short positions in futures contracts if,
in the aggregate, the market value of all such
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open positions exceeds the current value of its portfolio securities, plus or
minus unrealized gains and losses on the open positions, adjusted for the
historical relative volatility of the relationship between the portfolio and the
positions.
The fund will comply with certain regulations of the Commodity Futures
Trading Commission, under which an investment company may engage in futures
transactions and qualify for an exclusion from being a "commodity pool," which
require a portfolio to invest in futures contracts for bona fide hedging
purposes, or alternatively, to set aside cash and short-term obligations with
respect to long positions in a futures contract. Under these regulations, the
"underlying commodity value" (the size of the contract multiplied by the daily
settlement price of the contract) of each long position in a commodity futures
contract in which a portfolio may invest may not at any time exceed the sum of:
(1) the value of short-term U.S. debt obligations or other U.S. dollar-
denominated high quality short-term money market instruments and cash set aside
in an identifiable manner, plus any funds deposited as margin on the contract;
(2) unrealized appreciation on the contract held by the broker; and
(3) cash proceeds from existing investments due in not more than 30 days.
The fund reserves the right to engage in other types of futures
transactions in the future and to use futures for other than hedging purposes to
the extent permitted by regulatory authorities. If other types of futures
contracts are traded in the future, a portfolio may also use such investment
techniques, provided that the Board of Directors determines that their use is
consistent with the portfolio's investment objective or objectives.
Risks Associated with Futures
There are several risks associated with the use of futures contracts as
hedging techniques. A purchase or sale of a futures contract may result in
losses in excess of the amount invested in the futures contract. There can be
significant differences between the securities or currency markets and the
futures markets that could result in an imperfect correlation between the
markets, causing a given hedge not to achieve its objective. The degree of
imperfection of correlation depends on circumstances such as variations in
speculative market demand for interest rate or stock index futures, including
technical influences in futures trading, and differences between the portfolio
securities being hedged and the instruments underlying the hedging vehicle in
such respects as interest rate levels, maturities, conditions affecting
particular industries and creditworthiness of issuers. While a portfolio's
hedging transactions may protect the portfolio against adverse movements in the
general level of interest rates or stock or currency prices, such transactions
could also preclude the opportunity to benefit from favorable movements in the
level of interest rates or stock or currency prices. A decision as to whether,
when and how to hedge involves the exercise of skill and judgment and even a
well-conceived hedge may be unsuccessful to some degree because of market
behavior or unexpected interest rate trends. The successful use of futures is
dependent on the adviser's or sub-adviser's ability to predict correctly
movements in the direction of the stock market and no assurance can be given
that the adviser's or sub-adviser's judgment in this respect will be correct.
The price of futures contracts may not correlate perfectly with movement in
the underlying security or stock index, due to certain market distortions. This
might result from decisions by a significant number of market participants
holding stock index futures positions to close out their futures contracts
through offsetting transactions rather than to make additional margin deposits.
Also, increased participation by speculators in the futures market may cause
temporary price distortions. These factors may increase the difficulty of
effecting a fully successful hedging transaction, particularly over a short time
frame. If a hedging transaction is not successful, the portfolio might
experience losses which it would not have incurred if it had not established
futures positions.
Futures exchanges may limit the amount of fluctuation permitted in certain
futures contract prices during a single trading day. The daily limit establishes
the maximum amount that the price of a futures contract may vary either up or
down from the previous day's settlement price at the end of the current trading
session. Once the daily limit has been reached in a futures contract subject to
the limit, no more trades may be made on that day at a price beyond that limit.
The daily limit governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may work to prevent
the liquidation of unfavorable positions. For example, futures prices have
occasionally moved to the daily limit for several consecutive trading days with
little or no trading, thereby preventing prompt liquidation of positions and
subjecting some holders of futures contracts to substantial losses.
There can be no assurance that a liquid market will exist at a time when a
portfolio seeks to close out a futures position. When such a market does not
exist, the portfolio remains obligated to meet margin requirements until the
position is closed.
FOREIGN SECURITIES
The Tactical Asset Allocation and the LifeStyle portfolios may purchase
certain foreign securities and American Depositary Receipts ("ADRs"). ADRs are
dollar-denominated receipts issued generally by domestic banks and represent the
deposit with the bank of a security of a foreign issuer. ADRs are publicly
traded on exchanges or over-the-counter in the United States. Securities of
foreign issuers include debt securities of foreign governments and their
agencies, when these securities meet applicable
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standards of selection. A portfolio may concentrate its investments in
securities of issuers of one or more foreign countries. The Tactical Asset
Allocation portfolio may also invest up to 25% of its total assets in equity
securities of foreign issuers. It is anticipated that most of the Tactical Asset
Allocation portfolio's investments in securities of foreign issuers will be
American Depositary Receipts (ADRs). The Equity portfolio may also invest in
ADRs.
Risks of Foreign Securities
Investments in foreign securities, particularly those of non-governmental
issuers, involve considerations which are not ordinarily associated with
investing in domestic issuers. These considerations include political or
economic instability of the issuer or of the country of issue, the difficulty of
predicting international trade patterns, fluctuating exchange rates and the
possibility of imposition of exchange controls. Foreign securities may be
subject to foreign government taxes which would reduce the income yield on such
securities. Such securities may also be subject to greater fluctuations in price
than securities of domestic corporations or of the U.S. Government, the
possibility of expropriation, the unavailability of financial information or the
difficulty of interpreting financial information prepared under foreign
accounting standards. In addition, there may be less publicly available
information about a foreign company than about a domestic company. Foreign
companies generally are not subject to uniform accounting, auditing and
financial reporting standards comparable to those applicable to domestic
companies. There is generally less government regulation of stock exchanges,
brokers and listed companies abroad than in the United States, and, with respect
to certain foreign countries, there is a possibility of confiscatory taxation,
or diplomatic developments which could affect investment in those countries. It
is possible that market quotations for foreign securities will not be readily
available. In such event, these securities shall be valued at fair market value
as determined in good faith by Dean Investment Associates or Credit Suisse under
the supervision of the Board of Directors of the fund. If it should become
necessary, a portfolio could encounter greater difficulties in invoking legal
processes abroad than would be the case in the United States. Transaction costs
with respect to foreign securities may be higher. Dean Investment Associates and
Credit Suisse will consider these and other factors before investing in foreign
securities.
The LifeStyle portfolios may invest a portion of their international
holdings in securities of issuers in emerging market (developing) countries.
Investing in emerging market countries involves significantly higher risk than
investing in countries with developed markets as a result of uncertainty
regarding the companies and the markets in which they operate. Securities prices
can be more volatile than in developed countries as a result of investor
concerns regarding the stability of the government, internal economic pressures,
and the impact of external economic factors. In addition, securities markets in
emerging market countries may trade a small number of securities and may be
unable to respond effectively to increases in trading volume, potentially
resulting in a lack of liquidity and in volatility in the price of securities
traded on those markets. Also, securities markets in emerging market countries
typically offer less regulatory protection for investors.
OTHER INVESTMENT COMPANIES
Each of the portfolios may invest in shares issued by other investment
companies. The LifeStyle portfolios, subject to SEC approval, intend to invest
an unlimited portion of their assets in other investment companies. The Tactical
Asset Allocation portfolio may invest up to 10% of its total assets in money
market funds, within limits imposed by the 1940 Act upon investment by the
portfolio in other investment companies. If the forecasting models employed by
the sub-adviser of the Tactical Asset Allocation portfolio predict a decline in
the stock market, the sub-adviser expects to reduce equity exposure and increase
the portfolio's cash position, including investment in money market funds.
Except for the LifeStyle portfolios, a portfolio is limited in the degree to
which it may invest in shares of another investment company in that it may not,
at the time of the purchase, (1) acquire more than 3% of the outstanding voting
shares of the investment company, (2) invest more than 5% of the portfolio's
total assets in the investment company, or (3) invest more than 10% of the
portfolio's total assets in all investment company holdings. As a shareholder in
any investment company, a portfolio will bear its ratable share of the
investment company's expenses, including management fees in the case of a
management investment company.
ZERO COUPON AND STEP COUPON SECURITIES
The Bond, Managed, Tactical Asset Allocation, and the LifeStyle portfolios
may invest in zero coupon, strips, and step coupon securities. Zero coupon and
step coupon bonds do not make regular interest payments; instead they are issued
and traded at a discount from their face amounts. They do not entitle the holder
to any periodic payment of interest prior to maturity or prior to a specified
date when the securities begin paying current interest. Principal and accredit
discount (representing interest accrued but not paid) are paid at maturity.
"Strips" are debt securities that are stripped of their interest after the
securities are issued, but otherwise are comparable to zero coupon bonds. The
issuers of all zero coupon bonds, and the obligor of all "strips" purchased by
the portfolio, will be the U.S. Government and its agencies or
instrumentalities. The market value of "strips" and zero coupon bonds generally
fluctuates in response to changes in interest rates to a greater degree than
interest-paying securities of comparable term and quality. The discount from the
face amount or par value depends on the time remaining until cash payments
begin, prevailing interest rates, liquidity of the security, and the perceived
credit quality of the issuer.
Current Federal income tax law requires holders of zero coupon securities
and step coupon securities to report the
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portion of the original issue discount on such securities that accrues that year
as interest income, even though the holders receive no cash payments of interest
during the year. In order to qualify as a "regulated investment company" under
the Code, a portfolio must distribute its investment company taxable income,
including the original issue discount accrued on zero coupon or step coupon
bonds.
Generally, the market prices of zero coupon and step coupon securities are
more volatile than the prices of securities that pay interest periodically and
in cash and are likely to respond to changes in interest rates to a greater
degree than other types of debt securities having similar maturities and credit
quality.
ILLIQUID AND RESTRICTED SECURITIES
A portfolio may invest in an illiquid or restricted security if the adviser
or sub-adviser believes that it presents an attractive investment opportunity.
Generally, a security is considered illiquid if it cannot be disposed of within
seven days in the ordinary course of business at approximately the amount at
which a portfolio has valued the security. Its illiquidity might prevent the
sale of such a security at a time when the adviser or sub-adviser might wish to
sell, and these securities could have the effect of decreasing the overall level
of a portfolio's liquidity. A portfolio may be subject to significant delays in
disposing of illiquid securities, and transactions in illiquid securities may
entail registration expenses and other transaction costs that are higher than
those for transactions in liquid securities. Further, the lack of an established
secondary market may make it more difficult to value illiquid securities,
requiring the fund to rely on judgments that may be somewhat subjective in
determining value, which could vary from the amount that a portfolio could
realize upon disposition.
Restricted securities, including private placements, are subject to legal
or contractual restrictions on resale. They can be eligible for purchase without
SEC registration by certain institutional investors known as "qualified
institutional buyers," and under the fund's procedures, restricted securities
could be treated as liquid. However, some restricted securities may be illiquid,
and restricted securities that are treated as liquid could be less liquid than
registered securities traded on established secondary markets. The Equity, Bond,
Money Market, Tactical Asset Allocation, and the LifeStyle portfolios may invest
up to 10% of the total assets of the portfolio in illiquid securities, measured
at the time of investment.
LENDING OF PORTFOLIO SECURITIES
The portfolios may, from time to time, lend securities from their
portfolios to brokers, dealers and financial institutions and receive as
collateral cash or U.S. Treasury securities which at all times while the loan is
outstanding will be maintained in amounts equal to at least 100% of the current
market value of the loaned securities. Any cash collateral will be invested in
short-term securities. Such loans may not have terms longer than 30 days and
will be terminable at any time. The portfolios may also pay reasonable fees to
persons unaffiliated with the portfolios for services in arranging such loans.
Investment Restrictions
Each portfolio's investment objective or objectives as set forth in the
prospectus under "The Portfolios" together with the investment restrictions set
forth below, are fundamental policies of each existing portfolio and may not be
changed with respect to any portfolio without the approval of a majority of the
outstanding voting shares of that portfolio. The vote of a majority of the
outstanding voting shares of a portfolio means the vote at an annual or special
meeting of the lesser of: (a) 67% or more of the voting securities present at
such meeting, if the holders of more than 50% of the outstanding voting shares
of such portfolio are present or represented by proxy; or (b) more than 50% of
the outstanding voting securities of such portfolio. Under these restrictions,
an existing portfolio may not:
(1) Invest in a security if, with respect to 75% of its total assets, more than
5% of its total assets (taken at market value at the time of such investment)
would be invested in the securities of any one issuer, except that this
restriction does not apply to U.S. Government securities.
(2) Invest in a security if, with respect to 75% of its assets, it would hold
more than 10% (taken at the time of such investment) of the outstanding voting
securities of any one issuer, except that this restriction does not apply to
U.S. Government securities.
(3) Invest in a security if more than 25% of its total assets (taken at market
value at the time of such investment) would be invested in the securities of
issuers in any particular industry, except that this restriction does not apply
(a) to U.S. Government securities (or repurchase agreements with respect
thereto), and (b) with respect to the Money Market and Managed portfolios, to
securities or obligations (other than commercial paper) issued by domestic
branches of U.S. banks.
(4) Purchase or sell real estate, except that a portfolio may invest in
securities secured by real estate or real estate interests or issued by
companies in the real estate industry or which invest in real estate or real
estate interests.
(5) Purchase securities on margin (except for use of short-term credit necessary
for clearance of purchases and sales of portfolio securities), except a
portfolio engaged in transactions in options and futures, and options on futures
may make margin deposits in connection with those transactions.
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(6) Issue senior securities, except insofar as a portfolio may be deemed to have
issued a senior security by reason of borrowing money in accordance with that
portfolio's borrowing policies. For purposes of this investment restriction, the
writing of stock options, and collateral arrangements with respect to margin or
other deposits respecting futures contracts, and related options, are not deemed
to be an issuance of a senior security.
(7) Act as an underwriter of securities of other issuers, except, when in
connection with the disposition of portfolio securities, a portfolio may be
deemed to be an underwriter under the federal securities laws.
(8) Make short sales of securities, except short sales against the box.
(9) Borrow money or pledge, mortgage, or hypothecate its assets, except that a
portfolio may (a) borrow from banks for temporary purposes, but any such
borrowing is limited to an amount equal to 25% of a portfolio's net assets and a
portfolio will not purchase additional securities while borrowing funds in
excess of 5% of that portfolio's net assets; and (b) enter into reverse
repurchase agreements and transactions in options, and interest rate futures
contracts, stock index futures contracts, other futures contracts based on other
financial instruments, and options on such futures contracts. For these
purposes, the deposit of assets in escrow in connection with the writing of
covered put and call options and the purchase of securities on a "when-issued"
or delayed delivery basis and collateral arrangements with respect to initial or
variation margin and other deposits for futures contracts, and options on
futures contracts, will not be deemed to be pledges of a portfolio's assets.
(10) Invest in securities that are illiquid because they are subject to legal or
contractual restrictions on resale, in repurchase agreements maturing in more
than seven days, or other securities which in the determination of the adviser
are illiquid if, as a result of such investment, more than 10% of the total
assets of the portfolio (taken at market value at the time of such investment)
would be invested in such securities.
(11) Purchase or sell commodities or commodities contracts, except that any
portfolio may engage in transactions in interest rate futures contracts, stock
index futures contracts, and other futures contracts based on other financial
instruments, and on options on such futures contracts.
To the extent a portfolio covers its commitment under a reverse repurchase
agreement (or economically similar transaction) by the maintenance of a
segregated account consisting of assets determined to be liquid in accordance
with procedures adopted by the directors, equal in value to the amount of the
portfolio's commitment to repurchase, such an agreement will not be considered a
"senior security" by the portfolio and therefore will not be subject to
investment restriction no. 6.
Management of the Fund
Directors and Officers
Information pertaining to the directors and officers of the fund is set
forth below.
Name, Position, Principal Occupation During
and Age in 2000 the Past Five Years
----------------- ---------------------------
R. Stephen Radcliffe*, age 55 Executive Vice President, AUL
Chairman of the Board & President (2/1994 to Present)
Dr. Ronald D. Anderson, age 61, Director Professor: School of Business,
Indiana University, Indianapolis Indiana University,
801 W. Michigan St. Indianapolis, Indiana
Indianapolis, IN 46223
Dr. Leslie Lenkowsky, age 54, Director Professor: Indiana University
Indiana University Center of Philanthropy Center of Philanthropy
550 W. North St., Suite 301 (9/1997 to present)
Indianapolis, IN 46202 President, Hudson Institute
(6/1990 - 9/1997)
Constance E. Lund*, age 46, Treasurer Senior Vice President,
Corporate Finance, AUL
(1/2000 - present)
Vice President, Reporting and
Research, AUL (6/95-1/2000)
Vice President & Controller,
State Life Insurance Co.
(6/85 - 6/95)
James W. Murphy*, age 64 Senior Vice President, AUL
Vice President and Director (3/1979 - 4/2000)
11800 Pebblepointe Pass
Carmel, IN 46033
James P. Shanahan*, age 67 Senior Vice President, Pension
Director Operations, AUL
11103 Sloop Ct. (1/1984 - 1/1998)
Indianapolis, IN 46236
Richard A. Wacker*, age 52 Associate General Counsel, AUL,
Secretary (10/92 to present)
*Because of their positions as stated above, Ms. Lund, Mr. Murphy, Mr.
Radcliffe, Mr. Shanahan and Mr. Wacker are "interested persons" of the fund, as
defined in the 1940 Act. With the exception of Mr. Shanahan and Mr. Murphy,
whose addresses are listed above, the business address for each of these
individuals is One American Square, Indianapolis, Indiana 46282.
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<PAGE>
Compensation of Directors
The fund pays those directors who are not officers or employees of AUL a
fee of $4,500 per year plus $450.00 per board meeting attended. The fund also
pays travel expenses incurred by all directors to attend Board meetings. During
the fiscal year ended December 31, 1999, the fund paid fees aggregating $18,450
to all directors who are not "interested persons" of the fund. AUL pays all
salaries, fees, and expenses of any officer or director of the fund who is an
officer or employee of AUL. As of the end of the 1999 fiscal year, the officers
and directors, as a group, have no interest in any contracts which would entitle
them to give voting instructions for any portfolio.
The Investment Adviser
American United Life Insurance Company(R) serves as adviser to the fund
pursuant to an Investment Advisory agreement (the agreement) between it and the
fund. The adviser is responsible for administering affairs of the fund and
supervising the investment program for the portfolios in accordance with
applicable laws and regulations. The adviser also furnishes to the Board of
Directors, which has overall responsibility for the business and affairs of the
fund, periodic reports on the investment performance of each portfolio.
The agreement with the adviser, dated March 8, 1990, was originally
approved by a majority of the fund's directors, including a majority of the
directors who are not parties to the agreement or interested persons of any such
party (the "independent directors"). Subsequently, on May 10, 1991, the
agreement was approved by a majority of the fund's shareholders at a meeting
called for the purpose of voting on the approval of the agreement. From year to
year thereafter, the agreement will continue in effect, provided such
continuance is approved at least annually by (1) the holders of a majority of
the outstanding voting securities of the fund or by the Board and (2) a majority
of the independent directors. The agreement will terminate automatically in the
event of its assignment, and it may be terminated without penalty on sixty days'
written notice by the Board, or pursuant to a majority vote, in accordance with
the 1940 Act, of the persons entitled to vote in respect to the fund. The
advisory agreement was last approved by the Board, including a majority of the
independent directors, on February 2, 2000 for a one year period ending at the
regularly scheduled meeting of the Board held in the first quarter of 2001, or
if there is no regularly scheduled meeting of the Board held during the first
quarter of 2001, then until the next regularly scheduled meeting of the Board of
Directors held thereafter.
At the fund's request, the adviser provides, without charge, personnel (who
may be the fund's officers) to render certain clerical, accounting,
administrative and other services to the fund as may be requested. Also, the
adviser furnishes to the fund, without additional charge, such administrative
and management supervision and office facilities (which may be the adviser's own
offices) as the adviser may believe appropriate or as the fund may reasonably
request. However, the fund may also hire its own employees and contract for
services to be performed by third parties.
The fund pays the adviser a fee for its services under the agreement based
on an annual percentage of the average daily net assets of each portfolio. The
fund pays the adviser a monthly fee at an annual rate of .50% of the average
daily net assets for each of the Equity portfolio, Bond portfolio, and Managed
portfolio; .40% for the Money Market portfolio; .80% for the Tactical Asset
Allocation portfolio; and .70% for each of the LifeStyle portfolios. For the
years ended December 31, 1999, 1998, and 1997, respectively, the adviser was
entitled to receive (or did receive) the following advisory fees from the
portfolios: $470,603, $447,358, and $328,408 from the Equity portfolio;
$255,839, $209,661, and $154,861 from the Bond portfolio; $428,207, $332,382,
and $235,934 from the Money Market portfolio; $367,232, $339,371, and $258,903
from the Managed portfolio; $49,481, $45,828, and $16,830 from the Tactical
Asset Allocation portfolio. For the year ended December 31, 1999, and for the
period from the inception of the LifeStyle portfolios on March 31, 1998 through
December 31, 1998, respectively, the adviser was entitled to receive (or did
receive) $45,498 and $29,203 from the Conservative Investor portfolio, $51,681
and $30,065 from the Moderate Investor portfolio, and $50,509 and $29,155 from
the Aggressive Investor portfolio.
As of December 31, 1999, the percentage of the outstanding voting shares
owned by AUL and held in its general account were as follows: 5.61% of the
Equity portfolio, 11.76% of the Tactical Asset Allocation portfolio, 77.97% of
the Conservative Investor portfolio, 67.14% of the Moderate Investor portfolio,
and 68.78% of the Aggressive Investor portfolio. As of the same date, the
directors and officers of the fund, as a group, owned less than 1% of the fund's
shares or the shares of any portfolio.
The adviser conducts a conventional life insurance, reinsurance, and
annuity business, and manages pension and other accounts. As of December 31,
1999, the adviser had assets of $10,577,535,000 and had a policyholders' surplus
of $739,224,931. The adviser is registered with the SEC as an investment
adviser. Such registration does not involve supervision by the SEC over
investment advice.
The Sub-Advisers
Dean Investment Associates, ("Dean") a division of C.H. Dean and
Associates, Inc., serves as the sub-adviser for the Tactical Asset Allocation
portfolio pursuant to a sub-advisory agreement dated May 15, 1995. The
sub-advisory agreement initially was approved by the Board of Directors of the
fund, including a majority of the directors who are not parties to the agreement
or "interested persons" of any such party (as defined in the 1940 Act) on May
12, 1995. Credit Suisse Asset Management, serves as the sub-adviser for the
growth-oriented equity and foreign equity portions
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of each LifeStyle portfolio pursuant to a sub-advisory agreement which initially
was approved by the Board of Directors of the fund, including a majority of the
directors who are not parties to the agreement or "interested persons" of any
such party (as defined in the 1940 Act) on February 10, 1998. Both sub-advisory
agreements were last approved by the Board of Directors of the fund, including a
majority of the directors who are not parties to the agreement or "interested
persons" of any such party, on February 2, 2000 for a one year period ending at
the regularly scheduled meeting of the Board held in the first quarter of 2001,
or if there is no regularly scheduled meeting of the Board held during the first
quarter of 2001, then until the next regularly scheduled meeting of the Board of
Directors held thereafter. The sub-advisory agreements provide that they will
continue in effect from year to year thereafter if approved annually (a) by the
Board of Directors of the fund or by a majority of the outstanding shares of the
portfolio, and (b) by a majority of the directors who are not parties to such
agreement or "interested persons" of any such party. The sub-advisory agreements
may be terminated without penalty on 60 days' written notice at the option of
the fund or AUL and upon six months' written notice at the option of Dean or
Credit Suisse, and will terminate automatically in the event that the
sub-advisory agreements are assigned. For its services, Dean receives fees from
the adviser in the amount of (1) 68.75% of the advisory fees received by the
adviser with respect to the Tactical Asset Allocation portfolio, minus (2) 50%
of the amount of any excess expenses paid by the adviser on behalf of the
portfolio pursuant to the expense guarantee. For the years ended December 31,
1999, 1998, and 1997, Dean was entitled to receive (or did receive) $34,018,
$31,506, and $11,571 from the adviser. For its services, Credit Suisse also
receives fees from the adviser as follows: (a) for domestic equity securities:
0.60% on the first $25 million of assets, 0.55% on the next $25 million of
assets, 0.50% on the next $25 million of assets, and 0.45% thereafter, and (b)
for international equities: 0.80% on the first $25 million of assets, 0.70% on
the next $25 million of assets, and 0.60% thereafter. For the years ended
December 31, 1999, and for the period since March 31, 1998, the inception date
of the LifeStyle portfolios to December 31, 1998, respectively, Credit Suisse
was entitled to receive (or did receive) $29,467 and $23,200 from the adviser.
Subject to the supervision of the adviser and the fund's Board of
Directors, each sub-adviser is responsible for the actual management of the
portfolio or portion thereof, for which it serves as sub-adviser, and for making
decisions to buy, sell, or hold any particular security, and it places orders to
buy or sell securities on behalf of the portfolio. The sub-advisory agreements
may be terminated by the sub-advisers by notifying AUL, or by AUL by notifying
the fund's Board of Directors or by shareholder action. In the event that an
agreement with a sub-adviser is terminated, AUL may assume portfolio management
responsibilities.
Fund Expenses
General Expenses of the Fund
The fund is responsible for bearing all costs of its operations. Such costs
include fees to the adviser, shareholder servicing costs, directors' fees and
expenses, legal and auditing fees, custodian fees, registration fees, and
others. Sub-advisory fees paid to Dean Investment Associates and Credit Suisse
are borne by the adviser and not the portfolios. Fund expenses directly
attributable to a portfolio are charged to that portfolio; other expenses are
allocated proportionately among all the portfolios in relation to the net assets
of each portfolio. The adviser has currently agreed to reduce its fee with
respect to a portfolio to the extent necessary to prevent the portfolio's
ordinary operating expenses from exceeding 1.0% of the portfolio's average daily
net assets during the year. In the event that this fee arrangement is
insufficient to prevent a portfolio's aggregate ordinary operating expenses from
exceeding 1.0% of the portfolio's average daily net assets during the year, the
adviser has further agreed to assume a portfolio's expenses to the extent
necessary to limit such expenses to 1.0% of the portfolio's average daily net
assets during the year. Ordinary operating expenses include the advisory fee but
do not include interest, taxes, brokerage commissions and other transactional
expenses and, if any, legal claims and liabilities, litigation costs and
indemnification payments in connection with litigation, and other extraordinary
expenses. If the adviser has reduced its fee with respect to a portfolio in any
given year, in any of the next five succeeding years in which the portfolio's
ordinary operating expenses do not exceed 1.0% of average daily net assets, the
adviser's fee will be increased with respect to that portfolio by an amount
equal to any prior fee reduction; provided that such fee increase does not cause
the portfolio's expenses to exceed 1.0% of the portfolio's average daily net
assets in that year. The adviser may terminate the policy of reducing its fee
and/or assuming fund expenses upon 30 days written notice to the fund and such
policy will be terminated automatically by the termination of the Investment
Advisory agreement. During 1999, AUL reduced its advisory fee for the Tactical
Asset Allocation and the LifeStyle Portfolios.
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<PAGE>
Portfolio Expenses
On December 31 of the years 1999 to 1991 and for the period from April 10,
1990 (the date the fund commenced operations) through December 31, 1990, the
total expenses of each portfolio of the fund were the following percentages of
average daily net assets for the periods shown. The Tactical Asset Allocation
portfolio commenced operations July 31, 1995 and the LifeStyle portfolios
commenced operations on March 31, 1998.
<TABLE>
<CAPTION>
Money Tactical Conservative Moderate Aggressive
Year Equity Bond Market Managed Asset Investor Investor Investor
- ---- ------ ---- ------ ------- ----- ------------ -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1999 .63% .62% .55% .62% .99% .95% 1.00% .96%
1998 .62% .62% .61% .62% 1.00% .95%(2) .94%(2) .95%(2)
1997 .66% .67% .66% .67% 1.00% N.A. N.A. N.A.
1996 .70% .71% .70% .70% 1.00% N.A. N.A. N.A.
1995 .70% .70% .73% .70% 1.00%(1) N.A. N.A. N.A.
1994 .73% .73% .75% .73% N.A. N.A. N.A. N.A.
1993 .82% .80% .84%. .81% N.A. N.A. N.A. N.A.
1992 .84% .79% .85% .82% N.A. N.A. N.A. N.A.
1991 .80% .71% .85% .94% N.A. N.A. N.A. N.A.
1990 1.00% 1.00% 1.00% .98% N.A. N.A. N.A. N.A.
<FN>
(1) Ratio calculated for period July 31, 1995 through December 31, 1995 on an
annualized basis.
(2) Ratio calculated for period March 31, 1998 through December 31, 1998 on an
annualized basis.
</FN>
</TABLE>
Organizational Expenses of the Portfolios
Expenses incurred by the fund in connection with the organization of the
Tactical Asset Allocation portfolio aggregated approximately $8,688. These costs
have been deferred and are being amortized over a period of 5 years beginning
with the commencement of operations.
Expenses incurred by the fund through June 30, 1998 in connection with the
organization of the LifeStyle portfolios aggregated approximately $22,200. These
costs have been deferred and amortized over a period of 5 years beginning with
the commencement of operations.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Brokerage and Research Services
The portfolios generally pay a fee or incur an expense in connection with
effecting transactions in securities. Transactions on national stock exchanges
and other agency transactions involve the payment by a portfolio of brokerage
commissions. Such commissions may be negotiable and may vary among different
brokers. Also, a particular broker may charge different commissions according to
such factors as the difficulty and size of the transaction. There is generally
no stated commission in the case of fixed-income securities, most of which are
traded in the over-the-counter markets, but the price paid by a portfolio
usually includes an undisclosed dealer commission or mark-up. In underwritten
offerings, the price paid by a portfolio includes a disclosed, fixed commission
or discount retained by the underwriter or dealer.
The adviser or sub-adviser for a portfolio places orders for the purchase
and sale of portfolio securities and options for a portfolio through a
substantial number of broker-dealers. In executing transactions, the adviser or
sub-adviser will attempt to obtain the best execution for a portfolio taking
into account such factors as price (including the applicable brokerage
commission or dollar spread), size of order, the nature of the market for the
security, the timing of the transaction, the reputation, experience and
financial stability of the broker-dealer involved, the quality of the service,
the difficulty of execution and operational facilities of the firms involved,
and the firm's risk in positioning a block of securities. In effecting purchases
and sales of portfolio securities in transactions on national stock exchanges
for the account of a portfolio, the adviser or sub-adviser may pay higher
commission rates than the lowest available when the adviser or sub-adviser
believes it is reasonable to do so in light of the value of the brokerage and
research services provided by the broker-dealer effecting the transaction, as
described below. In the case of securities traded on the over-the-counter
markets, there is generally no stated commission, but the price includes an
undisclosed commission or mark-up.
Some securities considered for investment by the fund's portfolios may also
be appropriate for other accounts served by the adviser or sub-adviser,
including the adviser's or sub-adviser's general account. If a purchase or sale
of securities consistent with the investment policies of a portfolio and one or
more of these accounts served by the adviser or sub-adviser is considered at or
about the same time, it is the policy of AUL and each sub-adviser not to favor
any one account or portfolio over another, and any purchase or sale orders
executed contemporaneously are allocated at the average price and as nearly as
practicable on a pro rata basis in proportion to the amounts desired to be
purchased or sold by each account or portfolio. While it is conceivable that in
certain instances this procedure could adversely
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<PAGE>
affect the price or number of shares involved in a particular portfolio
transaction, it is believed that the procedure generally contributes to better
overall execution of the fund's portfolio transactions. This allocation method,
and the results of such allocations, are subject to periodic review by the
fund's adviser, sub-advisers, and Board of Directors.
For many years, it has been a common practice in the investment advisory
business for advisers of investment companies and other institutional investors
to receive research services from broker-dealers which execute portfolio
transactions for the clients of such advisers. Consistent with this practice,
the adviser or a sub-adviser may receive research services from many
broker-dealers with which the adviser or sub-adviser places portfolio
transactions. These services, which in some cases may also be purchased for
cash, include such matters as general economic and security market reviews,
industry and company reviews, evaluations of securities, and recommendations as
to the purchase and sale of securities. Some of these services may be of value
to the adviser or sub-adviser in advising its various clients (including the
fund), although not all of these services are necessarily useful and of value in
managing the fund. The management fee paid by the fund is not reduced because
the adviser, sub-advisers, and their affiliates receive such services.
As permitted by Section 28(e) of the Securities Exchange Act of 1934, the
adviser or sub-advisers may cause the fund to pay a broker-dealer, which
provides "brokerage and research services" (as defined in that Act) to the
adviser or sub-adviser, an amount of disclosed commission for effecting a
securities transaction in excess of the amount of commission which another
broker-dealer would have charged for effecting that transaction.
During the fiscal years ended December 31, 1999, 1998, and 1997,
respectively, brokerage commissions in the amount of $68,708, $69,955, and
$32,117 were paid for transactions in the Equity portfolio, brokerage
commissions in the amount of $31,128, $33,145, and $12,426 were paid for
transactions involving the Managed portfolio, and brokerage commissions in the
amount of $10,310, $5,390, and $822 were paid for transactions involving the
Tactical Asset Allocation portfolio. During the fiscal years ended December 31,
1999 and 1998, for the LifeStyle portfolios, brokerage commissions in the amount
$1,739 and $2,242 were paid for the Conservative Investor portfolio, $1,935 and
$3,366 were paid for the Moderate Investor portfolio, and $3,130 and $4,490 were
paid for the Aggressive Investor portfolio. There were no brokerage commissions
paid for the Bond and Money Market portfolios during these periods. The
aggregate dollar value of equity transactions (net of commissions and SEC
charges) on which brokerage commissions were paid for the years ended December
31, 1999, 1998, and 1997, respectively, were as follows: $44,548,721,
$49,594,782, and $23,657,542 for the Equity portfolio, $20,118,575, $22,812,949,
and $12,075,867 for the Managed portfolio, and $4,681,264, $2,535,595, and
$523,428 for the Tactical Asset Allocation portfolio. For the year ended
December 31, 1999 and for the period between March 31, 1998 and December 31,
1998, respectively, the aggregate dollar value of equity transactions (net of
commissions and SEC charges) on which brokerage commissions were paid for the
Conservative Investor Portfolio was $853,481 and $1,580,061; for the Moderate
Investor portfolio, $1,461,850 and $2,217,696, and for the Aggressive Investor
portfolio, $1,887,394 and $3,093,859. All of the broker-dealers through which
brokerage transactions were executed provided research services to AUL.
Portfolio Turnover
For reporting purposes, each portfolio's turnover rate is calculated by
dividing the value of the lesser of purchases or sales of portfolio securities
for the fiscal year by the monthly average of the value of portfolio securities
owned by the portfolio during the fiscal year. In determining such portfolio
turnover, all securities whose maturities at the time of acquisition were one
year or less are excluded. A 100% portfolio turnover rate would occur, for
example, if all of the securities in the portfolio (other than short-term
securities) were replaced once during the fiscal year. The turnover rate for
each of the portfolios that had investment operations during the periods shown
is listed in the section titled "Financial Highlights" in the prospectus.
The turnover rate for each of the portfolios will vary from year to year,
and, depending on market conditions, turnover could be greater in periods of
unusual market movement and volatility. A higher turnover rate would result in
greater brokerage commissions or other transactional expenses which must be
borne, directly or indirectly, by a portfolio and ultimately by the portfolio's
shareholders.
Performance Information
The fund may, from time to time, include the yield and effective yield of
the Money Market portfolio, the yield of the remaining portfolios, and the total
return of all portfolios in advertisements or sales literature. Performance
information for the portfolios will not be advertised or included in sales
literature unless accompanied by comparable performance information for a
Separate Account to which the fund offers its shares.
Current yield for the Money Market portfolio will be based on the change in
the value of a hypothetical investment (exclusive of capital charges) over a
particular 7-day period, less a pro rata share of portfolio expenses accrued
over that period (the "base period"), and stated as a percentage of the
investment at the start of the base period (the "base period return"). The base
period return is then annualized by multiplying by 365/7, with the resulting
yield figure carried to at least the nearest hundredth of one percent.
"Effective yield" for the Money Market portfolio assumes that all dividends
received during an annual period have been reinvested. Calculation of "effective
yield" begins
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<PAGE>
with the same "base period return" used in the calculation of yield, which is
then annualized to reflect weekly compounding pursuant to the following formula:
Effective Yield = [(Base Period Return + 1)**365/7]-1
For the 7-day period ended December 31, 1999, the current yield for the
Money Market portfolio was 6.0294% and the effective yield was 6.2112%.
Quotations of yield for the remaining portfolios will be based on all
investment income per share earned during a particular 30-day period (including
dividends and interest), less expenses accrued during the period ("net
investment income"), and are computed by dividing net investment income by the
maximum offering price per share on the last day of the period, according to the
following formula:
YIELD = 2[(a-b/cd + 1)**6 - 1]
where
a = dividends and interests 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, and
d = the maximum offering price per share on the last day of the period.
For the period ended December 31, 1999, the yield for the Equity portfolio
was 1.24%; for the Bond portfolio, 6.40%; for the Managed portfolio, 3.35%; for
the Tactical Asset Allocation portfolio, (2.45%); for the Conservative Investor
portfolio, 3.56%; for the Moderate Investor portfolio, 2.45%; and for the
Aggressive Investor portfolio, 1.54%.
Quotations of average annual total return for a portfolio will be expressed
in terms of the average annual compounded rate of return of a hypothetical
investment in the portfolio over certain periods that will include periods of
one, five, and ten years (or, if less, up to the life of the portfolio),
calculated pursuant to the following formula: P (1 + T)**n = ERV (where P = a
hypothetical initial payment of $1,000, T = the average annual total return, n =
the number of years, and ERV = the ending redeemable value of a hypothetical
$1,000 payment made at the beginning of the period). Quotations of total return
may also be shown for other periods. All total return figures reflect the
deduction of a proportional share of portfolio expenses on an annual basis, and
assume that all dividends and distributions are reinvested when paid. The
average annual total return for each of the portfolios for the following periods
ended December 31, 1999 was:
One Five Ten Since
Portfolio Year Years Years Inception
- --------- ---- ----- ------ ---------
Equity (0.94%) 14.38% N.A. 12.55%*
Bond (1.10%) 6.91% N.A. 7.55%*
Money Market 4.56% 4.80% N.A. 4.48%*
Managed (0.75%) 11.59% N.A. 10.29%*
Tactical Asset Allocation (3.06%) N.A. N.A. 9.25%**
Conservative Investor 5.78% N.A. N.A. 6.66%***
Moderate Investor 8.24% N.A. N.A. 7.65%***
Aggressive Investor 11.66% N.A. N.A. 9.49%***
* commenced operations April 10, 1990
** commenced operations July 31, 1995
*** commenced operations March 31, 1998
Performance information for a portfolio may be compared, in advertisements,
sales literature, and reports to shareholders to: (1) the Standard & Poor's
Index of 500 Common Stocks ("S&P 500"), the Dow Jones Industrial Average
("DJIA"), the Lehman Brothers Government Bond Index, the Lehman Brothers
Aggregate Index, the Donoghue Money Market Institutional Averages, the Lehman
Brothers Government Corporation Index, the Salomon High Yield Index, or other
indices that measure performance of a pertinent group of securities; (2) other
groups of mutual funds tracked by Lipper Analytical Services, a widely used
independent research firm which ranks mutual funds by overall performance,
investment objectives, and assets, or tracked by other services, companies,
publications or persons who rank mutual funds on overall performance or other
criteria; and (3) the Consumer Price Index (measure for inflation) to assess the
real rate of return from an investment in the portfolio. Unmanaged indices may
assume the reinvestment of dividends but generally do not reflect deductions for
administrative and management costs and expenses.
Quotations of yield or total return for the fund will not take into account
charges and deductions against any Separate Account or Accounts to which the
fund shares are sold or charges and deductions against the life or annuity
contracts issued by AUL.
Performance information for any portfolio reflects only the performance of
a hypothetical investment in the portfolio during the particular time period on
which the calculations are based. Performance information should be considered
in light of the portfolio's investment objectives and policies, and the market
conditions during the given time period, and should not be considered as a
representation of what may be achieved in the future.
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<PAGE>
Taxation
Federal Income Tax Status
Each portfolio intends to qualify annually and elect to be treated as a
regulated investment company under Sub-chapter M of the Internal Revenue Code
(the "Code").
To qualify as a regulated investment company, each portfolio must, among
other things: (1) derive in each taxable year at least ninety percent (90%) of
its gross income from dividends, interest, payments with respect to securities
loans, and gains from the sale or other disposition of stock, securities or
foreign currencies, or other income derived with respect to its business of
investing in such stock, securities or currencies; (2) derive in each taxable
year less than thirty percent (30%) of its gross income from the sale or other
disposition of stocks, securities, and certain other assets held less than three
months; (3) diversify its holdings so that, at the end of each quarter of the
taxable year, (a) at least fifty percent (50%) of the market value of the
portfolio's assets are represented by cash, U.S. Government securities, the
securities of other regulated investment companies with such other securities
any one issuer limited for the purposes of this calculation to an amount not
greater than five percent (5%) of the value of the portfolio's total assets and
ten percent (10%) of the outstanding voting securities of such issuer, and (b)
not more than twenty-five percent (25%) of the value of its total assets is
invested in the securities of any one issuer (other than U.S. Government
securities or the securities of other regulated investment companies); and (4)
distribute at least ninety percent (90%) of its net investment income (which
includes dividends, interest, and net short-term capital gains in excess of any
net long-term capital losses) each taxable year. Certain hedging transactions
that may be undertaken by one or more portfolios may be limited by the
requirements relating to a portfolio's status as a regulated investment company.
As a regulated investment company, a portfolio will not be subject to U.S.
federal income tax on its net investment income and net capital gains (any net
long-term capital gains in excess of the sum of net short-term capital losses
and capital loss carryovers from prior years), if any, that it distributes to
shareholders. Each portfolio intends to distribute to its shareholders, at least
annually, substantially all of its net investment income and any net capital
gains. In addition, amounts not distributed by a portfolio on a timely basis in
accordance with a calendar year distribution requirement may be subject to a
nondeductible four percent (4%) excise tax. To avoid the tax, a portfolio must
distribute during each calendar year, (1) at least ninety-eight percent (98%) of
its ordinary income (not taking into account any capital gains or losses) for
the calendar year, (2) at least ninety-eight percent (98%) of its capital gains
in excess of its capital losses (adjusted for certain ordinary losses) for the
twelve-month period ending on October 31 of the calendar year, and (3) all
ordinary income and capital gains for previous years that were not distributed
during such years. Each year, each portfolio will determine whether it may be
subject to the calendar year distribution requirement. If a portfolio determines
that it is subject to this distribution requirement, it intends to make its
distributions in accordance with the calendar year distribution requirement. A
distribution will be treated as paid December 31 if it is declared by a
portfolio in October, November, or December of the year and paid by the
portfolio by January 31 of the following year. Such distributions will be
taxable to shareholders in the year in which the distributions are declared,
rather than the year in which the distributions are received.
Shareholder Information
Description of Fund Shares
The fund was incorporated under the laws of Maryland on July 26, 1989. The
capitalization of the fund consists of 400,000,000 authorized shares of common
stock with a par value of $0.001 each with 20,000,000 unallocated shares. When
issued, shares of the fund are fully paid, non-assessable, and freely
transferable. The Board of Directors may establish additional portfolios (with
different investment objectives and fundamental policies) at any time in the
future. Establishment and offering of additional portfolios will not alter the
rights of the fund's shareholders. Shares do not have preemptive rights or
subscription rights. In liquidation of a portfolio of the fund, each shareholder
is entitled to receive his or her pro rata share of the net assets of that
portfolio.
Voting Rights
Shareholders of the fund are given certain voting rights. Each share of
each portfolio will be given one vote, and each fractional share will be given a
proportionate fractional vote, unless a different allocation of voting rights is
required under applicable law for a mutual fund that is an investment medium for
variable insurance products.
Under the fund's charter, the fund is not required to hold annual meetings
of shareholders to elect directors or for
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other purposes and it is not anticipated that the fund will hold shareholders'
meetings unless required by law or the fund's charter. In this regard, the fund
will be required to hold a meeting to elect directors to fill any existing
vacancies on the Board if, at any time, fewer than a majority of the directors
have been elected by the shareholders of the fund. In addition, the charter
provides that the holders of not less than two-thirds of the outstanding shares
of the fund may remove a person serving as director either by declaration in
writing or at a meeting called for such purpose. The fund's shares do not have
cumulative voting rights.
<PAGE>
In accordance with current law, it is anticipated that AUL will request
voting instructions from owners or participants of any contracts that are funded
by separate accounts that are registered investment companies under the 1940 Act
and will vote shares in any such separate account attributable to the contracts
in proportion to the voting instructions received. AUL may vote shares of any
portfolio, if any, that it owns beneficially in its own discretion. In
connection with the organization of the fund, AUL invested in shares of the
portfolios to provide the initial capital. Thus, until a significant number of
shares of the portfolios are sold in connection with contracts funded by
registered separate accounts, AUL may control the portfolios. It is anticipated
that AUL and one or more of its separate accounts will be the sole record
shareholders of the fund.
Net Asset Value of the Fund's Shares
As indicated under "Net Asset Value" in the prospectus, the fund's net
asset value per share for the purpose of pricing purchase and redemption orders
generally is determined at or about 4:00 P.M. eastern standard time, on each day
the NYSE is open for trading. The determination may be made earlier than 4:00
P.M. EST if the NYSE closes earlier than 4:00 P.M. and it is possible to
determine the net asset value at that time. Net asset value will not be
determined on days that the NYSE is closed, on any federal holidays or on days
when AUL is not open for business. Traditionally, in addition to federal
holidays, AUL is not open for business on the day after Thanksgiving and either
the day before or after Christmas or Independence Day.
The Money Market portfolio's securities are valued using the amortized cost
method of valuation. This involves valuing a money market security at cost on
the date of acquisition and thereafter assuming a constant accretion of a
discount or amortization of a premium to maturity, regardless of the impact of
fluctuating interest rates on the market value of the instrument. While this
method provides certainty in valuation, it may result in periods during which
value, as determined by amortized cost, is higher or lower than the price the
portfolio would receive if it sold the instrument. During such periods the yield
to investors in the portfolio may differ somewhat from that obtained in a
similar investment company which uses available market quotations to value all
of its portfolio securities.
The SEC's regulations require the Money Market portfolio to adhere to
certain conditions in connection with using the amortized cost method of
valuation. The portfolio is required to maintain a dollar-weighted average
portfolio maturity of 90 days or less, to limit its investments to instruments
having remaining maturities of 13 months or less (except securities held subject
to repurchase agreements having 13 months or less to maturity), and to invest
only in securities determined by the adviser to be of the highest quality with
minimal credit risks.
Purchases and Redemptions
The fund may suspend the right of redemption of shares of any portfolio for
any period: (a) during which the New York Stock Exchange (the "NYSE") is closed
other than customary weekend and holiday closings or during which trading on the
NYSE is restricted; (b) when the Securities and Exchange Commission (the "SEC")
determines that a state of emergency exists which may make payment or transfer
not reasonably practicable; (c) as the SEC may by order permit for the
protection of the security holders of the fund; or (d) at any other time when
the fund may, under applicable laws and regulations, suspend payment on the
redemption of its shares.
Custodian, Transfer Agent, and Dividend Disbursing Agent
The Bank of New York, New York, New York, serves as the fund's custodian
and Dividend Dispursing Agent. AUL serves as the fund's Transfer Agent.
Independent Accountants
PricewaterhouseCoopers LLP serves as independent accountants of the fund
and performs certain accounting and auditing services for the fund.
Legal Counsel
Dechert Price & Rhoads, Washington, D.C., has passed upon certain legal
matters in connection with the shares offered by this prospectus, and also acts
as outside counsel to the fund.
Code of Ethics
The fund, the Advisor and the Distributor have adopted a Code of Ethics.
Under the provisions of the Codes, personnel of the fund, the Advisor and the
Distributor may not knowingly, within certain time periods, purchase or sell any
security in which the fund may invest unless it is determined that, in view of
the nature of and the market for, the security, such a purchase or sale will not
affect the price paid or received by the fund for the security. Copies of these
Codes of Ethics may be reviewed and copied at the Public Reference Room of the
Securities and Exchange Commission. For more information about the Public
Reference Room, call 1-202-942-8080. They are also available from the SEC's
EDGAR database Information at http://www.sec.gov. Copies of the Codes can also
be obtained, after payment of a fee for duplication, by writing the Public
Reference Section of the SEC, Washington, D.C. 20549-0102 or by electronic
request at [email protected].
Financial Statements
The Financial Statements of the fund, as of December 31, 1999, including
the Notes thereto, are incorporated by reference in the statement of additional
information from the Annual Report of the fund as of December 31, 1999. The
Financial Statements have been audited by PricewaterhouseCoopers LLP, the
independent accountants for the fund. Management's Discussion and Analysis is
contained in the fund's Annual Report, which is available without charge and may
be obtained by writing to the fund at One American Square, Indianapolis, IN
46282 or by calling the fund at (800) 249-6269.
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APPENDIX I
CORPORATE BOND AND COMMERCIAL PAPER RATINGS
CORPORATE BONDS
Bonds rated Aa by Moody's Investors Service, Inc. ("Moody's") are judged by
Moody's to be of high quality by all standards. Together with bonds rated Aaa
(Moody's highest rating) they comprise what are generally known as high-grade
bonds. Aa bonds are rated lower than Aaa bonds because margins of protection may
not be as large as those of Aaa bonds, 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 those applicable to Aaa securities.
Bonds which are rated A by Moody's 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 some time in the future.
Moody's Baa rated bonds are considered as medium-grade obligations, i.e.,
they are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present, but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and, in
fact, have speculative characteristics as well.
Bonds rated AA by Standard & Poor's are judged by Standard & Poor's to be
high-grade obligations and in the majority of instances differ only in small
degree from issues rated AAA (Standard & Poor's highest rating). Bonds rated AAA
are considered by Standard & Poor's to be the highest grade obligations and
possess the ultimate degree of protection as to principal and interest. With AA
bonds, as with AAA bonds, prices move with the long-term money market. Bonds
rated A by Standard & Poor's have a strong capacity to pay principal and
interest, although they are somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions.
Standard & Poor's BBB rated bonds, or medium-grade category bonds, are
borderline between definitely sound obligations and those where the speculative
elements begin to predominate. These bonds have adequate asset coverage and
normally are protected by satisfactory earnings. Their susceptibility to
changing conditions, particularly to depressions, necessitates constant
watching. These bonds generally are more responsive to business and trade
conditions than to interest rates. This group is the lowest which qualifies for
commercial bank investment.
COMMERCIAL PAPER
The prime rating is the highest commercial paper rating assigned by
Moody's. Among the factors considered by Moody's in assigning ratings are the
following: (1) evaluation of the management of the issuer; (2) economic
evaluation of the issuer's industry or industries and an appraisal of
speculative-type risks which may be inherent in certain areas; (3) evaluation of
the issuer's products in relation to competition and customer acceptance; (4)
liquidity; (5) amount and quality of long-term debt; (6) trend of earnings over
a period of ten years; (7) financial strength of a parent company and the
relationships which exist with the issuer; and (8) recognition by management of
obligations which may be present or may arise as a result of public interest
questions and preparations to meet such obligations. Issuers within this prime
category may be given ratings 1, 2 or 3, depending on the relative strengths of
these factors.
Commercial paper rated A by Standard & Poor's has the following
characteristics: (1) liquidity ratios are adequate to meet cash requirements;
(2) long-term senior debt rating should be A or better, although in some cases
BBB credits may be allowed if other factors outweigh the BBB; (3) the issuer
should have access to at least two additional channels of borrowing; (4) basic
earnings and cash flow should have an upward trend with allowances made for
unusual circumstances; and (5) typically the issuer's industry should be well
established and the issuer should have a strong position within its industry and
the reliability and quality of management should be unquestioned. Issuers rated
A are further referred to by use of numbers 1, 2 and 3 to denote relative
strength within this highest classification.
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<PAGE>
We have not authorized anyone to provide you with information that is
different from the information in this statement of additional information. You
should only rely on the information in this statement of additional information
or in the prospectus or in other information provided to you by us.
There is a prospectus that has general information about the fund. The fund
also files annual and semi-annual reports with the SEC. These reports provide
more information about the fund's investments. The annual report also discusses
market conditions and investment strategies that significantly affected the
fund's performance in 1999.
You may request a free copy of the prospectus or a copy of the annual or
semi-annual reports by writing to us at One American Square, Indianapolis,
Indiana 46282 or by calling us at (800) 249-6269. If you have other questions,
call or write us.
Information about the fund can also be reviewed and copied at the SEC's
Public Reference Room in Washington, D.C. or may be obtained by calling the SEC
at (800) SEC-0330. Reports and other information is also available on the SEC's
Internet site at http://www.sec.gov. Copies of this information can be ordered
by writing the Public Reference Section of the SEC, Washington, D.C. 20549. The
SEC will charge a duplicating fee for this service.
The fund has filed a registration statement with the SEC under the
Securities Act of 1933 and the Investment Company Act of 1940, as amended, that
provides information about the fund's securities. This information is
incorporated by reference.
AUL AMERICAN SERIES FUND, INC.
Variable Life and Annuity Contracts
Sold By
AMERICAN UNITED
LIFE INSURANCE COMPANY(R)
One American Square
Indianapolis, Indiana 46282
Statement of Additional Information
Dated: May 1, 2000
Investment Company Filing No.: 811-05850
