JOHN HANCOCK CALIFORNIA TAX-FREE INCOME FUND
CLASS A AND CLASS B SHARES
Statement Of Additional Information
January 1, 1997
This Statement of Additional Information provides information about
John Hancock California Tax-Free Income Fund (the "Fund"), a diversified
open-end investment company, in addition to the information that is contained in
the combined Tax-Free Income Funds' Prospectus (the "Prospectus").
This Statement of Additional Information is not a prospectus. It should
be read in conjunction with the Prospectus, a copy of which can be obtained free
of charge by writing or telephoning:
John Hancock Signature Services, Inc.
P.O. Box 9116
Boston, Massachusetts 02205-9116
1-800-225-5291
TABLE OF CONTENTS
Organization of the Fund..................................................2
Investment Objective and Policies.........................................2
Investment Restrictions..................................................22
Those Responsible for Management.........................................24
Investment Advisory and other Services...................................34
Distribution Contracts...................................................36
Initial Sales Charge on Class A Shares...................................38
Deferred Sales Charge on Class B Shares..................................40
Net Asset Value..........................................................43
Special Redemptions......................................................44
Additional Services and Programs.........................................44
Description of the Fund's Shares.........................................45
Tax Status...............................................................47
Calculation of Performance...............................................53
Brokerage Allocation.....................................................55
Transfer Agent Services..................................................57
Custody of Portfolio.....................................................57
Independent Auditors.....................................................57
Appendix A...............................................................A-1
Financial Statements.....................................................F-1
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ORGANIZATION OF THE FUND
The Fund is a diversified open-end management investment company
organized as a business trust under the laws of The Commonwealth of
Massachusetts pursuant to a Declaration of Trust dated July 1, 1996. Prior to
the approval of John Hancock Advisers, Inc. (the "Adviser"), the Fund's adviser
effective December 22, 1994, the Fund was known as Transamerica California
Tax-Free Income Fund. The Adviser is an indirect wholly owned subsidiary of John
Hancock Mutual Life Insurance Company (the "Life Company"), a Massachusetts life
insurance company chartered in 1862, with national headquarters at John Hancock
Place, Boston, Massachusetts.
INVESTMENT OBJECTIVE AND POLICIES
Investment Objective. The Fund's investment objective is to provide as
high a level of current income exempt from both federal income taxes and
California personal income taxes as is consistent with preservation of capital.
This objective may not be changed without a vote of shareholders.
As a fundamental investment policy, the Fund normally invests
substantially all of its assets (at least 80%) in the following debt obligations
issued by or on behalf of the State of California, its political subdivisions,
municipalities, agencies, instrumentalities or public authorities and
obligations issued by other governmental entities (for example, certain U.S.
territories or possessions) the interest on which is excluded from gross income
for federal income tax purposes and is exempt from California personal income
taxes (collectively referred to as "California Tax Exempt Securities") subject
to the following quality standards at the time of purchase:
(1) Bonds must be rated at least BB/Ba by a nationally recognized
statistical rating organization or, if unrated, be of
equivalent quality. Not more than 20% of the fund's total
assets will be invested in bonds rated BB or Ba and no more
than 25% of its total assets to be invested in unrated debt
obligations.
(2) Other types of California Tax Exempt Securities, including
variable and floating rate obligations rated within the
categories set forth above for bonds, notes or commercial
paper or, if unrated, are determined to be of comparable
quality in the opinion of the Adviser.
For a description of the tax exempt ratings described above, See
Appendix A attached to this Statement of Additional Information.
Bonds rated BBB or BB by S&P or Fitch, or Baa or Ba by Moody's, are
considered to have some speculative characteristics and, to varying degrees, can
pose special risks generally involving the ability of the issuer to make payment
of principal and interest to a greater extent than higher rated securities. In
addition, because the ratings and quality limitations on the Fund's investments
apply at the time of purchase, a subsequent change in the rating or quality of a
security held by the Fund would not require the Fund to sell the security. The
Adviser will purchase bonds rated BBB or BB or Baa or Ba where, based upon
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price, yield and its assessment of quality, investment in these bonds is
determined to be consistent with the Fund's objective of preservation of
capital. The Adviser will evaluate and monitor the quality of all investments,
including bonds rated BBB or BB or Baa or Ba, and will dispose of these bonds as
determined to be necessary to assure that the Fund's overall portfolio is
constituted in a manner consistent with the goal of preservation of capital. To
the extent that the Fund's investments in bonds rated BBB or BB or Baa or Ba
will emphasize obligations believed to be consistent with the goal of preserving
capital, these obligations may not provide yields as high as those of other
obligations having these ratings, and the differential in yields between these
bonds and obligations with higher quality ratings may not be as significant as
might otherwise be generally available. Many issuers of securities choose not to
have their obligations rated. Although unrated securities eligible for purchase
by the Fund must be determined to be comparable in quality to securities having
certain specified ratings, the market for unrated securities may not be as broad
as for rated securities since many investors rely on rating organizations for
credit appraisal.
The Fund may invest in any combination of California Tax Exempt
Securities; however, it is expected that during normal investment conditions, a
substantial portion of the Fund's assets will be invested in municipal bonds
(without regard to maturities) and other longer-term obligations. When
determined to be appropriate, based upon market conditions, a substantial
portion of the Fund's holdings of California Tax Exempt Securities will consist
of notes and commercial paper and other shorter-term obligations. The Fund may
invest up to 20% of its total assets in "private activity bonds" (meeting the
quality standards noted above), the interest on which may constitute a
preference item for purposes of determining the alternative minimum tax.
As a fundamental investment policy, the Fund invests at least 80% of
its total assets in California Tax Exempt Securities (except during adverse
market conditions) for liquidity and flexibility, the fund may place up to 20%
of total assets in taxable and tax-free investment grade short-term securities.
For defensive purposes, it may invest more assets in these securities. The
income from some short-term investments may be subject to California and/or
federal income taxes. As a result, distributions of the fund which are
attributable to income from these investments will be subject to California
and/or federal income taxes. At the end of each quarter of its taxable year,
these investments can not exceed 50% of the Fund's total assets. The Fund will
not be pursuing its objective of obtaining tax- exempt income to the extent it
invests in taxable securities. There can be no assurance that the Fund will
achieve its investment objective.
Description of Tax-Exempt Securities. In seeking to achieve its
investment objective, the Fund invests in a variety of Tax-Exempt Securities.
"Tax Exempt Securities" are debt obligations generally issued by or on behalf of
states, territories and possessions of the United States, the District of
Columbia and their political subdivisions, agencies or instrumentalities the
interest on which, in the opinion of the bond issuer's counsel (not the Fund's
counsel), is excluded from gross income for federal income tax purposes and (in
the case of California Tax Exempt Securities) exempt from California personal
income taxes. See "Tax Status" below. These securities consist of municipal
bonds, municipal notes and municipal commercial paper as well as variable or
floating rate obligations and participation interests.
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The two principal classifications of municipal obligations are general
obligations and revenue obligations. General obligations are secured by the
issuer's pledge of its full faith, credit and taxing power for the payment of
principal and interest. Revenue obligations are payable only from the revenues
derived from a particular facility or class of facilities or in some cases from
the proceeds of a special excise or other tax. For example, industrial
development and pollution control bonds are in most cases revenue obligations
since payment of principal and interest is dependent solely on the ability of
the user of the facilities financed or the guarantor to meet its financial
obligations, and in certain cases, the pledge of real and personal property as
security for payment. The payment of principal and interest by issuers of
certain obligations purchased by the Fund may be guaranteed by a letter of
credit, note, repurchase agreement, insurance or other credit facility agreement
offered by a bank or other financial institution. These guarantees and the
creditworthiness of guarantors will be considered by the Adviser in determining
whether a municipal obligation meets the Fund's investment quality requirements.
No assurance can be given that a municipality or guarantor will be able to
satisfy the payment of principal or interest on a municipal obligation.
Municipal Bonds. Municipal bonds at the time of issuance are generally
long-term securities with maturities of as much as twenty years or more but may
have remaining maturities of shorter duration at the time of purchase by the
Fund. Municipal bonds are issued to obtain funds for various public purposes
including the construction of a wide range of public facilities such as
airports, highways, bridges, schools, hospitals, housing, mass transportation,
streets and water and sewer works. Other public purposes for which Municipal
Bonds may be issued include refunding outstanding obligations, obtaining funds
for general operating expenses and obtaining funds to lend to other public
institutions and facilities. In addition, certain types of industrial
development bonds are issued by or on behalf of public authorities to obtain
funds for many types of local, privately operated facilities. Such debt
instruments are considered municipal obligations if the interest paid on them is
excluded from gross income for federal income tax purposes.
The interest on bonds issued to finance essential state and local
government operations is fully tax-exempt under the Internal Revenue Code of
1986, as amended (the "Code"). Interest on certain nonessential or private
activity bonds (including those for housing and student loans) issued after
August 7, 1986, while still tax-exempt, constitutes a tax preference item for
taxpayers in determining their alternative minimum tax: as a result, the Fund's
distributions attributable to such interest also constitute tax preference
items. The Code also imposes certain limitations and restrictions on the use of
tax-exempt bond financing for non-governmental business activities, such as
industrial development bonds.
Municipal Notes. Municipal notes are short-term obligations of
municipalities, generally with a maturity ranging from six months to three
years. The principal types of such Notes include tax, bond and revenue
anticipation notes and project notes.
Municipal Commercial Paper. Municipal commercial paper is a short-term
obligation of a municipality, generally issued at a discount with a maturity of
less than one year. Such paper is likely to be issued to meet seasonal working
capital needs of a municipality or interim construction financing. Municipal
commercial paper is backed in many cases by letters of credit, lending
agreements, note repurchase agreements or other credit facility agreements
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offered by banks and other institutions. The yields of municipal bonds depend
upon, among other things, general money market conditions, general conditions of
the municipal bond market, size of a particular offering, the maturity of the
obligation and rating of the issue.
Variable or Floating Rate Obligations. Certain of the obligations in
which the Fund may invest may be variable or floating rate obligations on which
the interest rate is adjusted at predesignated periodic intervals (variable
rate) or when there is a change in the market rate of interest on which the
interest rate payable on the obligation is based (floating rate). Variable or
floating rate obligations may include a demand feature which entitles the
purchaser to demand prepayment of the principal amount prior to stated maturity.
Also, the issuer may have a corresponding right to prepay the principal amount
prior to maturity. Variable and floating rate instruments are generally
considered to be "derivative" instruments because they derive their values from
the performance of an underlying asset, index or other benchmark. See
"Derivative Instruments" below. As with any other type of debt security, the
marketability of variable or floating rate instruments may vary depending upon a
number of factors, including the type of issuer and the terms of the
instruments. The Fund may also invest in more recently developed floating rate
instruments which are created by dividing a municipal security's interest rate
into two or more different components. Typically, one component ("floating rate
component" or "FRC") pays an interest rate that is reset periodically through an
auction process or by reference to an interest rate index. A second component
("inverse floating rate component" or "IFRC") pays an interest rate that varies
inversely with changes to market rates of interest, because the interest paid to
the IFRC holders is generally determined by subtracting a variable or floating
rate from a predetermined amount (i.e., the difference between the total
interest paid by the municipal security and that paid by the FRC). The Fund may
purchase FRC's without limitation. Up to 10% of the Fund's total assets may be
invested in IFRC's in an attempt to protect against a reduction in the income
earned on the Fund's other investments due to a decline in interest rates. The
extent of increases and decreases in the value of an IFRC generally will be
greater than comparable changes in the value of an equal principal amount of a
fixed-rate municipal security having similar credit quality, redemption
provisions and maturity. To the extent that such instruments are not readily
marketable, as determined by the Adviser pursuant to guidelines adopted by the
Board of Trustees, they will be considered illiquid for purposes of the Fund's
10% investment restriction on investment in non-readily marketable securities.
Participation Interests. The Fund may purchase from financial
institutions tax exempt participation interests in tax exempt securities. A
participation interest gives the Fund an undivided interest in the tax exempt
security in the proportion that the Fund's participation interest bears to the
total amount of the tax exempt security. For certain participation interests,
the Fund will have the right to demand payment, on a specified number of days'
notice, for all or any part of the Fund's participation interest in the tax
exempt security plus accrued interest. Participation interests that are
determined to be not readily marketable will be considered as such for purposes
of the Fund's 10% investment restriction on investment in non-readily marketable
illiquid securities. The Fund may also invest in Certificates of Participation
(COP's) which provide participation interests in lease revenues. Each
Certificate represents a proportionate interest in or right to the
lease-purchase payment made under municipal lease obligations or installment
sales contracts. Typically, municipal lease obligations are issued by a state or
municipal financing authority to provide funds for the construction of
facilities (e.g., schools, dormitories, office buildings or prisons) or the
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acquisition of equipment. In certain states, such as California, COP's
constitute a majority of new municipal financing issues. The facilities are
typically used by the state or municipality pursuant to a lease with a financing
authority. Certain municipal lease obligations may trade infrequently.
Participation interests in municipal lease obligations will not be considered
illiquid for purposes of the Fund's 10% limitation on illiquid securities
provided the Adviser determines that there is a readily available market for
such securities. In reaching liquidity decisions, the Adviser will consider,
among others, the following factors: (1) the frequency of trades and quotes for
the security; (2) the number of dealers wishing to purchase or sell the security
and the number of other potential purchasers; (3) dealer undertakings to make a
market in the security and (4) the nature of the security and the nature of the
marketplace trades (e.g., the time needed to dispose of the security, the method
of soliciting offers and the mechanics of the transfer.) With respect to
municipal lease obligations, the Adviser also considers: (1) the willingness of
the municipality to continue, annually or biannually, to appropriate funds for
payment of the lease; (2) the general credit quality of the municipality and the
essentiality to the municipality of the property covered by the lease; (3) an
analysis of factors similar to that performed by nationally recognized
statistical rating organizations in evaluating the credit quality of a municipal
lease obligation, including (i) whether the lease can be canceled; (ii) if
applicable, what assurance there is that the assets represented by the lease can
be sold; (iii) the strength of the lessee's general credit (e.g., its debt,
administrative, economic and financial characteristics); (iv) the likelihood
that the municipality will discontinue appropriating funding for the leased
property because the property is no longer deemed essential to the operations of
the municipality (e.g., the potential for an event of nonappropriation); and (v)
the legal recourse in the event of failure to appropriate; and (4) any other
factors unique to municipal lease obligations as determined by the Adviser.
Callable Bonds. The Fund may purchase and hold callable municipal bonds
which contain a provision in the indenture permitting the issuer to redeem the
bonds prior to their maturity dates at a specified price which typically
reflects a premium over the bonds' original issue price. These bonds generally
have call-protection (a period of time during which the bonds may not be called)
which usually lasts for 7 to 10 years, after which time such bonds may be called
away. An issuer may generally be expected to call its bonds, or a portion of
them during periods of relatively declining interest rates, when borrowings may
be replaced at lower rates than those obtained in prior years. If the proceeds
of a bond called under such circumstances are reinvested, the result may be a
lower overall yield due to lower current interest rates. If the purchase price
of such bonds included a premium related to the appreciated value of the bonds,
some or all of that premium may not be recovered by bondholders, such as the
Fund, depending on the price at which such bonds were redeemed.
Special Considerations relating to California Tax-Exempt Securities.
Since the Fund concentrates its investments in California Tax-Exempt Securities,
the Fund will be affected by any political, economic or regulatory developments
affecting the ability of California issuers to pay interest or repay principal.
General. In the early 1990's, California experienced a prolonged
recession coupled with deteriorating fiscal and budget conditions. The state
also contended with natural disasters including fires, a prolonged drought and a
major earthquake in the Los Angeles area (January 1994), rapidly growing
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population, and increasing social service requirements. Over the past years, the
economy has begun to show signs of renewed economic growth, albeit at a modest
pace. However, it is unlikely that the California economy will stage a major
turnaround or expand at rates equal to the mid-1980's. Economic growth in the
1990's is likely to occur at a more subdued rate than in the 1980's.
In 1995, the California economy continued the recovery started a year
earlier. After four consecutive years of on-going job losses, company
relocations out of state, and at times, unemployment rates in excess of 9%, the
State has registered two consecutive years of job growth and declining
unemployment rates. During 1994 and throughout most of 1995, California posted
non-farm employment gains of 1.3% and 2.3%. Sectors exhibiting employment growth
have been the construction and related manufacturing, wholesale, and retail
trade industries, transportation and recreation, business, and management
consulting. This period has also seen personal income growth exceeding 3%
annually, increasing retail sales, and increased international trade,
particularly manufactured goods. Over the next two years, non-farm employment is
projected to annually expand at rates above 2% . These trends are expected to
continue and allow the State's recovery to gain momentum over the next two
years. Over the next two years, growth in employment and personal income is
forecast to outpace the growth of the national economy. Any setbacks to this
recovery or future breakdowns in fiscal discipline could lead to additional
budgetary pressures on State and local governments.
The prolonged recession has seriously impacted California tax revenues
and produced the need for additional expenditures on health and welfare
services. Since the late 1980's, the State's Administrations have recognized
that its budget problems stem in part from a structural imbalance. The largest
General Fund programs -- K-12 schools and community colleges, health and
welfare, and corrections -- have been increasing faster than the revenue base,
driven by the State's rapid population growth. These structural concerns will be
exacerbated in coming years by the expected need to substantially increase
capital and operating funds for corrections as a result of a "Three Strikes" law
enacted in 1994.
The principal sources of the State's General Fund revenues are the
California personal income tax (44% of total revenues) sales and use tax (34%)
and bank and corporation taxes (13%). The State maintains a Special Fund for
Economic Uncertainties (the "SFEU") derived from General Fund revenues as a
reserve to meet cash needs of the General Fund but which is required to be
replenished as soon as sufficient revenues are available. Because of the
recession, the SFEU has not carried a positive balance since 1991; in FY 96-97,
the Legislature has appropriated $305 million to the Fund the SFEU.
Orange County, California emerged from under court supervision in June
1996, after filing for protection under Chapter 9 of the Federal Bankruptcy Code
in December 1994. This fiscal crisis caused the County to default on note
obligations and involved it in numerous legal proceedings which could continue
over the next several years. The aftermath still continues in fiscal year 1997
with the County having reduced staff, reorganized departments, cut discretionary
spending and services, initiated a program to increase solid waste revenues and
issued recovery notes to meet cashflow needs and begin repaying Investment Pool
participants. Failure by the voters to approve a one-half cent increase in the
County Sales Tax prompted the County to cut additional services and examine
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alternative plans for meeting the County's obligations. Local Orange County
governments have also had to adjust budgets and reduce spending in some
instances to compensate for their investment pool losses and County service
costs. A Recovery Plan which includes the diversion of public transit revenues
to the General Fund was adopted by the County and approved by the State
Legislature in the fall of 1995. The final form of the Recovery plan was
approved in June 1996, and calls for the County to pay for investment losses to
the investment pool participants (approximately 23% of their principal
investments in the pool) over 15 years. Some repayment is contingent upon the
outcome of litigation filed by the County against brokerage firms and
professional advisers. The remainder was raised from bond financing. The final
bond financing of the Recovery Plan was completed in June, allowing the County
to emerge from bankruptcy on June 12, 1996.
The County of Los Angeles entered fiscal year 1996 with a projected
budget shortfall of $1.2 billion. After several years of closing prospective
gaps through deficit financing and the use of non-recurring revenues,
significant concern exists over the ability of the County to meet this
challenge. Even after the infusion of Federal aid for health care, the County
was still required to close clinic offices, cut expenditures and significantly
reduce staff. It is anticipated that the County may have to enact additional
cuts during the year and endorse a similar program to balance the fiscal year
1997 budget. The recovery plan approved by the State Legislature would allow the
County to divert transit revenues to the General Fund. Concerns over the longer
term effects of the current imbalance caused Moody's and S&P to downgrade
various securities of the County. The General Obligation debt of the County was
lowered from A1 to A and from A+ to A- by Moody's and S&P, respectively.
The State of California has no existing obligation with respect to any
obligations or securities of the Counties or other local entities. State
legislation passed to facilitate the recovery plans for Orange County and Los
Angeles County permits the counties to transfer funds designated for specific
purposes to general purposes funds but does not commit any state funds to
resolving these situations. However, the state may be obligated to intervene to
ensure that school districts have sufficient funds to operate or maintain
certain county-administered State programs.
Recent Budgets. The State failed to enact its 1992-93 budget by July 1,
1992. Starting on July 1, 1992, the Controller was required to issue "registered
warrants" in lieu of normal warrants backed by cash to pay many State
obligations. Available cash was used to pay constitutionally mandated and
priority obligations. Between July 1 and September 3, 1992, the Controller
issued an aggregate of approximately $3.8 billion of registered warrants all of
which were called for redemption by September 4, 1992 following enactment of the
1992-93 Budget Act and issuance by the State of short-term notes.
The 1992-93 Budget Act, when finally adopted, was projected to
eliminate the State's accumulated deficit, with additional expenditure cuts and
a $1.3 billion transfer of State education funding costs to local governments by
shifting local property taxes to school districts. However, the recession
continued, forcing the State to continue to carry its $2.8 billion budget
deficit as of June 30, 1993.
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The 1993-94 Budget Act also relied on expenditure cuts and an
additional $2.6 billion transfer of costs to local government, particularly
counties. A major feature of the budget was a two-year plan to eliminate the
accumulated deficit by borrowing into the 1994-95 fiscal year. With the
recession continuing longer than expected, revenues only exceeded expenditures
by about $500 million. However, this was the first operating surplus in four
years and reduced the accumulated deficit to $2.0 billion, after taking into
account certain other accounting reserves.
The 1994-95 Budget Act was passed on July 8, 1994, and provided for an
estimated $41.9 billion of General Fund revenues, and $40.9 billion of
expenditures. The budget assumed receipt of about $750 million of new federal
assistance for the costs of undocumented immigrants, as well as a plan to defer
retirement of $1 billion of the accumulated budget deficit until the 1995-96
fiscal year. The Federal government has apparently budgeted only $33 million of
this immigration aid. However, this shortfall is expected to be almost fully
offset by higher than projected revenues, and lower than projected caseload
growth as the economy improves.
Because of the accumulated budget deficit over the past several years,
the payment of certain unbudgeted expenditures to schools to maintain constant
per-pupil aid levels, and a reduction of the level of available internal
borrowing, the State's cash resources have been significantly depleted. This has
required the State to rely on a series of external borrowings for the past
several years to pay its normal expenses, including borrowings which have gone
past the end of the fiscal year. In February 1994, the State borrowed $3.2
billion, maturing by December 1994. In July 1994, the State borrowed a total of
$7.0 billion to meet its cash flow requirements for the 1994-95 fiscal year and
to fund part of its deficit into the 1995-96 fiscal year. A total of $4.0
billion of this borrowing matures in April 1996. The State will continue to
utilize external borrowing to meet its cash needs to the foreseeable future.
In order to assure repayment of the $4 billion, 22-month borrowing, the
State enacted legislation (the "Trigger Law") which can lead to automatic,
across-the-board cuts in General Fund expenditures in either the 1994-95 or
1995-96 fiscal years if cash flow projections made at certain times during those
years show deterioration from the projections made in July 1994, when the
borrowings were made. This plan places the burden on the legislature to maintain
ongoing control over the annual budget, and could exert additional pressure on
local governments reliant on appropriated program expenditures. On November 15,
1994, the State Controller as part of the Trigger Law reported that the cash
position of the General Fund on June 30, 1995 would be about $580 million better
than earlier projected, so no automatic budget adjustments were required in
1994-95. The Controller's report showed that loss of federal funds was offset by
higher revenues, lower expenditures, and certain other increases in cash
resources.
Again in 1995, the State experienced difficulties in obtaining a
consensus on the Budget which produced a two-month delay in passage. The enacted
FY 1995-96 Budget projects General Fund revenues of $44.1 billion and
expenditures of $43.4 billion. Key components built into the budget included the
receipt of about $830 million of new Federal aid for undocumented aliens' costs
and the successful resolution of litigation concerning previous budget actions.
This Budget proposes to eliminate the outstanding deficit including all
short-term borrowings and generate a small surplus of $289 million by year end.
On October 16, 1995, the State Controller indicated that the cash position of
the General Fund exceeded requirements for enacting the Trigger Law. Initial
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results show that the major tax sources (Income, Sales and Corporation Taxes) of
the state are exceeding projections by $440 million. The tax revenue growth
provides some evidence of the breadth of California's economic rebound and
offsets some reductions in anticipated Federal aid during 1995. Attainment of FY
1995-96 Budget projections hinge on the continuation of the economic recovery
into 1996 and the maintenance of fiscal discipline by the state.
The FY 1996-97 budget was signed on July 15, 1996, and calls for
General Fund expenditures of $47.25 billion against expected revenues of $47.64
billion, a general increase of 4% over FY 1995-96. Specific features of the
proposal include additional investments in infrastructure, educational
technology and programs, reductions in welfare expenditures and renter tax
credits. Following enactment of the 1996-97 Budget, a federal welfare reform
act, the "Personal Responsibility and Work Opportunity Act" was signed into law.
The Law includes lifetime limits on certain welfare assistance, denial of
benefits to illegal immigrants, a reduction in benefits to certain legal
noncitizens and changes in the Food Stamp program, including lower benefits and
a work requirement. The Law requires states to implement the program not later
than 7/1/97, and provides CA approximately $3.7 billion in block grant funds for
FY 96-97. CA plans to implement the Law effective 1/1/97, however, since the
federal law did not include all the changes anticipated by CA when the state
budget was signed into effect, the State anticipates that it will realize only
$360 million of the $600 million in welfare reductions originally anticipated.
An overall assessment of the effect of these changes on the State's General Fund
will not be known for some time, and will depend on how the State implements the
Law.
Rating Agencies. The ongoing structural imbalances, and sluggish
recovery of the California economy have placed the State under ongoing scrutiny
from the municipal credit rating agencies. However, recent actions by the rating
agencies have been more positive. In July, 1996 S&P upgraded the States general
obligation ratings to an A+ from an A.
Constitutional Considerations. Changes in California laws during the
last two decades have limited the ability of California State and municipal
issuers to obtain sufficient revenue to pay their bond obligations.
In 1978, California voters approved an amendment to the California
Constitution known as Proposition 13. Proposition 13 limits ad valorem
(according to value) taxes on real property and restricts the ability of taxing
entities to increase real property taxes and assessments, and limits the ability
of local governments to raise other taxes.
Article XIII B of the California Constitution (the "Appropriation
Limit") imposes a limit on annual appropriations. Originally adopted in 1979,
Article XIII B was modified by Proposition 98 in 1988 and Proposition 111 in
1990. The appropriations subject to the Article consist of tax proceeds which
include tax revenues and certain other funds. Excluded from the Appropriation
Limits are prior (pre 1979) debt service and subsequent debt incurred as the
result of voter authorizations, court mandates, qualified capital outlay
projects and certain increases in gasoline taxes and motor vehicle weight fees.
Certain civil disturbance emergencies declared by the Governor and
appropriations approved by a two-thirds vote of the legislature are excluded
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from the determination of excess appropriations, and the appropriations limit
may be overridden by local voter approval for up to a four-year period.
On November 8, 1988, California voters approved Proposition 98, a
combined initiative constitutional amendment and statute called "the Classroom
Instruction Improvement and Accountability Act." This amendment changed school
funding below the University level by guaranteeing K-14 schools a minimum share
of General Fund Revenues. Suspension of the Proposition 98 funding formula
requires a two-thirds vote of Legislature and the Governor's concurrence.
Proposition 98 also contains provisions transferring certain funds in excess of
the Article III B limit to K-14 schools.
As amended by Proposition 111, the Appropriation Limit recalculated
annually by taking the actual Fiscal Year 1986-1987 limit and applying the
Proposition 111 cost of living and population adjustments as if that limit had
been in effect. The Appropriations Limit is tested over consecutive two-year
periods under this amendment. Any excess "proceeds of taxes" received over such
two-year period above the Appropriation Limits for the two-year period is
divided equally between transfers to K-14 and taxpayers.
Throughout the next few fiscal years, the State's financial
difficulties are expected to remain serious. As more operational and fiscal
responsibilities are shifted to local governments, there will be additional
pressure exerted upon local governments, especially counties and school
districts which rely upon State aid.
During the recent recession, original Prop. 98 appropriations turned
out to be higher than the minimum percentage provided in the law. The
Legislature responded by designated the "extra" payments as a "loan" from future
years. In July, 1996, a lawsuit that challenged the validity of these loans was
settled. It requires that the State and schools share in the repayment of these
loans with repayments spread over an eight year period to mitigate any adverse
fiscal impact.
Certain debt obligations held by the Fund may be payable solely from
lease payments on real property leased to the State, counties, cities or various
public entities structured in such a way as to not constitute a debt to the
leasing entity. To ensure that a debt is not technically created, California law
requires that the lessor can proportionally reduce its lease payments equal to
its loss of beneficial use and occupancy. Moreover, the lessor does not agree to
pay lease payments beyond the current period; it only agrees to include lease
payments in its annual budget every year. In the event of a default, the only
remedy available against the lessor is that of reletting the property or suing
annually for the rents due; no acceleration of lease payments is permitted.
The Fund also holds debt obligations payable solely from the revenues
of health care institutions. Certain provisions under California state law may
adversely affect these revenues and, consequently, payment of those debt
obligations.
The Federally sponsored Medicaid program for health care services to
eligible welfare recipients is known as the Medi-Cal program. In the past, the
Medi-Cal program has provided a cost-based system of reimbursement for impatient
care furnished to Medi-Cal beneficiaries by any eligible hospital. The State now
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selectively contracts by county with California hospitals to provide
reimbursement for non-emergency inpatient services to Medi-Cal beneficiaries,
generally on a flat per-diem payment basis regardless of cost. California law
also permits private health plans and insurers to contract selectively with
hospitals for services to beneficiaries on negotiated terms, generally at rates
lower than standard charges.
Debt obligations payable solely from revenues of health care
institutions may also be insured by the state pursuant to an insurance program
operated by the Office of Statewide Health Planning and Development (the
"Office"). Most of such debt obligations are secured by a mortgage of real
property in favor of the Office and the holders. If a default occurs on such
insured debt obligations, the Office has the option of either continuing to meet
debt service obligations or foreclosing the mortgage and requesting the State
Treasurer to issue debentures payable from a reserve fund established under the
insurance fund or payable from appropriated state funds.
Security for certain debt obligations held by the Fund may be in form
of a mortgage or deed of trust on real property. California has statutory
provisions which limit the remedies of a creditor secured by a mortgage or deed
of trust. Principally, the provisions establish conditions governing the limits
of a creditor's right to a deficiency judgment. In the case of a default, the
creditor's rights under the mortgage or deed of trust are subject to constraints
imposed by California real property law upon transfers of title to real property
by private power of sale. These laws require that the loan must have been in
arrears for at least seven months before foreclosure proceedings can begin.
Under California's anti-deficiency legislation, there is no personal recourse
against a mortgagor of single-family residence regardless of whether the
creditor chooses judicial or non-judicial foreclosure. These disruptions could
disrupt the stream of revenues available to the issuer for paying debt service.
Under California law, mortgage loans secured by single-family
owner-occupied dwellings may be prepaid at any time. Prepayment changes on such
mortgage loans may be imposed only with respect to voluntary payments made
during the first five years of the mortgage loan, and cannot in any event exceed
six months, advance interest on the amount prepaid in excess of 20% of the
original principal amount of the mortgage loan. This limitation could affect the
flow of revenues available to the issuer for debt service on these outstanding
debt obligations.
Substantially all of California is located within an active geologic
region subject to major seismic activity. Any California municipal obligation in
the Fund could be affected by an interruption of revenues because of damaged
facilities, or, consequently, income tax deductions for casualty losses or
property tax assessment reductions. Compensatory financial assistance could be
constrained by the inability of (1) an issuer to have obtained earthquake
insurance coverage at reasonable rates; (2) an issuer to perform on its contract
of insurance in the event of widespread losses; or (3) the Federal or State
government to appropriate sufficient funds within their respective budget
limitations.
The January 1994 major earthquake in greater Los Angeles (Northridge)
was estimated to have resulted in up to $20 billion in property damage.
Significant damage was incurred by public and private facilities in four
counties. Los Angeles, Ventura, Orange and San Bernadino Counties were declared
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State and Federal disasters. The Federal government approved a total of $9.5
billion in earthquake relief funds for assistance to homeowners and small
businesses, as well as repair of damaged public facilities.
As described in the summary above, the Fund's investments are
susceptible to possible adverse effects of the complex political, economic and
regulatory matters affecting California issuers. In the view of the Adviser, it
is impossible to determine the impact of any legislation, voter initiatives or
other similar measures which have been or may be introduced to limit or increase
the taxing or spending authority of state and local governments or to predict
such governments' abilities to pay the interest on, or repay the principal of,
their obligations.
Legislation limiting taxation and spending may, however, affect the
creditworthiness of state or local agencies in the future. If either California
or any of its local governmental entities is unable to meet its financial
obligations, the income derived by the Fund, its net asset value, its ability to
preserve or realize capital appreciation or its liquidity could be adversely
affected.
When-Issued and Forward Commitment Securities. The Fund may purchase
securities on a when-issued basis and may purchase or sell securities on a
forward commitment basis to hedge against anticipated changes in interest rates
and prices. "When-issued" refers to securities whose terms are available and for
which a market exists, but which have not been issued. The Fund will engage in
when-issued transactions with respect to securities purchased for its portfolio
in order to obtain what is considered to be an advantageous price and yield at
the time of the transaction. For when-issued transactions, no payment is made
until delivery is due, often a month or more after the purchase. In a forward
commitment transaction, the Fund contracts to purchase or sell securities for a
fixed price at a future date beyond customary settlement time.
When the Fund engages in forward commitment and when-issued
transactions, it relies on the seller or the buyer, as the case may be, to
consummate the transaction. The failure of the issuer or seller to consummate
the transaction may result in the Fund losing the opportunity to obtain a price
and yield considered to be advantageous. The purchase of securities on a
when-issued and forward commitment basis also involves a risk of loss if the
value of the security to be purchased declines prior to the settlement date. If
the Fund chooses to dispose of the right to acquire a when-issued security prior
to its acquisition or dispose of its right to deliver or receive against a
forward commitment, it may recognize a taxable gain or a loss.
On the date the Fund enters into an agreement to purchase securities on
a when-issued or forward commitment basis, the Fund will segregate in a separate
account cash or liquid securities equal in value to the Fund's commitment. These
assets will be valued daily at market, and additional cash or securities will be
segregated in a separate account to the extent that the total value of the
assets in the account declines below the amount of the commitments.
Alternatively, the Fund may enter into offsetting contracts for the forward sale
of other securities that it owns.
Repurchase Agreements. The Fund may enter into repurchase agreements
for the purpose of realizing additional (taxable) income. In a repurchase
agreement the Fund would buy a security for a relatively short period (generally
not more than 7 days) subject to the obligation to sell it back to the issuer at
a fixed time and price plus accrued interest. The Fund will enter into
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<PAGE>
repurchase agreements only with member banks of the Federal Reserve System and
with "primary dealers" in U.S. Government securities. The Adviser will
continuously monitor the creditworthiness of the parties with whom the Fund
enters into repurchase agreements.
The Fund has established a procedure providing that the securities
serving as collateral for each repurchase agreement must be delivered to the
Fund's custodian either physically or in book-entry form and that the collateral
must be marked to market daily to ensure that each repurchase agreement is fully
collateralized at all times. In the event of bankruptcy or other default by a
seller of a repurchase agreement, the Fund could experience delays in
liquidating the underlying securities during the period in which the Fund seeks
to enforce its rights thereto, possible subnormal levels of income, decline in
value of the underlying securities or lack of access to income during this
period, as well as the expense of enforcing its rights.
Reverse Repurchase Agreements. The Fund may also enter into reverse
repurchase agreements which involve the sale of U.S. Government securities held
in its portfolio to a bank with an agreement that the Fund will buy back the
securities at a fixed future date at a fixed price plus an agreed amount of
"interest" which may be reflected in the repurchase price. Reverse repurchase
agreements are considered to be borrowings by the Fund. Reverse repurchase
agreements involve the risk that the market value of securities purchased by the
Fund with proceeds of the transaction may decline below the repurchase price of
the securities sold by the Fund which it is obligated to repurchase. The Fund
will also continue to be subject to the risk of a decline in the market value of
the securities sold under the agreements because it will reacquire those
securities upon effecting their repurchase. The Fund will not enter into reverse
repurchase agreements and other borrowings exceeding in the aggregate 15% of the
Fund's total assets (including the amount borrowed) valued at market less
liabilities (not including the amount borrowed) at the time the borrowing was
made. To minimize various risks associated with reverse repurchase agreements,
the Fund will establish and maintain with the Fund's custodian a separate
account consisting of highly liquid, marketable securities in an amount at lease
equal to the repurchase prices of these securities (plus accrued interest
thereon) under such agreements. In addition, the Fund will not purchase
additional securities while all borrowings exceed 5% of the value of its total
assets. The Fund will enter into reverse repurchase agreements only with
federally insured banks or savings and loan associations which are approved in
advance as being creditworthy by the Trustees. Under procedures established by
the Trustees, the Adviser will monitor the creditworthiness of the banks
involved.
Lending of Securities. The Fund may lend portfolio securities to
brokers, dealers, and financial institutions for the purpose of realizing
additional (taxable) income if the loan is collateralized by cash or U.S.
Government securities according to applicable regulatory requirements. The Fund
may reinvest any cash collateral in short-term securities and money market
funds. When the Fund lends portfolio securities, there is a risk that the
borrower may fail to return the securities involved in the transaction. As a
result, the Fund may incur a loss or, in the event of the borrower's bankruptcy,
the Fund may be delayed in or prevented from liquidating the collateral. It is a
fundamental policy of the Fund not to lend portfolio securities having a total
value exceeding 33 1/3% of its total assets.
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Options on Securities and Securities Indices. The Fund may purchase and
write (sell) call and put options on debt securities in which it may invest or
on any securities index based on debt securities in which it may invest. These
options may be listed on national domestic securities exchanges or foreign
securities exchanges or traded in the over-the-counter market. The Fund may
write covered put and call options and purchase put and call options as a
substitute for the purchase or sale of securities or to protect against declines
in the value of portfolio securities and against increases in the cost of
securities to be acquired.
Writing Covered Options. A call option on securities written by the
Fund obligates the Fund to sell specified securities to the holder of the option
at a specified price if the option is exercised at any time before the
expiration date. A put option on securities written by the Fund obligates the
Fund to purchase specified securities from the option holder at a specified
price if the option is exercised at any time before the expiration date. Options
on securities indices are similar to options on securities, except that the
exercise of securities index options requires cash settlement payments and does
not involve the actual purchase or sale of securities. In addition, securities
index options are designed to reflect price fluctuations in a group of
securities or segment of the securities market rather than price fluctuations in
a single security. Writing covered call options may deprive the Fund of the
opportunity to profit from an increase in the market price of the securities in
its portfolio. Writing covered put options may deprive the Fund of the
opportunity to profit from a decrease in the market price of the securities to
be acquired for its portfolio.
All call and put options written by the Fund are covered. A written
call option or put option may be covered by (i) maintaining cash or liquid
securities in a segregated account maintained by the Fund's custodian with a
value at least equal to the Fund's obligation under the option, (ii) entering
into an offsetting forward commitment and/or (iii) purchasing an offsetting
option or any other option which, by virtue of its exercise price or otherwise,
reduces the Fund's net exposure on its written option position. A written call
option on securities is typically covered by maintaining the securities that are
subject to the option in a segregated account. The Fund may cover call options
on a securities index by owning securities whose price changes are expected to
be similar to those of the underlying index.
The Fund may terminate its obligations under an exchange traded call or
put option by purchasing an option identical to the one it has written.
Obligations under over-the-counter options may be terminated only by entering
into an offsetting transaction with the counterparty to such option. Such
purchases are referred to as "closing purchase transactions."
Purchasing Options. The Fund would normally purchase call options in
anticipation of an increase, or put options in anticipation of a decrease
("protective puts") in the market value of securities of the type in which it
may invest. The Fund may also sell call and put options to close out its
purchased options.
The purchase of a call option would entitle the Fund, in return for the
premium paid, to purchase specified securities at a specified price during the
option period. The Fund would ordinarily realize a gain on the purchase of a
call option if, during the option period, the value of such securities exceeded
the sum of the exercise price, the premium paid and transaction costs; otherwise
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<PAGE>
the Fund would realize either no gain or a loss on the purchase of the call
option.
The purchase of a put option would entitle the Fund, in exchange for
the premium paid, to sell specified securities at a specified price during the
option period. The purchase of protective puts is designed to offset or hedge
against a decline in the market value of the Fund's portfolio securities. The
Fund would ordinarily realize a gain if, during the option period, the value of
the underlying securities or currency decreased below the exercise price
sufficiently to cover the premium and transaction costs; otherwise the Fund
would realize either no gain or a loss on the purchase of the put option. Gains
and losses on the purchase of put options may be offset by countervailing
changes in the value of the Fund's portfolio securities. Under certain
circumstances, the Fund may not be treated as the tax owner of a security if the
Fund has purchase a put option on the same security. If this occurred, the
interest on the security would be taxable.
The Fund's options transactions will be subject to limitations
established by each of the exchanges, boards of trade or other trading
facilities on which such options are traded. These limitations govern the
maximum number of options in each class which may be written or purchased by a
single investor or group of investors acting in concert, regardless of whether
the options are written or purchased on the same or different exchanges, boards
of trade or other trading facilities or are held or written in one or more
accounts or through one or more brokers. Thus, the number of options which the
Fund may write or purchase may be affected by options written or purchased by
other investment advisory clients of the Adviser. An exchange, board of trade or
other trading facility may order the liquidation of positions found to be in
excess of these limits, and it may impose certain other sanctions.
Risks Associated with Options Transactions. There is no assurance that
a liquid secondary market on an options exchange will exist for any particular
exchange-traded option or at any particular time. If the Fund is unable to
effect a closing purchase transaction with respect to covered options it has
written, the Fund will not be able to sell the underlying securities or dispose
of assets held in a segregated account until the options expire or are
exercised. Similarly, if the Fund is unable to effect a closing sale transaction
with respect to options it has purchased, it would have to exercise the options
in order to realize any profit and will incur transaction costs upon the
purchase or sale of underlying securities.
Reasons for the absence of a liquid secondary market on an exchange
include the following: (i) there may be insufficient trading interest in certain
options; (ii) restrictions may be imposed by an exchange on opening transactions
or closing transactions or both; (iii) trading halts, suspensions or other
restrictions may be imposed with respect to particular classes or series of
options; (iv) unusual or unforeseen circumstances may interrupt normal
operations on an exchange; (v) the facilities of an exchange or the Options
Clearing Corporation may not at all times be adequate to handle current trading
volume; or (vi) one or more exchanges could, for economic or other reasons,
decide or be compelled at some future date to discontinue the trading of options
(or a particular class or series of options), in which event the secondary
market on that exchange (or in that class or series of options) would cease to
exist although outstanding options on that exchange that had been issued by the
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Options Clearing Corporation as a result of trades on that exchange would
continue to be exercisable in accordance with their terms.
The Fund's ability to terminate over-the-counter options is more
limited than with exchange-traded options and may involve the risk that
broker-dealers participating in such transactions will not fulfill their
obligations. The Adviser will determine the liquidity of each over-the-counter
option in accordance with guidelines adopted by the Trustees.
The writing and purchase of options is a highly specialized activity
which involves investment techniques and risks different from those associated
with ordinary portfolio securities transactions. The successful use of options
depends in part on the Adviser's ability to predict future price fluctuations
and, for hedging transactions, the degree of correlation between the options and
securities markets.
Futures Contracts and Options on Futures Contracts. To hedge against
changes in interest rates or securities prices, the Fund may purchase and sell
futures contracts on debt securities and debt securities indices, and purchase
and write call and put options on these futures contracts. The Fund may also
enter into closing purchase and sale transactions with respect to any of these
contracts and options. All futures contracts entered into by the Fund are traded
on U.S. exchanges or boards of trade that are licensed, regulated or approved by
the Commodity Futures Trading Commission ("CFTC").
Futures Contracts. A futures contract may generally be described as an
agreement between two parties to buy and sell particular financial instruments
for an agreed price during a designated month (or to deliver the final cash
settlement price, in the case of a contract relating to an index or otherwise
not calling for physical delivery at the end of trading in the contract).
Positions taken in the futures markets are not normally held to
maturity but are instead liquidated through offsetting transactions which may
result in a profit or a loss. While futures contracts on securities will usually
be liquidated in this manner, the Fund may instead make, or take, delivery of
the underlying securities whenever it appears economically advantageous to do
so. A clearing corporation associated with the exchange on which futures
contracts are traded guarantees that, if still open, the sale or purchase will
be performed on the settlement date.
Hedging Strategies. Hedging is an attempt to establish with more
certainty than would otherwise be possible the effective price or rate of return
on portfolio securities or securities that the Fund proposes to acquire. When
interest rates are rising or securities prices are falling, the Fund can seek to
offset a decline in the value of its current portfolio securities through the
sale of futures contracts. When interest rates are falling or securities prices
are rising, the Fund, through the purchase of futures contracts, can attempt to
secure better rates or prices than might later be available in the market when
it effects anticipated purchases.
The Fund may, for example, take a "short" position in the futures
market by selling futures contracts in an attempt to hedge against an
anticipated rise in interest rates or a decline in market prices that would
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<PAGE>
adversely affect the value of the Fund's portfolio securities. Such futures
contracts may include contracts for the future delivery of securities held by
the Fund or securities with characteristics similar to those of the Fund's
portfolio securities.
If, in the opinion of the Adviser, there is a sufficient degree of
correlation between price trends for the Fund's portfolio securities and futures
contracts based on other debt securities or indices, the Fund may also enter
into such futures contracts as part of its hedging strategy. Although under some
circumstances prices of securities in the Fund's portfolio may be more or less
volatile than prices of such futures contracts, the Adviser will attempt to
estimate the extent of this volatility difference based on historical patterns
and compensate for any differential by having the Fund enter into a greater or
lesser number of futures contracts or by attempting to achieve only a partial
hedge against price changes affecting the Fund's portfolio securities.
When a short hedging position is successful, any depreciation in the
value of portfolio securities will be substantially offset by appreciation in
the value of the futures position. On the other hand, any unanticipated
appreciation in the value of the Fund's portfolio securities would be
substantially offset by a decline in the value of the futures position.
On other occasions, the Fund may take a "long" position by purchasing
futures contracts. This would be done, for example, when the Fund anticipates
the subsequent purchase of particular securities when it has the necessary cash,
but expects the prices then available in the applicable market to be less
favorable than prices that are currently available. The Fund may also purchase
futures contracts as a substitute for transactions in securities to alter the
investment characteristics of portfolio securities or to gain or increase its
exposure to a particular securities market.
Options on Futures Contracts. The Fund may purchase and write options
on futures for the same purposes as its transactions in futures contracts. The
purchase of put and call options on futures contracts will give the Fund the
right (but not the obligation) for a specified price to sell or to purchase,
respectively, the underlying futures contract at any time during the option
period. As the purchaser of an option on a futures contract, the Fund obtains
the benefit of the futures position if prices move in a favorable direction but
limits its risk of loss in the event of an unfavorable price movement to the
loss of the premium and transaction costs.
The writing of a call option on a futures contract generates a premium
which may partially offset a decline in the value of the Fund's assets. By
writing a call option, the Fund becomes obligated, in exchange for the premium
(upon exercise of the option) to sell a futures contract if the option is
exercised, which may have a value higher than the exercise price. Conversely,
the writing of a put option on a futures contract generates a premium which may
partially offset an increase in the price of securities that the Fund intends to
purchase. However, the Fund becomes obligated (upon exercise of the option) to
purchase a futures contract if the option is exercised, which may have a value
lower than the exercise price. The loss incurred by the Fund in writing options
on futures is potentially unlimited and may exceed the amount of the premium
received.
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The holder or writer of an option on a futures contract may terminate
its position by selling or purchasing an offsetting option of the same series.
There is no guarantee that such closing transactions can be effected. The Fund's
ability to establish and close out positions on such options will be subject to
the development and maintenance of a liquid market.
Other Considerations. The Fund will engage in futures and related
options transactions solely for bona fide hedging purposes as permitted by the
CFTC. To the extent that the Fund is using futures and related options for
hedging purposes, futures contracts will be sold to protect against a decline in
the price of securities that the Fund owns or futures contracts will be
purchased to protect the Fund against an increase in the price of securities it
intends to purchase. The Fund will determine that the price fluctuations in the
futures contracts and options on futures used for hedging purposes are
substantially related to price fluctuations in securities held by the Fund or
securities or instruments which it expects to purchase. As evidence of its
hedging intent, the Fund expects that on 75% or more of the occasions on which
it takes a long futures or option position (involving the purchase of futures
contracts), the Fund will have purchased, or will be in the process of
purchasing, equivalent amounts of related securities in the cash market at the
time when the futures or option position is closed out. However, in particular
cases, when it is economically advantageous for the Fund to do so, a long
futures position may be terminated or an option may expire without the
corresponding purchase of securities or other assets.
The Fund will engage in transactions in futures contracts and related
options only to the extent such transactions are consistent with the
requirements of the Internal Revenue Code of 1986, as amended (the "Code"), for
maintaining its qualifications as a regulated investment company for federal
income tax purposes.
Transactions in futures contracts and options on futures involve
brokerage costs, require margin deposits and, in the case of contracts and
options obligating the Fund to purchase securities, require the Fund to
establish with the custodian a segregated account consisting of cash or liquid
securities in an amount equal to the underlying value of such contracts and
options.
While transactions in futures contracts and options on futures may
reduce certain risks, these transactions themselves entail certain other risks.
For example, unanticipated changes in interest rates, securities prices may
result in a poorer overall performance for the Fund than if it had not entered
into any futures contracts or options transactions.
Perfect correlation between the Fund's futures positions and portfolio
positions will be impossible to achieve. There are no futures contracts based
upon individual securities, except certain U.S. Government securities. The only
futures contracts available to hedge the Fund's portfolio are various futures on
U.S. Government securities and securities indices. In the event of an imperfect
correlation between a futures position and a portfolio position which is
intended to be protected, the desired protection may not be obtained and the
Fund may be exposed to risk of loss.
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Some futures contracts or options on futures may become illiquid under
adverse market conditions. In addition, during periods of market volatility, a
commodity exchange may suspend or limit trading in a futures contract or related
option, which may make the instrument temporarily illiquid and difficult to
price. Commodity exchanges may also establish daily limits on the amount that
the price of a futures contract or related option can vary from the previous
day's settlement price. Once the daily limit is reached, no trades may be made
that day at a price beyond the limit. This may prevent the Fund from closing out
positions and limiting its losses
Derivative Instruments. The Fund may purchase or enter into derivative
instruments to enhance return, to hedge against fluctuations in interest rates
or securities prices, to change the duration of the Fund's fixed income
portfolio or as a substitute for the purchase or sale of securities. The Fund's
investments in derivative securities may include certain floating rate and
indexed securities. The Fund's transactions in derivative contracts may include
the purchase or sale of futures contracts on securities or indices; options on
futures contracts; and options on securities or indices and forward commitments
to purchase or sell securities.
All of the Fund's transactions in derivative instruments involve a risk
of loss or depreciation due to unanticipated adverse changes in interest rates
or securities prices. The loss on derivative contracts may exceed the Fund's
initial investment in these contracts. In addition, the Fund may lose the entire
premium paid for purchased options that expire before they can be profitably
exercised by the Fund.
Restricted Securities. The Fund may purchase securities that are not
registered ("restricted securities") under the Securities Act of 1933 ("1933
Act"), including commercial paper issued in reliance on Section 4(2) of the 1933
Act and securities offered and sold to "qualified institutional buyers" under
Rule 144A under the 1933 Act. However, the Fund will not invest more than 10% of
its net assets in illiquid investments, which include repurchase agreements
maturing in more than seven days, securities that are not readily marketable and
restricted securities. However, if the Trustees determines, based upon a
continuing review of the trading markets for specific Section 4(2) paper or Rule
144A securities, that they are liquid, then such securities may be purchased
without regard to the 10% limit. The Trustees may adopt guidelines and delegate
to the Adviser the daily function of determining the monitoring and liquidity of
restricted securities. The Trustees, however, will retain sufficient oversight
and be ultimately responsible for the determinations. The Trustees will
carefully monitor the Fund's investments in these securities, focusing on such
important factors, among others, as valuation, liquidity and availability of
information. This investment practice could have the effect of increasing the
level of illiquidity in the Fund if qualified institutional buyers become for a
time uninterested in purchasing these restricted securities.
The Fund may acquire other restricted securities including securities
for which market quotations are not readily available. These securities may be
sold only in privately negotiated transactions or in public offerings with
respect to which a registration statement is in effect under the 1933 Act. Where
registration is required, the Fund may be obligated to pay all or part of the
registration expenses and a considerable period may elapse between the time of
the decision to sell and the time the Fund may be permitted to sell a security
under an effective registration statement. If, during such a period, adverse
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market conditions were to develop, the Fund might obtain a less favorable price
than prevailed when it decided to sell. Restricted securities will be priced at
fair market value as determined in good faith by the Fund's Trustees.
To the extent that the Fund's holdings of participation interests, COPs
and inverse floaters are determined to be illiquid, such holdings will be
subject to the 10% restriction on illiquid investments.
Short Term Trading and Portfolio Turnover. Short-Term trading means the
purchase and subsequent sale of a security after it has been held for a
relatively brief period of time. Short-Term trading may have the effect of
increasing portfolio turnover and may increase net short-term capital gains,
distributions from which would be taxable to shareholders as ordinary income.
The Fund's portfolio securities may be changed without regard to the holding
period of these securities (subject to certain tax restrictions), when the
Adviser deems that this action will help achieve the Fund's objective given a
change in an issuer's operations or changes in general market conditions. A high
rate of portfolio turnover (100% or greater) involves correspondingly greater
brokerage expenses and may make it more difficult for the Fund to qualify as a
regulated investment company for federal income tax purposes. The Fund's
portfolio turnover rate is set forth in the table under the caption "Financial
Highlights" in the Prospectus.
Swaps, Caps, Floor and Collars. As one way of managing its exposure to
different types of investments, the Fund may enter into interest rate swaps, and
other types of swap agreements such as caps, collars and floors. In a typical
interest rate swap, one party agrees to make regular payments equal to a
floating interest rate times a "notional principal amount," in return for
payments equal to a fixed rate times the same amount, for a specified period of
time. Swaps may also depend on other prices or rates, such as the value of an
index or mortgage prepayment rates.
In a typical cap or floor agreement, one party agrees to make payments
only under specified circumstances, usually in return for payment of a fee by
the other party. For example, the buyer of an interest rate cap obtains the
right to receive payments to the extent that a specified interest rate exceeds
an agreed-upon level, while the seller of an interest rate floor is obligated to
make payments to the extent that a specified interest rate falls below an
agreed-upon level. An interest rate collar combines elements of buying a cap and
selling a floor.
Swap agreements will tend to shift the Fund's investment exposure from
one type of investment to another. Caps and floors have an effect similar to
buying or writing options. Depending on how they are used, swap agreements may
increase or decrease the overall volatility of a Fund's investments and its
share price and yield.
Swap agreements are sophisticated hedging instruments that typically
involve a small investment of cash relative to the magnitude of risks assumed.
As a result, swaps can be highly volatile and may have a considerable impact on
the Fund's performance. Swap agreements are subject to risks related to the
counterpart's ability to perform, and may decline in value if the counterpart's
credit worthiness deteriorates. The Fund may also suffer losses if it is unable
to terminate outstanding swap agreements or reduce its exposure through
21
<PAGE>
offsetting transactions. The Fund will maintain in a segregated account with its
custodian, cash or liquid, high grade debt securities equal to the net amount,
if any, of the excess of the Fund's obligations over its entitlement with
respect to swap, cap, collar or floor transactions.
INVESTMENT RESTRICTIONS
The Fund has adopted certain fundamental investment restrictions upon
its investments set forth below which may not be changed without approval by the
holders of a majority of the outstanding shares of the Fund. A majority for this
purpose means: (a) more than 50% of the outstanding shares of the Fund or (b)
67% or more of the shares represented at a meeting where more than 50% of the
outstanding shares of the Fund are represented, whichever is less. Under these
restrictions, the Fund may not:
1. Borrow money except from banks for temporary or emergency (not
leveraging) purposes, including the meeting of redemption
requests that might otherwise require the untimely disposition
of securities, in an amount up to 15% of the value of the
Fund's total assets (including the amount borrowed) valued at
market less liabilities (not including the amount borrowed) at
the time the borrowing was made. While borrowings exceed 5% of
the value of the Fund's total assets, the Fund will not
purchase any additional securities. Interest paid on
borrowings will reduce the Fund's net investment income.
2. Pledge, hypothecate, mortgage or otherwise encumber its
assets, except in an amount up to 10% of the value of its
total assets but only to secure borrowings for temporary or
emergency purposes or as may be necessary in connection with
maintaining collateral in connection with writing put and call
options or making initial margin deposits in connection with
the purchase or sale of financial futures, index futures
contracts and related options.
3. With respect to 75% of its total assets, purchase securities
(other than obligations issued or guaranteed by the United
States government, its agencies or instrumentalities and
shares of other investment companies) of any issuer if the
purchase would cause immediately thereafter more than 5% of
the value of the Fund's total assets to be invested in the
securities of such issuer or the Fund would own more than 10%
of the outstanding voting securities of such issuer.
4. Make loans to others, except through the purchase of
obligations in which the Fund is authorized to invest,
entering in repurchase agreements and lending portfolio
securities in an amount not exceeding one third of its total
assets.
5. Purchase securities subject to restrictions on disposition
under the Securities Act of 1933 or securities which are not
readily marketable if such purchase would cause the Fund to
have more than 10% of its net assets invested in such types of
securities.
22
<PAGE>
6. Purchase or retain the securities of any issuer, if those
officers and Trustees of the Fund or the Adviser who own
beneficially more than 1/2 of 1% of the securities of such
issuer, together own more than 5% of the securities of such
issuer.
7. Write, purchase or sell puts, calls or combinations thereof,
except put and call options on debt securities, futures
contracts based on debt securities, indices of debt securities
and futures contracts based on indices of debt securities,
sell securities on margin or make short sales of securities or
maintain a short position, unless at all times when a short
position is open it owns an equal amount of such securities or
securities convertible into or exchangeable, without payment
of any further consideration, for securities of the same issue
as, and equal in amount to, the securities sold short, and
unless not more than 10% of the Fund's net assets (taken at
current value) is held as collateral for such sales at any one
time.
8. Underwrite the securities of other issuers, except insofar as
the Fund may be deemed an underwriter under the Securities Act
of 1933 in disposing of a portfolio security.
9. Invest more than 25% of its assets in the securities of
"issuers" in any single industry; provided that there shall be
no limitation on the purchase of obligations issued or
guaranteed by the United States Government, its agencies or
instrumentalities or by any state or political subdivision
thereof. For purposes of this limitation when the assets and
revenues of an agency, authority, instrumentality or other
political subdivision are separate from those of the
government creating the issuing entity and a security is
backed only by the assets and revenues of the entity, the
entity would be deemed to be the sole issuer of the security.
Similarly, in the case of an industrial development or
pollution control bond, if that bond is backed only by the
assets and revenues of the nongovernmental user, then such
nongovernmental user would be deemed to be the sole issuer.
If, however, in either case, the creating government or some
other entity guarantees a security, such a guarantee would be
considered a separate security and would be treated as an
issue of such government or other entity unless all securities
issued or guaranteed by the government or other entity owned
by the Fund do not exceed 10% of the Fund's total assets.
10. Purchase or sell real estate, real estate investment trust
securities, commodities or commodity contracts, except
commodities and commodities contracts which are necessary to
enable the Fund to engage in permitted futures and options
transactions necessary to implement hedging strategies, or oil
and gas interests. This limitation shall not prevent the Fund
from investing in municipal securities secured by real estate
or interests in real estate or holding real estate acquired as
a result of owning such municipal securities.
11. Invest in common stock or in securities of other investment
companies, except that securities of investment companies may
be acquired as part of a merger, consolidation or acquisition
of assets and units of registered unit investment trusts whose
23
<PAGE>
assets consist substantially of tax-exempt securities may be
acquired to the extent permitted by Section 12 of the Act or
applicable rules.
12. Invest more than 5% of the value of its total assets in
securities of issuers having a record, including predecessors,
of fewer than three years of continuous operation, except
obligations issued or guaranteed by the United States
Government, its agencies or instrumentalities, unless the
securities are rated by a nationally recognized rating
service.
13. Issue any senior securities, except insofar as the Fund may be
deemed to have issued a senior security by: entering into a
repurchase agreement; purchasing securities in a when-issued
or delayed delivery basis; purchasing or selling any options
or financial futures contract; borrowing money or lending
securities in accordance with applicable investment
restrictions.
In order to comply with certain state regulatory policies, the Fund has
adopted a non-fundamental policy prohibiting the purchase of warrants. The
Fund's Trustees have approved the following non-fundamental investment policy
pursuant to an order of the SEC: Notwithstanding any investment restriction to
the contrary, the Fund may, in connection with the John Hancock Group of Funds
Deferred Compensation Plan for Independent Trustees, purchase securities of
other investment companies within the John Hancock Group of Funds provided that,
as a result, (i) no more than 10% of the Fund's assets would be invested in
securities of all other investment companies, (ii) such purchase would not
result in more than 3% of the total outstanding voting securities of any one
such investment company being held by the Fund and (iii) no more than 5% of the
Fund's assets would be invested in any one such investment company.
THOSE RESPONSIBLE FOR MANAGEMENT
The business of the Fund is managed by its Trustees who elect officers
who are responsible for the day-to-day operations of the Fund and who execute
policies formulated by the Trustees. Several of the officers and/or Trustees of
the Fund are also officers and/or directors of the Adviser or officers and
Trustees of the Fund's principal distributor, John Hancock Funds, Inc. ("John
Hancock Funds").
24
<PAGE>
<TABLE>
<CAPTION>
Positions Held Principal Occupations(s)
Name and Address With the Company During the Past Five Years
- ---------------- ---------------- --------------------------
<S> <C> <C>
Edward J. Boudreau, Jr. * Trustee, Chairman and Chief Chairman and Chief Executive
101 Huntington Avenue Executive Officer (1, 2) Officer, the Adviser and The
Boston, MA 02199 Berkeley Financial Group ("Berkeley
October 1944 Group"); Chairman, NM Capital
Management, Inc. ("NM Capital") and
John Hancock Advisers International
Limited ("Advisers International");
Chairman, Chief Executive Officer
and President, John Hancock Funds,
Inc. ("John Hancock Funds"), John
Hancock Signature Services, Inc.
("Signature Services"), First
Signature Bank and Trust Company and
Sovereign Asset Management
Corporation ("SAMCorp."); Director,
John Hancock Freedom Securities
Corporation, John Hancock Insurance
Agency, Inc. ("Insurance Agency,
Inc."), John Hancock Capital
Corporation and New England/Canada
Business Council; Member, Investment
Company Institute Board of
Governors; Director, Asia Strategic
Growth Fund, Inc.; Trustee, Museum
of Science; Vice Chairman and
President, the Adviser (until July
1992); Chairman, John Hancock
Distributors, Inc. (until April,
1994).
- -------------------
* Trustee may be deemed to be an "interested person" of the Fund as defined
in the Investment Company Act of 1940.
(1) Member of the Executive Committee. The Executive Committee may generally
exercise most of the powers of the Board of Trustees.
(2) A member of the Investment Committee of the Adviser.
(3) Member of the Audit Committee and the Administration Committee.
25
<PAGE>
Positions Held Principal Occupations(s)
Name and Address With the Company During the Past Five Years
- ---------------- ---------------- --------------------------
James F. Carlin Trustee (3) Chairman and CEO, Carlin
233 West Central Street Consolidated, Inc.
Natick, MA 01760 (management/investments); Director,
April 1940 Arbella Mutual Insurance Company
(insurance), Consolidated Group
Trust (insurance administration),
Carlin Insurance Agency, Inc., West
Insurance Agency, Inc. (until May
1995) Uno Restaurant Corp.;
Chairman, Massachusetts Board of
Higher Education (since 1995);
Receiver, the City of Chelsea (until
August 1992).
William H. Cunningham Trustee (3) Chancellor, University of Texas
601 Colorado Street System and former President of the
O'Henry Hall University of Texas, Austin, Texas;
Austin, TX 78701 Lee Hage and Joseph D. Jamail
January 1944 Regents Chair of Free Enterprise;
Director, LaQuinta Motor Inns, Inc.
(hotel management company);
Director, Jefferson-Pilot
Corporation (diversified life
insurance company) and LBJ
Foundation Board (education
foundation); Advisory Director,
Texas Commerce Bank - Austin.
Charles F. Fretz Trustee (3) Retired; self employed; Former Vice
RD #5, Box 300B President and Director, Towers,
Clothier Springs Road Perrin, Foster & Crosby, Inc.
Malvern, PA 19355 (international management
June 1928 consultants) (1952-1985).
- -------------------
* Trustee may be deemed to be an "interested person" of the Fund as defined
in the Investment Company Act of 1940.
(1) Member of the Executive Committee. The Executive Committee may generally
exercise most of the powers of the Board of Trustees.
(2) A member of the Investment Committee of the Adviser.
(3) Member of the Audit Committee and the Administration Committee.
26
<PAGE>
Positions Held Principal Occupations(s)
Name and Address With the Company During the Past Five Years
- ---------------- ---------------- --------------------------
Harold R. Hiser, Jr. Trustee (3) Executive Vice President,
123 Highland Avenue Schering-Plough Corporation
Short Hill, NJ 07078 (pharmaceuticals) (retired 1996);
October 1931 Director, ReCapital Corporation
(reinsurance) (until 1995).
Anne C. Hodsdon * President and Director (1, 2) President, Chief Operating Officer
101 Huntington Avenue and Director, the Adviser; Director,
Boston, MA 02199 The Berkeley Group, John Hancock
April 1953 Funds, Signature Services (since
October 1996); Director, Advisers
International; Executive Vice
President, the Adviser (until
December 1994); Senior Vice
President, the Adviser (until
December 1993).
Charles L. Ladner Trustee (3) Director, Energy North, Inc. (public
UGI Corporation utility holding company) (until
P.O. Box 858 1992); Senior Vice President of UGI
Valley Forge, PA 19482 Corp. Holding Company Public
February 1938 Utilities, LPGAS.
- -------------------
* Trustee may be deemed to be an "interested person" of the Fund as defined
in the Investment Company Act of 1940.
(1) Member of the Executive Committee. The Executive Committee may generally
exercise most of the powers of the Board of Trustees.
(2) A member of the Investment Committee of the Adviser.
(3) Member of the Audit Committee and the Administration Committee.
27
<PAGE>
Positions Held Principal Occupations(s)
Name and Address With the Company During the Past Five Years
- ---------------- ---------------- --------------------------
Leo E. Linbeck, Jr. Trustee (3) Chairman, President, Chief Executive
3810 W. Alabama Officer and Director, Linbeck
Houston, TX 77027 Corporation (a holding company
August 1934 engaged in various phases of the
construction industry and
warehousing interests); Former
Chairman, Federal Reserve Bank of
Dallas (1992, 1993); Chairman of
the Board and Chief Executive
Officer, Linbeck Construction
Corporation; Director, PanEnergy
Corporation (a diversified energy
company), Daniel Industries, Inc.
(manufacturer of gas measuring
products and energy related
equipment), GeoQuest International
Holdings, Inc. (a geophysical
consulting firm) (1980-1993);
Former Director, Greater Houston
Partnership (1980 -1995).
Patricia P. McCarter Trustee (3) Director and Secretary, The McCarter
1230 Brentford Road Corp. (machine manufacturer).
Malvern, PA 19355
May 1928
- -------------------
* Trustee may be deemed to be an "interested person" of the Fund as defined
in the Investment Company Act of 1940.
(1) Member of the Executive Committee. The Executive Committee may generally
exercise most of the powers of the Board of Trustees.
(2) A member of the Investment Committee of the Adviser.
(3) Member of the Audit Committee and the Administration Committee.
28
<PAGE>
Positions Held Principal Occupations(s)
Name and Address With the Company During the Past Five Years
- ---------------- ---------------- --------------------------
Steven R. Pruchansky Trustee (1, 3) Director and President, Mast
4327 Enterprise Avenue Holdings, Inc. (since 1991);
Naples, FL 33942 Director, First Signature Bank &
August 1944 Trust Company (until August 1991);
Director, Mast Realty Trust (until
1994); President, Maxwell Building
Corp. (until 1991).
Richard S. Scipione * Trustee (1) General Counsel, John Hancock Life
John Hancock Place Company; Director, the Adviser,
P.O. Box 111 Advisers International, John Hancock
Boston, MA 02117 Funds, Signature Services, John
August 1937 Hancock Distributors, Inc.,
Insurance Agency, Inc., John Hancock
Subsidiaries, Inc., SAMCorp. and NM
Capital; Trustee, The Berkeley
Group; Director, JH Networking
Insurance Agency, Inc.; Director,
John Hancock Property and Casualty
Insurance and its affiliates (until
November, 1993),
Norman H. Smith Trustee (3) Lieutenant General, United States
243 Mt. Oriole Lane Marine Corps; Deputy Chief of Staff
Linden, VA 22642 for Manpower and Reserve Affairs,
March 1933 Headquarters Marine Corps;
Commanding General III Marine
Expeditionary Force/3rd Marine
Division (retired 1991).
- -------------------
* Trustee may be deemed to be an "interested person" of the Fund as defined
in the Investment Company Act of 1940.
(1) Member of the Executive Committee. The Executive Committee may generally
exercise most of the powers of the Board of Trustees.
(2) A member of the Investment Committee of the Adviser.
(3) Member of the Audit Committee and the Administration Committee.
29
<PAGE>
Positions Held Principal Occupations(s)
Name and Address With the Company During the Past Five Years
- ---------------- ---------------- --------------------------
John P. Toolan Trustee (3) Director, The Smith Barney Muni Bond
13 Chadwell Place Funds, The Smith Barney Tax-Free
Morristown, NJ 07960 Money Funds, Inc., Vantage Money
September 1930 Market Funds (mutual funds), The
Inefficient-Market Fund, Inc.
(closed-end investment company) and
Smith Barney Trust Company of
Florida; Chairman, Smith Barney
Trust Company (retired December,
1991); Director, Smith Barney,
Inc., Mutual Management Company and
Smith Barney Advisers, Inc.
(investment advisers) (retired
1991); Senior Executive Vice
President, Director and member of
the Executive Committee, Smith
Barney, Harris Upham & Co.,
Incorporated (investment bankers)
(until 1991).
Robert G. Freedman Vice Chairman and Chief Investment Vice Chairman and Chief Investment
101 Huntington Avenue Officer (2) Officer, the Adviser; Director, the
Boston, MA 02199 Adviser, Advisers International,
July 1938 John Hancock Funds, Signature
Services, SAMCorp., Insurance
Agency, Inc., Southeastern Thrift &
Bank Fund and NM Capital; Senior
Vice President, The Berkeley Group;
President, the Adviser (until
December 1994);
- -------------------
* Trustee may be deemed to be an "interested person" of the Fund as defined
in the Investment Company Act of 1940.
(1) Member of the Executive Committee. The Executive Committee may generally
exercise most of the powers of the Board of Trustees.
(2) A member of the Investment Committee of the Adviser.
(3) Member of the Audit Committee and the Administration Committee.
30
<PAGE>
Positions Held Principal Occupations(s)
Name and Address With the Company During the Past Five Years
- ---------------- ---------------- --------------------------
James B. Little Senior Vice President and Chief Senior Vice President, the Adviser,
101 Huntington Avenue Financial Officer The Berkeley Group, John Hancock
Boston, MA 02199 Funds and Signature Services.
February 1935
Susan S. Newton Vice President and Secretary Vice President and Assistant
101 Huntington Avenue Secretary, the Adviser; Vice
Boston, MA 02199 President, John Hancock Funds,
March 1950 Signature Services; Secretary,
SAMCorp; Vice President, The
Berkeley Group, John Hancock
Distributors, Inc. (until 1994).
John A. Morin Vice President Vice President and Secretary, the
101 Huntington Avenue Adviser, The Berkeley Group,
Boston, MA 02199 Signature Services and John Hancock
July 1950 Funds; Counsel, John Hancock Mutual
Life Insurance Company.
James J. Stokowski Vice President and Treasurer Vice President, the Adviser.
101 Huntington Avenue
Boston, MA 02199
November 1946
- -------------------
* Trustee may be deemed to be an "interested person" of the Fund as defined
in the Investment Company Act of 1940.
(1) Member of the Executive Committee. The Executive Committee may generally
exercise most of the powers of the Board of Trustees.
(2) A member of the Investment Committee of the Adviser.
(3) Member of the Audit Committee and the Administration Committee.
</TABLE>
31
<PAGE>
All of the officers listed are officers or employees of the Adviser or
affiliated companies. Some of the Trustees and officers may also be officers and
trustees of one or more of the other funds for which the Adviser serves as
investment adviser.
As of November 29, 1996, the officers and Trustees of the Fund as a
group beneficially owned less than 1% of these outstanding shares. As of
November 29, 1996, Merrill Lynch Pierce Fenner & Smith, 4800 Deerlake Dr. East,
Jacksonville, FL held 1,748,920 shares representing 6.19% of the Fund's
outstanding Class A Shares and 815,918 shares representing 10.08% of the Fund's
outstanding Class B Shares (such ownership is as nominee only and does not
represent beneficial ownership). At such date, no other person owned of record
or was known by the Fund to own beneficially as much as 5% of the outstanding
shares of the Fund.
Between December 22, 1994 and December 22, 1996, the Trustees
established an Advisory Board to facilitate a smooth transition of management
between Transamerica Fund Management Company ("TFMC"), the prior investment
adviser, and the Adviser. The members of the Advisory Board were distinct from
the Trustees, did not serve the Fund in any other capacity and were persons who
had no power to determine what securities were purchased or sold and behalf of
the Fund.
Compensation of the Trustees and Advisory Board. The following table
provides information regarding the compensation paid by the Fund and the other
investment companies in the John Hancock Fund Complex to the Independent
Trustees and the Advisory Board members for their services. The three
non-Independent Trustees, Ms. Hodsdon, Messrs. Boudreau and Scipione and each of
the officers of the Fund are interested persons of the Adviser or affiliated
companies, are compensated by the Adviser/or affiliated companies and received
no compensation from the Fund for their services.
32
<PAGE>
Total Compensation
from all Funds in John
Aggregate Compensation Hancock Funds Complex
Trustees from the Fund(1) to Trustees(2)
- -------- ---------------- --------------
James F. Carlin $ 3,826 $ 74,250
William H. Cunningham + 4,050 74,250
Charles F. Fretz 3,790 74,500
Harold R. Hiser, Jr.+ 3,790 70,250
Charles L. Ladner 3,790 74,500
Leo E. Linbeck, Jr. 5,060 74,250
Patricia P. McCarter + 3,790 74,250
Steven R. Pruchansky + 3,869 77,500
Norman H. Smith + 3,869 77,500
John P. Toolan + 3,776 74,250
------- --------
Total: $39,610 $745,500
(1) Compensation for the fiscal year ended August 31, 1996.
(2) The total compensation paid by the John Hancock Funds Complex to the
Independent Trustees is as of the calendar years ended December 31,
1996. As of such date there were 68 funds in the John Hancock Funds
Complex, of which each of these Independent Trustees serve 32.
All of the officers listed are officers or employees of the Adviser or
affiliated companies. Some of the Trustees and officers may also be officers
and/or trustees of one or more of the other funds for which the Adviser serves
as investment adviser.
As of November 30, 1996, the value of the aggregate accrued deferred
compensation from all funds in the John Hancock Funds Complex for Mr. Cunningham
was $131,671, for Mr. Hiser was $90,742, for Ms. McCarter was $69,177, for Mr.
Smith was $32,582 and for Mr. Toolan was $165,963 under the John Hancock Group
of Funds Deferred Compensation Plan for Independent Trustees.
33
<PAGE>
Total Compensation from
Certain Funds in John
Aggregate Compensation Hancock Fund Complex to
Advisory Board from the Fund* Advisory Board*
- -------------- -------------- ---------------
R. Trent Campbell $ 6,228 $47,000
Mrs. Lloyd Bentsen 6,244 47,000
Thomas R. Powers 6,213 47,000
Thomas B. McDade 6,118 47,000
------- --------
Total: $24,803 $188,000
*As of December 31, 1996.
INVESTMENT ADVISORY AND OTHER SERVICES
The Adviser, located at 101 Huntington Avenue, Boston, Massachusetts
02199-7603 was organized in 1968 and presently has more than $19 billion in
assets under management in its capacity as investment adviser to the Fund and
the other mutual funds and publicly traded investment companies in the John
Hancock group of funds having a combined total of over 1,080,000 shareholders.
The Adviser is an affiliate of the Life Company, one of the most recognized and
respected financial institutions in the nation. With total assets under
management of $80 billion, the Life Company is one of the 10 largest life
insurance companies in the United States, and carries a high rating from
Standard & Poor's and A.M. Best's. Founded in 1862, the Life Company has been
serving clients for over 130 years.
The Trust, on behalf of the Fund has entered into an investment
management contract with the Adviser. Under the investment management contract,
the Adviser provides the Fund with (i) a continuous investment program,
consistent with the Fund's stated investment objective and policies, and (ii)
supervision of all aspects of the Fund's operations except those that are
delegated to a custodian, transfer agent or other agent. The Adviser is
responsible for the management of the Fund's portfolio assets.
The Fund bears all costs of its organization and operation, including
expenses of preparing, printing and mailing all shareholders' reports, notices,
prospectuses, proxy statements and reports to regulatory agencies; expenses
relating to the issuance, registration and qualification of shares; government
fees; interest charges; expenses of furnishing to shareholders their account
statements; taxes; expenses of redeeming shares; brokerage and other expenses
connected with the execution of portfolio securities transactions; expenses
pursuant to the Fund's plan of distribution; fees and expenses of custodians
including those for keeping books and accounts and calculating the net asset
value of shares; fees and expenses of transfer agents and dividend disbursing
agents; legal, accounting, financial, management, tax and auditing fees and
expenses of the Fund (including an allocable portion of the cost of the
Adviser's employees rendering such services to the Fund; the compensation and
expenses of Trustees who are not otherwise affiliated with the Trust, the
Adviser or any of their affiliates; expenses of Trustees' and shareholders'
meetings; trade association membership; insurance premiums; and any
34
<PAGE>
extraordinary expenses. For two years, the Fund also paid the fees of the
members of the Fund's Advisory Board (described above).
As provided by the investment management contract, the Fund pays the
Adviser an investment management fee, which is accrued daily and paid monthly in
arrears, equal on an annual basis to 0.55% of the Fund's average daily net asset
value.
The Adviser may voluntarily and temporarily reduce its advisory fee or
make other arrangements to limit the Fund's expenses to a specified percentage
of average daily net assets. The Adviser retains the right to re-impose the
advisory fee and recover any other payments to the extent that, at the end of
any fiscal year, the Fund's annual expenses fall below this limit.
Securities held by the Fund may also be held by other funds or
investment advisory clients for which the Adviser or its affiliates provide
investment advice. Because of different investment objectives or other factors,
a particular security may be bought for one or more funds or clients when one or
more are selling the same security. If opportunities for purchase or sale of
securities by the Adviser or for other funds or clients for which the Adviser
renders investment advice arise for consideration at or about the same time,
transactions in such securities will be made, insofar as feasible, for the
respective funds or clients in a manner deemed equitable to all of them. To the
extent that transactions on behalf of more than one client of the Adviser or its
affiliates may increase the demand for securities being purchased or the supply
of securities being sold, there may be an adverse effect on price.
Pursuant to the investment management contract, the Adviser is not
liable to the Fund or its shareholders for any error of judgment or mistake of
law or for any loss suffered by the Fund in connection with the matters to which
its contract relates, except a loss resulting from willful misfeasance, bad
faith or gross negligence on the part of the Adviser in the performance of its
duties or from its reckless disregard of its obligations and duties under the
contract.
Under the investment management contract, the Fund may use the name
"John Hancock" or any name derived from or similar to it only for so long as the
investment management contract or any extension, renewal or amendment thereof
remains in effect. If the Fund's investment management contract is no longer in
effect, the Fund (to the extent that it lawfully can) will cease to use such
name or any other name indicating that it is advised by or otherwise connected
with the Adviser. In addition, the Adviser or the Life Company may grant the
non-exclusive right to use the name "John Hancock" or any similar name to any
other corporation or entity, including but not limited to any investment company
of which the Life Company or any subsidiary or affiliate thereof or any
successor to the business of any subsidiary or affiliate thereof shall be the
investment adviser.
The investment management contract, and the distribution contract
discussed below, continue in effect from year to year if approved annually by
vote of a majority of the Trustees who are not interested persons of one of the
parties to the contract, cast in person at a meeting called for the purpose of
voting on such approval, and by either the Trustees or the holders of a majority
of the Fund's outstanding voting securities. Each contract automatically
35
<PAGE>
terminates upon assignment and may be terminated without penalty on 60 days'
notice at the option of either party to the contract or by vote of a majority of
the outstanding voting securities of the Fund.
For the fiscal year ended December 31, 1994 advisory fees payable by
the Fund to TFMC, the Fund's former investment adviser, amounted to $1,919,101.
For the fiscal year ended December 31, 1995 and for the period ended August 31,
1996, advisory fees payable by the Fund to the Adviser amounted to $1,907,146
and $1,392,170, respectively. However, a portion of such fees were not imposed
pursuant to the voluntary fee and expense limitation arrangements then in
effect.
Administrative Services Agreement. The Fund was a party to an
administrative services agreement with TFMC (the "Services Agreement"), pursuant
to which TFMC performed bookkeeping and accounting services and functions,
including preparing and maintaining various accounting books, records and other
documents and keeping such general ledgers and portfolio accounts as are
reasonably necessary for the operation of the Fund. Other administrative
services included communications in response to shareholder inquiries and
certain printing expenses of various financial reports. In addition, such staff
and office space, facilities and equipment were provided as necessary to provide
administrative services to the Fund. The Services Agreement was amended in
connection with the appointment of the Adviser as adviser to the Fund to permit
services under the Agreement to be provided to the Fund by the Adviser and its
affiliates. The Services Agreement was terminated during 1995.
For the fiscal year ended December 31, 1994, the Fund paid to TFMC
(pursuant to the Services Agreement) $158,594, of which $109,540 was paid to
TFMC and $49,054, were paid for certain data processing and pricing information
services, respectively. No fee relating to the Services Agreement was paid or
incurred during the fiscal year 1995.
Accounting and Legal Services Agreement. The Trust, on behalf of the
Fund, is a party to an Accounting and Legal Services Agreement with the Adviser.
Pursuant to this agreement, the Adviser provides the Fund with certain tax,
accounting and legal services. For the fiscal year ended August 31, 1996, the
Fund paid Adviser $11,694 for services under this agreement.
DISTRIBUTION CONTRACT
The Fund has a Distribution Agreement contract with John Hancock Funds. Under
the agreement, John Hancock Funds is obligated to use its best efforts to sell
shares on behalf of each class of the Fund. Shares of the Fund are also sold by
selected broker-dealers (the "Selling Brokers") which have entered into selling
agency agreements with John Hancock Funds. John Hancock Funds accepts orders for
the purchase of the shares of the Fund which are continually offered at net
asset value next determined, plus an applicable sales charge, if any. In
connection with the sale of Class A or Class B shares, John Hancock Funds and
Selling Brokers receive compensation in the form of a sales charge imposed, in
the case of Class A shares, at the time of sale or, in the case of Class B
shares, on a deferred basis. The sales charges are discussed further in the
Prospectus.
36
<PAGE>
The Fund's Trustees adopted Distribution Plans with respect to Class A and Class
B shares (the "Plans"), pursuant to Rule 12b-1 under the Investment Company Act
of 1940. Under the Plans, the Fund will pay distribution and service fees at an
aggregate annual rate of up to 0.15% and 1.00%, respectively, of the Fund's
daily net assets attributable to shares of that class. However, the service fee
will not exceed 0.15% and 0.25% of the Fund's average daily net assets
attributable to Class A and Class B shares, respectively. John Hancock Funds has
agreed to limit the payment of expenses under the Fund's Class B Plan to 0.90%
of the average daily net assets of its Class B shares. In each case, up to 0.25%
is for service expenses and the remaining amount is for distribution expenses.
The distribution fee will be used to reimburse John Hancock Funds for their
distribution expenses, including but not limited to: (i) initial and ongoing
sales compensation to Selling Brokers and others (including affiliates of John
Hancock Funds) engaged in the sale of Fund shares; (ii) marketing, promotional
and overhead expenses incurred in connection with the distribution of Fund
shares; and (iii) with respect to Class B shares only, interest expenses on
unreimbursed distribution expenses. The service fees will be used to compensate
Selling Brokers for providing personal and account maintenance services to
shareholders. In the event the John Hancock Funds is not fully reimbursed for
payments or expenses they incur under the Class A Plan, these expenses will not
be carried beyond twelve months from the date they were incurred. Unreimbursed
expenses under the Class B Plan will be carried forward together with interest
on the balance of these unreimbursed expenses. The Fund does not treat
unreimbursed expenses under the Class B Plan as a liability of the Fund because
the Trustees may terminate Class B Plan expenses at any time. For the fiscal
year ended August 31, 1996, an aggregate of $3,990,001 of Distribution Expenses
or 4.84% of the average net assets of the Fund's Class B shares was not
reimbursed or recovered by John Hancock Funds through the receipt of deferred
sales charges or Rule 12b-1 fees in prior periods.
The Plans were approved by a majority of the voting securities of the Fund. The
Plans and all amendments were approved by the Trustees, including a majority of
the Trustees who are not interested persons of the Fund and who have no direct
or indirect financial interest in the operation of the Plans (the "Independent
Trustees"), by votes cast in person at meetings called for the purpose of voting
on such Plans.
Pursuant to the Plans, at least quarterly, John Hancock Funds provide the Fund
with a written report of the amounts expended under the Plans and the purpose
for which these expenditures were made. The Trustees review these reports on a
quarterly basis to determine their continued appropriateness.
The Plans provide that they will continue in effect only so long as their
continuance is approved at least annually by a majority of both the Trustees and
the Independent Trustees. The Plans provide that they may be terminated without
penalty, (a) by the vote of a majority of the Independent Trustees, (b) by the
vote of a majority of the Fund's outstanding shares of the applicable class upon
60 days' written notice to John Hancock Funds, and (c) automatically in the
event of assignment. The Plans further provide that they may not be amended to
increase the maximum amount of the fees for the services described therein
without the approval of a majority of the outstanding shares of the class of the
Fund which has voting rights with respect to that Plan. Each plan provides, that
no material amendment to the Plans will, in any event, be effective unless it is
approved by a vote of a majority of the Trustees and the Independent Trustees of
37
<PAGE>
the Fund. The holders of Class A and Class B shares have exclusive voting rights
with respect to the Plan applicable to their respective class of shares. In
adopting the Plans, the Trustees concluded that, in their judgment, there is a
reasonable likelihood that the Plans will benefit the holders of the applicable
class of shares of the Fund.
Amounts paid to John Hancock Funds by any class of shares of the Fund will not
be used to pay the expenses incurred with respect to any other class of shares
of the Fund; provided, however, that expenses attributable to the Fund as a
whole will be allocated, to the extent permitted by law, according to a formula
based upon gross sales dollars and/or average daily net assets of each such
class, as may be approved from time to time by vote of a majority of Trustees.
From time to time, the Fund may participate in joint distribution activities
with other Funds and the costs of those activities will be borne by each Fund in
proportion to the relative net asset value of the participating Fund.
<TABLE>
<CAPTION>
Printing and Interest,
Mailing of Compensation Carrying or
Prospectuses to to Selling Expenses of Other Finance
Advertising New Shareholders Brokers Distributor Charges
----------- ---------------- ------- ----------- -------
<S> <C> <C> <C> <C> <C>
Class A shares $26,796 $3,258 $189,189 $ 77,813 - 0 -
Class B shares $38,202 $5,016 $166,514 $109,049 $190,931
</TABLE>
INITIAL SALES CHARGE ON CLASS A SHARES
The sales charges applicable to purchases of Class A Shares of the Fund
are described in the Prospectus. Methods of obtaining reduced sales charges
referred to generally in the Prospectus are described in detail below. In
calculating the sales charge applicable to current purchases of Class A Shares,
the investor is entitled to cumulate current purchases with the greater of the
current value (at offering price) of the Class A Shares of the Fund, or if John
Hancock Signature Services, Inc. ("Signature Services") is notified by the
investor's dealer or the investor at the time of the purchase, the cost of the
Class A Shares owned.
Combined Purchases. In calculating the sales charge applicable to
purchases of Class A Shares made at one time, the purchases will be combined if
made by (a) an individual, his or her spouse and their children under the age of
21 purchasing securities for his or her own account, (b) a trustee or other
fiduciary purchasing for a single trust, estate or fiduciary account and (c)
certain groups of four or more individuals making use of salary deductions or
similar group methods of payment whose funds are combined for the purchase of
mutual fund shares. Further information about combined purchases, including
certain restrictions on combined group purchases, is available from Signature
Services or a Selling Broker's.
Without Sales Charge. Class A shares may be offered without a front-end
sales charge or CDSC to various individuals and institutions as follows:
38
<PAGE>
o Any state, county or any instrumentality, department, authority, or
agency of these entities that is prohibited by applicable investment
laws from paying a sales charge or commission when it purchases shares
of any registered investment management company.
o A bank, trust company, credit union, savings institution or other
depository institution, its trust departments or common trust funds if
it is purchasing $1 million or more for non-discretionary customers or
accounts.
o A Trustee/Director or officer of the Fund; a Director or officer of the
Adviser and its affiliates or Selling Brokers; employees or sales
representatives of any of the foregoing; retired officers, employees or
Directors of any of the foregoing; a member of the immediate family
(spouse, children, grandchildren, mother, father, sister, brother,
mother-in-law, father-in-law) of any of the foregoing; or any fund,
pension, profit sharing or other benefit plan for the individuals
described above.
o A broker, dealer, financial planner, consultant or registered
investment advisor that has entered into an agreement with John Hancock
Funds providing specifically for the use of Fund shares in fee-based
investment products or services made available to their clients.
o A former participant in an employee benefit plan with John Hancock
funds, when he or she withdraws from his or her plan and transfers any
or all of his or her plan distributions directly to the Fund.
o A member of an approved affinity group financial services plan.1
o A member of a class action lawsuit against insurance companies who is
investing settlement proceeds.
o Existing full service clients of the Life Company who were group
annuity contract holders as of September 1, 1994, and participant
directed defined contribution plans with at least 100 eligible
employees at the inception of the Fund account, may purchase Class A
shares with no initial sales charge. However, if the shares are
redeemed within 12 months after the end of the calendar year in which
the purchase was made, a CDSC will be imposed at the following rate:
Amount Invested CDSC Rate
- --------------- ---------
$1 to $4,999,999 1.00%
Next $5 million to $9,999,999 0.50%
Amounts of $10 million and over 0.25%
Accumulation Privilege. Investors (including investors combining
purchases) who are already Class A Shareholders may also obtain the benefit of
the reduced sales charge by taking into account not only the amount then being
invested but also the purchase price or value of the Class A Shares already held
by such person.
Combination Privilege. Reduced sales charges (according to the schedule
set forth in the Prospectus) also are available to an investor based on the
aggregate amount of his concurrent and prior investments in Class A Shares of
the Fund and shares of all other John Hancock funds which carry a sales charge.
- ------------
1 For investments made under these provisions, John Hancock Funds may make a
payment out of its own resources to the Selling Broker in an amount not to
exceed 0.25% of the amount invested.
39
<PAGE>
Letter of Intention. The reduced sales loads are also applicable to
investments made over a specified period pursuant to a Letter of Intention
("LOI"), which should be read carefully prior to its execution by an investor.
The Fund offers two options regarding the specified period for making
investments under the LOI. All investors have the option of making their
investments over a period of thirteen (13) months. Investors who are using the
Fund as a funding medium for a qualified retirement plan, however, may opt to
make the necessary investments called for by the LOI over a forty-eight (48)
month period. These qualified retirement plans include IRA, SEP, SARSEP, 401(k),
403(b) (including TSA's) and 457 plans. Such an investment (including
accumulations and combinations) must aggregate $100,000 or more invested during
the specified period from the date of the LOI or from a date within ninety (90)
days prior thereto, upon written request to Signature Services. The sales charge
applicable to all amounts invested under the LOI is computed as if the aggregate
amount intended to be invested had been invested immediately. If such aggregate
amount is not actually invested, the difference in the sales charge actually
paid and the sales charge payable had the LOI not been in effect is due from the
investor. However, for the purchases actually made within the specified period,
the sales charge applicable will not be higher than that which would have been
applied (including accumulations and combinations) had the LOI been for the
amount actually invested.
The LOI authorizes Signature Services to hold in escrow sufficient
Class A shares (approximately 5% of the aggregate) to make up any difference in
sales charges on the amount intended to be invested and the amount actually
invested, until such investment is completed within the specified period, at
which time the escrow shares will be released. If the total investment specified
in the LOI is not completed, the Class A shares held in escrow may be redeemed
and the proceeds used as required to pay such sales charge as may be due. By
signing the LOI, the investor authorizes Signature Services to act as his
attorney-in-fact to redeem any escrowed shares and adjust the sales charge, if
necessary. A LOI does not constitute a binding commitment by an investor to
purchase, or by the Fund to sell, any additional shares and may be terminated at
any time.
Class A shares may also be acquired without an initial sales charge in
connection with certain liquidation, merger or acquisition transactions
involving other investment companies or personal holding companies.
DEFERRED SALES CHARGE ON CLASS B SHARES
Investments in Class B shares are purchased at net asset value per
share without the imposition of a sales charge so that the Fund will receive the
full amount of the purchase payment.
Contingent Deferred Sales Charge. Class B Shares which are redeemed
within six years of purchase will be subject to a contingent deferred sales
charge ("CDSC") at the rates set forth in the Prospectus as a percentage of the
dollar amount subject to the CDSC. The charge will be assessed on an amount
equal to the lesser of the current market value or the original purchase cost of
the Class B Shares being redeemed. Accordingly, no CDSC will be imposed on
increases in account value above the initial purchase prices, including Class B
Shares derived from reinvestment of dividends or capital gains distributions.
40
<PAGE>
Class B shares are not available to full-service defined contribution
plans administered by Signature Services or the Life Company that had more than
100 eligible employees at the inception of the Fund account.
The amount of the CDSC, if any, will vary depending on the number of
years from the time of payment for the purchase of Class B Shares until the time
of redemption of such shares. Solely for purposes of determining the number of
years from the time of any payment for the purchases of shares, all payments
during a month will be aggregated and deemed to have been made on the first day
of the month.
In determining whether a CDSC applies to a redemption, the calculation
will be determined in a manner that results in the lowest possible rate being
charged. It will be assumed that your redemption comes first from shares you
have held beyond the six- year CDSC redemption period or those you acquired
through dividend and capital gain reinvestment, and next from the shares you
have held the longest during the six-year period. For this purpose, the amount
of any increase in a share's value above its initial purchase price is not
regarded as a share exempt from CDSC. Thus, when a share that has appreciated in
value is redeemed during the CDSC period, a CDSC is assessed only on its initial
purchase price. However, you cannot redeem appreciation value only in order to
avoid a CDSC.
When requesting a redemption for a specific dollar amount please
indicate if you require the proceeds to equal the dollar amount requested. If
not indicated, only the specified dollar amount will be redeemed from your
account and the proceeds will be less any applicable CDSC.
Example:
You have purchased 100 shares at $10 per share. The second year after your
purchase, your investment's net asset value per share has increased by $2 to
$12, and you have gained 10 additional shares through dividend reinvestment. If
you redeem 50 shares at this time your CDSC will be calculated as follows:
* Proceeds of 50 shares redeemed at $12 per share $600
* Minus proceeds of 10 shares not subject to CDSC
(dividend reinvestment) -120
* Minus appreciation on remaining shares (40 shares X $2) -80
----
* Amount subject to CDSC $400
Proceeds from the CDSC are paid to John Hancock Funds and are used in
whole or in part by John Hancock Funds to defray its expenses related to
providing distribution-related services to the Fund in connection with the sale
of the Class B Shares, such as the payment of compensation to select Selling
Brokers for selling Class B Shares. The combination of the CDSC and the
distribution and service fees facilitates the ability of the Fund to sell the
Class B Shares without a sales charge being deducted at the time of the
purchase.
41
<PAGE>
Waiver of Contingent Deferred Sales Charge. The CDSC will be waived on
redemptions of Class B shares and of Class A shares that are subject to a CDSC,
unless indicated otherwise, in these circumstances:
For all account types:
* Redemptions made pursuant to the Fund's right to liquidate your account
if you own shares worth less than $100.
* Redemptions made under certain liquidation, merger or acquisition
transactions involving other investment companies or personal holding
companies.
* Redemptions due to death or disability.
* Redemptions made under the Reinstatement Privilege, as described in
"Sales Charge Reductions and Waivers" of the Prospectus.
* Redemptions of Class B shares made under a periodic withdrawal plan, as
long as your annual redemptions do not exceed 12% of your account
value, including reinvested dividends, at the time you established your
periodic withdrawal plan and 12% of the value of subsequent investments
(less redemptions) in that account at the time you notify Signature
Services. (Please note, this waiver does not apply to periodic
withdrawal plan redemptions of Class A shares that are subject to a
CDSC.)
For Retirement Accounts (such as IRA, Rollover IRA, TSA, 457, 403(b), 401(k),
Money Purchase Pension Plan, Profit-Sharing Plan and other qualified plans as
described in the Code) unless otherwise noted.
* Redemptions made to effect mandatory or life expectancy distributions
under the Code.
* Returns of excess contributions made to these plans.
* Redemptions made to effect distributions to participants or
beneficiaries from employer sponsored retirement plans under Section
401(a) of the Code (such as 401(k), Money Purchase Pension Plans and
Profit-Sharing Plans).
* Redemptions from certain IRA and retirement plans that purchased shares
prior to October 1, 1992 and certain IRA plans that purchased shares
prior to May 15, 1995.
42
<PAGE>
Please see matrix for reference.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
Type of 401(a) Plan 403(b) 457 IRA, IRA Non-
Distribution (401(k), MPP, Rollover retirement
PSP)
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Death or Waived Waived Waived Waived Waived
Disability
- ---------------------------------------------------------------------------------------------------------------------
Over 70 1/2 Waived Waived Waived Waived for 12% of account
mandatory value annually in
distributions periodic payments
- ---------------------------------------------------------------------------------------------------------------------
Between 59 1/2 Waived Waived Waived Waived for Life 12% of account
and 70 1/2 Expectancy or value annually in
12% of account periodic payments
value annually
in periodic
payments
- ---------------------------------------------------------------------------------------------------------------------
Under 59 1/2 Waived Waived for Waived for Waived for 12% of account
annuity payments annuity payments annuity payments value annually in
(72t) or 12% of (72t) or 12% of (72t) or 12% of periodic payments
account value account value account value
annually in annually in annually in
periodic payments periodic payments periodic payments
- ---------------------------------------------------------------------------------------------------------------------
Loans Waived Waived N/A N/A N/A
- ---------------------------------------------------------------------------------------------------------------------
Termination of Not Waived Not Waived Not Waived Not Waived N/A
Plan
- ---------------------------------------------------------------------------------------------------------------------
Hardships Waived Waived Waived N/A N/A
- ---------------------------------------------------------------------------------------------------------------------
Return of Waived Waived Waived Waived N/A
Excess
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
If you qualify for a CDSC waiver under one of these situations, you
must notify Signature Services at the time you make your redemption. The waiver
will be granted once Signature Services has confirmed that you are entitled to
the waiver.
NET ASSET VALUE
For purposes of calculating the net asset value ("NAV") of the Fund's
shares, the following procedures are utilized wherever applicable.
43
<PAGE>
Debt investment securities are valued on the basis of valuations
furnished by a principal market maker or a pricing service, both of which
generally utilize electronic data processing techniques to determine valuations
for normal institutional size trading units of debt securities without exclusive
reliance upon quoted prices.
Short-Term debt investments which have a remaining maturity of 60 days
or less are generally valued at amortized cost which approximates market value.
If market quotations are not readily available or if in the opinion of the
Adviser any quotation or price is not representative of true market value, the
fair value of the security may be determined in good faith in accordance with
procedures approved by the Trustees.
The NAV for each fund and class is determined each business day at the
close of regular trading on the New York Stock Exchange (typically 4:00 p.m.
Eastern Time) by dividing a class's net assets by the number of its shares
outstanding.
SPECIAL REDEMPTIONS
Although it is the Fund's present policy to make payment of redemption
proceeds in cash, if the Trustees determine that a material adverse effect would
otherwise be experienced by remaining investors, redemption proceeds may be paid
in whole or in part by a distribution in kind of securities from the Fund in
conformity with rules of the Securities and Exchange Commission, valuing such
securities in the same manner they are valued in determining NAV, and selecting
the securities in such manner as the Board may deem fair and equitable. If such
a distribution occurs, investors receiving securities and selling them before
their maturity could receive less than the redemption value of such securities
and, in addition, could incur certain transaction costs. Such a redemption is
not as liquid as a redemption paid in cash or federal funds. The Fund has
elected to be governed by Rule 18f-1 under the 1940 Act, pursuant to which the
Fund is obligated to redeem shares solely in cash up to the lesser of $250,000
or 1% of the net asset value of the Fund during any 90 day period for any one
account.
ADDITIONAL SERVICES AND PROGRAMS
Exchange Privilege. As described more fully in the Prospectus, the Fund
permits exchanges of shares of any class of the Fund for shares of the same
class in any other John Hancock fund offering that class.
Systematic Withdrawal Plan. As described briefly in the Prospectus, the
Fund permits the establishment of a Systematic Withdrawal Plan. Payments under
this plan represent proceeds arising from the redemption of Fund shares. Since
the redemption price of Fund shares may be more or less than the shareholder's
cost, depending upon the market value of the securities owned by the Fund at the
time of redemption, the distribution of cash pursuant to this plan may result in
recognition of gain or loss for purposes of Federal, state and local income
taxes. The maintenance of a Systematic Withdrawal Plan concurrently with
purchases of additional Class A or Class B Shares of the Fund could be
disadvantageous to a shareholder because of the initial sales charge payable on
the purchases of Class A Shares and the CDSC imposed on redemptions of Class B
Shares and because redemptions are taxable events. Therefore, a shareholder
44
<PAGE>
should not purchase Fund shares at the same time as a Systematic Withdrawal Plan
is in effect. The Fund reserves the right to modify or discontinue the
Systematic Withdrawal Plan of any shareholder on 30 days' prior written notice
to such shareholder, or to discontinue the availability of such plan in the
future. The shareholder may terminate the plan at any time by giving proper
notice to Signature Services.
Monthly Automatic Accumulation Program ("MAAP"). This program is
explained more fully in the Prospectus. The program, as it relates to automatic
investment checks, is subject to the following conditions;
The investments will be drawn on or about the day of the month
indicated.
The privilege of making investments through the Monthly Automatic
Accumulation Program may be revoked by Signature Services without prior notice
if any investment is not honored by the shareholder's bank. The bank shall be
under no obligation to notify the shareholder as to the non-payment of any
checks.
The program may be discontinued by the shareholder either by calling
Signature Services or upon written notice to Signature Services which is
received at least five (5) business days prior to the due date of any
investment.
Reinvestment Privilege. A shareholder who has redeemed Fund shares may,
within 120 days after the date of redemption, reinvest without payment of a
sales charge any part of the redemption proceeds in shares of the same class of
the Fund or another John Hancock mutual fund, subject to the minimum investment
limit in that fund. The proceeds from the redemption of Class A Shares may be
reinvested at net asset value without paying a sales charge in Class A Shares of
the Fund or in Class A Shares of another John Hancock fund. If a CDSC was paid
upon a redemption, a shareholder may reinvest the proceeds from that redemption
at net asset value in additional shares of the class from which the redemption
was made. The shareholder's account will be credited with the amount of any CDSC
charged upon the prior redemption and the new shares will continue to be subject
to the CDSC. The holding period of the shares acquired through reinvestment
will, for purposes of computing the CDSC payable upon a subsequent redemption,
include the holding period of the redeemed shares. The Fund may modify or
terminate the reinvestment privilege at any time.
A redemption or exchange of Fund shares is a taxable transaction for
Federal income tax purposes even if the reinvestment privilege is exercised, and
any gain or loss realized by a shareholder on the redemption or other
disposition of Fund shares will be treated for tax purposes as described under
the caption "Dividends, Distributions and Tax Status."
DESCRIPTION OF THE FUND'S SHARES
The Trustees of the Fund are responsible for the management and
supervision of the Fund. The Declaration of Trust permits the Trustees to issue
an unlimited number of full and fractional shares of beneficial interest of the
Fund, without par value. Under the Declaration of Trust, the Trustees have the
authority to create and classify shares of beneficial interest in separate
45
<PAGE>
series, without further action by shareholders. As of the date of this Statement
of Additional Information, the Trustees have authorized the issuance of one
series of shares of the Fund. In addition, the Trustees have authorized the
issuance of two classes of shares of the Fund, designated as Class A and Class
B.
The shares of each class of the Fund represent an equal proportionate
interest in the aggregate net assets attributable to the classes of the Fund.
Holders of Class A and Class B shares have certain exclusive voting rights on
matters relating to their respective distribution plans. The different classes
of the Fund may bear different expenses relating to the cost of holding
shareholder meetings necessitated by the exclusive voting rights of any class of
shares.
Dividends paid by the Fund, if any, with respect to each class of
shares will be calculated in the same manner, at the same time and on the same
day and will be in the same amount, except for differences resulting from the
facts that (i) the distribution and service fees relating to Class A and Class B
shares will be borne exclusively by that class (ii) Class B shares will pay
higher distribution and service fees than Class A shares and (iii) each of Class
A and Class B shares will bear any other class expenses properly allocable to
that class of shares, subject to the conditions the Internal Revenue Service
imposes with respect to multiple-class structure. Similarly, the net asset value
per share may vary depending on whether Class A or Class B shares are purchased.
In the event of liquidation, shareholders of each class are entitled to
share pro rata in the net assets of the Fund available for distribution to these
shareholders. Shares entitle their holders to one vote per share, are freely
transferable and have no preemptive, subscription or conversion rights. When
issued, shares are fully paid and non-assessable by the Fund, except as set
forth below.
Unless otherwise required by the 1940 Act or the Declaration of Trust,
the Fund has no intention of holding annual meetings of shareholders. Fund
shareholders may remove a Trustee by the affirmative vote of at least two-thirds
of the Fund's outstanding shares and the Trustees shall promptly call a meeting
for such purpose when requested to do so in writing by the record holders of not
less than 10% of the outstanding shares of the Fund. Shareholders may, under
certain circumstances, communicate with other shareholders in connection with
requesting a special meeting of shareholders. However, at any time that less
than a majority of the Trustees holding office were elected by the shareholders,
the Trustees will call a special meeting of shareholders for the purpose of
electing Trustees.
Under Massachusetts law, shareholders of a Massachusetts business trust
could, under certain circumstances, be held personally liable for acts or
obligations of the trust. However, the Fund's Declaration of Trust contains an
express disclaimer of shareholder liability for acts, obligations or affairs of
the Fund. The Declaration of Trust also provides for indemnification out of the
Fund's assets for all losses and expenses of any Fund shareholder held
personally liable by reason of being or having been a shareholder. The
Declaration of Trust also provides that no series of the Fund shall be liable
for the liabilities of any other series. Furthermore, no Fund included in this
Fund's prospectus shall be liable for the liabilities of any other John Hancock
fund. Liability is therefor limited to circumstances in which the Fund itself
would be unable to meet its obligations, and the possibility of this occurrence
is remote.
46
<PAGE>
In order to avoid conflicts with portfolio trades for the Fund, the
Adviser and the Fund have adopted extensive restrictions on personal securities
trading by personnel of the Adviser and its affiliates. Some of these
restrictions are: pre-clearance for all personal trades and a ban on the
purchase of initial public offerings, as well as contributions to specified
charities of profits on securities held for less than 91 days. These
restrictions are a continuation of the basic principle that the interests of the
Fund and its shareholders come first.
A shareholder's account is governed by the laws of The Commonwealth of
Massachusetts.
TAX STATUS
Federal Income Taxation
The Fund has qualified and elected to be treated as a "regulated
investment company" under Subchapter M of the Code, and intends to continue to
so qualify in the future. As such and by complying with the applicable
provisions of the Code regarding the sources of its income, the timing of its
distributions, and the diversification of its assets, the Fund will not be
subject to Federal income tax on taxable and tax-exempt income (including net
realized capital gains, if any) which is distributed to shareholders in
accordance with the timing requirements of the Code.
The Fund will be subject to a 4% non-deductible Federal excise tax on
certain amounts not distributed (and not treated as having been distributed) on
a timely basis in accordance with annual minimum distribution requirements. The
Fund intends under normal circumstances to seek to avoid or minimize liability
for such tax by satisfying such distribution requirements.
The Fund expects to qualify to pay "exempt-interest dividends," as
defined in the Code. To qualify to pay exempt-interest dividends, the Fund must,
at the close of each quarter of its taxable year, have at least 50% of the value
of its total assets invested in municipal securities whose interest is excluded
from gross income under Section 103(a) of the Code. In purchasing municipal
securities, the Fund intends to rely on opinions of nationally recognized bond
counsel for each issue as to the excludability of interest on such obligations
from gross income for federal income tax purposes. The Fund will not undertake
independent investigations concerning the tax-exempt status of such obligations,
nor does it guarantee or represent that bond counsels' opinions are correct.
Bond counsels' opinions will generally be based in part upon covenants by the
issuers and related parties regarding continuing compliance with federal tax
requirements. Tax laws enacted principally during the 1980's not only had the
effect of limiting the purposes for which tax-exempt bonds could be issued and
reducing the supply of such bonds, but also increased the number and complexity
of requirements that must be satisfied on a continuing basis in order for bonds
to be and remain tax-exempt. If the issuer of a bond or a user of a
bond-financed facility fails to comply with such requirements at any time,
interest on the bond could become taxable, retroactive to the date the
obligations was issued. In that event, a portion of the Fund's distributions
attributable to interest the Fund received on such bond for the current year and
for prior years could be characterized or recharacterized as taxable income. The
availability of tax-exempt obligations and the value of the Fund's portfolio may
be affected by restrictive federal income tax legislation enacted in recent
years or by similar future legislation.
47
<PAGE>
If the Fund satisfies the applicable requirements, dividends paid by
the Fund which are attributable to tax exempt interest on municipal securities
and designated by the Fund as exempt-interest dividends in a written notice
mailed to its shareholders within sixty days after the close of its taxable year
may be treated by shareholders as items of interest excludable from their gross
income under Section 103(a) of the Code. The recipient of tax-exempt income is
required to report such income on his federal income tax return. However, a
shareholder is advised to consult his tax adviser with respect to whether
exempt-interest dividends retain the exclusion under Section 103(a) if such
shareholder would be treated as a "substantial user" under Section 147(a)(1)
with respect to some or all of the tax-exempt obligations held by the Fund. The
Code provides that interest on indebtedness incurred or continued to purchase or
carry shares of the Fund is not deductible to the extent it is deemed related to
the Fund's exempt- interest dividends. Pursuant to published guidelines, the
Internal Revenue Service may deem indebtedness to have been incurred for the
purpose of purchasing or carrying shares of the Fund even though the borrowed
funds may not be directly traceable to the purchase of shares.
Although all or a substantial portion of the dividends paid by the Fund
may be excluded by the Fund's shareholders from their gross income for federal
income tax purposes, the Fund may purchase specified private activity bonds, the
interest from which (including the Fund's distributions attributable to such
interest) may be a preference item for purposes of the federal alternative
minimum tax (both individual and corporate). All exempt-interest dividends from
the Fund, whether or not attributable to private activity bond interest, may
increase a corporate shareholder's liability, if any, for corporate alternative
minimum tax and will be taken into account in determining the extent to which a
shareholder's Social Security or certain railroad retirement benefits are
taxable.
Distributions other than exempt-interest dividends from the Fund's
current or accumulated earnings and profits ("E&P") will be taxable under the
Code for investors who are subject to tax. Taxable distributions include
distributions from the Fund that are attributable to (i) taxable income,
including but not limited to taxable bond interest, recognized market discount
income, original issue discount income accrued with respect to taxable bonds,
income from repurchase agreements, income from securities lending, income from
dollar rolls, income from interest rate swaps, caps, floors and collars, and a
portion of the discount from certain stripped tax-exempt obligations or their
coupons or (ii) capital gains from the sale of securities or other investments
(including from the disposition of rights to when-issued securities prior to
issuance) or from options and futures contracts. If these distributions are paid
from the Fund's "investment company taxable income," they will be taxable as
ordinary income; and if they are paid from the Fund's "net capital gain," they
will be taxable as long-term capital gain. (Net capital gain is the excess (if
any) of net long-term capital gain over net short-term capital loss, and
investment company taxable income is all taxable income and capital gains or
losses, other than those gains and losses included in computing net capital
gain, after reduction by deductible expenses.) Some distributions from
investment company taxable income and/or net capital gain may be paid in January
but may be taxable to shareholders as if they had been received on December 31
of the previous year. The tax treatment described above will apply without
regard to whether distributions are received in cash or reinvested in additional
shares of the Fund.
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Distributions, if any, in excess of E&P will constitute a return of
capital under the Code, which will first reduce an investor's federal tax basis
in Fund shares and then, to the extent such basis is exceeded, will generally
give rise to capital gains. Amounts that are not allowable as a deduction in
computing taxable income, including expenses associated with earning tax-exempt
interest income, do not reduce the Fund's current earnings and profits for these
purposes. Consequently, the portion, if any, of the Fund's distributions from
gross tax-exempt interest income that exceeds its net tax-exempt interest would
be taxable as ordinary income to the extent of such disallowed deductions even
though such excess portion may represent an economic return of capital.
Shareholders who have chosen automatic reinvestment of their distributions will
have a federal tax basis in each share received pursuant to such a reinvestment
equal to the amount of cash they would have received had they elected to receive
the distribution in cash, divided by the number of shares received in the
reinvestment.
After the close of each calendar year, the Fund will inform
shareholders of the federal income tax status of its dividends and distributions
for such year, including the portion of such dividends that qualifies as
tax-exempt and the portion, if any, that should be treated as a tax preference
item for purposes of the federal alternative minimum tax. Shareholders who have
not held shares of the Fund for its full taxable year may have designated as
tax-exempt or as a tax preference item a percentage of distributions which is
not equal to the actual amount of tax-exempt income or tax preference item
income earned by the Fund during the period of their investment in the Fund.
The amount of the Fund's net short-term and long-term capital gains, if
any, in any given year will vary depending upon the Adviser's current investment
strategy and whether the Adviser believes it to be in the best interest of the
Fund to dispose of portfolio securities or enter into options or futures
transactions that will generate capital gains. At the time of an investor's
purchase of Fund shares, a portion of the purchase price is often attributable
to realized or unrealized appreciation in the Fund's portfolio. Consequently,
subsequent distributions on these shares from such appreciation may be taxable
to such investor even if the net asset value of the investor's shares is, as a
result of the distributions, reduced below the investor's cost for such shares,
and the distributions in reality represent a return of a portion of the purchase
price.
Upon a redemption of shares of the Fund (including by exercise of the
exchange privilege) a shareholder will ordinarily realize a taxable gain or loss
depending upon the amount of the proceeds and the investor's basis in his
shares. Such gain or loss will be treated as capital gain or loss if the shares
are capital assets in the shareholder's hands and will be long-term or
short-term, depending upon the shareholder's tax holding period for the shares
and subject to the special rules described below. A sales charge paid in
purchasing Class A shares of the Fund cannot be taken into account for purposes
of determining gain or loss on the redemption or exchange of such shares within
90 days after their purchase to the extent shares of the Fund or another John
Hancock Fund are subsequently acquired without payment of a sales charge
pursuant to the reinvestment or exchange privilege. Such disregarded load will
result in an increase in the shareholder's tax basis in the shares subsequently
acquired. Also, any loss realized on a redemption or exchange may be disallowed
to the extent the shares disposed of are replaced with other shares of the Fund
within a period of 61 days beginning 30 days before and ending 30 days after the
shares are disposed of, such as pursuant to automatic dividend reinvestments. In
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such a case, the basis of the shares acquired will be adjusted to reflect the
disallowed loss. Any loss realized upon the redemption of shares with a tax
holding period of six months or less will be disallowed to the extent of all
exempt-interest dividends paid with respect to such shares and, to the extent in
excess of the amount disallowed, will be treated as a long-term capital loss to
the extent of any amounts treated as distributions of long-term capital gain
with respect to such shares.
Although its present intention is to distribute, at least annually, all
net capital gain, if any, the Fund reserves the right to retain and reinvest all
or any portion of the excess of net long-term capital gain over net short-term
capital loss in any year. The Fund will not in any event distribute net capital
gain realized in any year to the extent that a capital loss is carried forward
from prior years against such gain. To the extent such excess was retained and
not exhausted by the carryforward of prior years' capital losses, it would be
subject to Federal income tax in the hands of the Fund. Upon proper designation
of this amount by the Fund, each shareholder would be treated for Federal income
tax purposes as if the Fund had distributed to him on the last day of its
taxable year his pro rata share of such excess, and he had paid his pro rata
share of the taxes paid by the Fund and reinvested the remainder in the Fund.
Accordingly, each shareholder would (a) include his pro rata share of such
excess as long-term capital gain in his return for his taxable year in which the
last day of the Fund's taxable year falls, (b) be entitled either to a tax
credit on his return for, or to a refund of, his pro rata share of the taxes
paid by the Fund, and (c) be entitled to increase the adjusted tax basis for his
shares in the Fund by the difference between his pro rata share of such excess
and his pro rata share of such taxes.
For Federal income tax purposes, the Fund is permitted to carry forward
a net capital loss in any year to offset its net capital gains, if any, during
the eight years following the year of the loss. To the extent subsequent capital
gains are offset by such losses, they would not result in Federal income tax
liability to the Fund and, as noted above, would not be distributed as such to
shareholders. The Fund has $7,860,974 of capital loss carryforwards. Of this
amount $44,815 expires August 31, 2001, $267,864 expires August 31, 2002 and
$5,169,717 expires August 31, 2003 and $2,378,578 expires August 31, 2004.
Dividends and capital gain distributions from the Fund will not qualify
for the dividends-received deduction for corporate shareholders.
The Fund is required to accrue income on any debt securities that have
more than a de minimis amount of original issue discount (or debt securities
acquired at a market discount, if the Fund elects to include market discount in
income currently) prior to the receipt of the corresponding cash payments. The
mark to market rules applicable to certain options and futures contracts may
also require the Fund to recognize gain without a concurrent receipt of cash.
However, the Fund must distribute to shareholders for each taxable year
substantially all of its net income and net capital gains, including such income
or gain, to qualify as a regulated investment company and avoid liability for
any federal income or excise tax. Therefore, the Fund may have to dispose of its
portfolio securities under disadvantageous circumstances to generate cash, or
may have to leverage itself by borrowing the cash, to satisfy these distribution
requirements.
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The Fund will be required to report to the Internal Revenue Service
(the "IRS") all taxable distributions to shareholders, as well as gross proceeds
from the redemption or exchange of Fund shares, except in the case of certain
exempt recipients, i.e., corporations and certain other investors distributions
to which are exempt from the information reporting provisions of the Code. Under
the backup withholding provisions of Code Section 3406 and applicable Treasury
regulations, all such reportable distributions and proceeds may be subject to
backup withholding of federal income tax at the rate of 31% in the case of
non-exempt shareholders who fail to furnish the Fund with their correct taxpayer
identification number and certain certifications required by the IRS or if the
IRS or a broker notifies the Fund that the number furnished by the shareholder
is incorrect or that the shareholder is subject to backup withholding as a
result of failure to report interest or dividend income. However, the Fund's
taxable distributions may not be subject to backup withholding if the Fund can
reasonably estimate that at least 95% of its distributions for the year will be
exempt-interest dividends. The Fund may refuse to accept an application that
does not contain any required taxpayer identification number or certification
that the number provided is correct. If the backup withholding provisions are
applicable, any such distributions and proceeds, whether taken in cash or
reinvested in shares, will be reduced by the amounts required to be withheld.
Any amounts withheld may be credited against a shareholder's U.S. federal income
tax liability. Investors should consult their tax advisers about the
applicability of the backup withholding provisions.
Limitations imposed by the Code on regulated investment companies like
the Fund may restrict the Fund's ability to enter into futures and options
transactions.
Certain options and futures transactions undertaken by the Fund may
cause the Fund to recognize gains or losses from marking to market even though
its positions have not been sold or terminated and affect the character as
long-term or short-term and timing of some capital gains and losses realized by
the Fund. Also, certain of the Fund's losses on its transactions involving
options or futures contracts and/or offsetting or successor portfolio positions
may be deferred rather than being taken into account currently in calculating
the Fund's gains. Some of these transactions may also cause the Fund to dispose
of investments sooner than would otherwise have occurred. These transactions may
therefore affect the amount, timing and character of the Fund's distributions to
shareholders. The Fund will take into account the special tax rules (including
consideration of available elections) applicable to options and futures
contracts in order to seek to minimize any potential adverse tax consequences.
The foregoing discussion relates solely to U.S. Federal income tax law
as applicable to U.S. persons (i.e., U.S. citizens or residents and U.S.
domestic corporations, partnerships, trusts or estates) subject to tax under
such law. The discussion does not address special tax rules applicable to
certain classes of investors, such as insurance companies and financial
institutions. Dividends (including exempt-interest dividends), capital gain
distributions, and ownership of or gains realized on the redemption (including
an exchange) of Fund shares may also be subject to state and local taxes, except
as described below under "State Taxation." Shareholders should consult their own
tax advisers as to the Federal, state or local tax consequences of ownership of
shares of, and receipt of distributions from, the Fund in their particular
circumstances.
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Non-U.S. investors not engaged in a U.S. trade or business with which
their investment in the Fund is effectively connected will be subject to U.S.
Federal income tax treatment that is different from that described above. These
investors may be subject to nonresident alien withholding tax at the rate of 30%
(or a lower rate under an applicable tax treaty) on amounts treated as ordinary
dividends from the Fund and, unless an effective IRS Form W-8 or authorized
substitute for Form W-8 is on file, to 31% backup withholding on certain other
payments from the Fund. Non-U.S. investors should consult their tax advisers
regarding such treatment and the application of foreign taxes to an investment
in the Fund.
State Taxation
The Fund is not subject to Massachusetts corporate excise or franchise
taxes. Provided that the Fund qualifies as a regulated investment company under
the Code, it will also not be required to pay any Massachusetts income tax.
The following discussion assumes that the Fund will be qualified as a
regulated investment company under subchapter M of the Code and will be
qualified thereunder to pay exempt interest dividends.
Individual shareholders of the Fund who are subject to California
personal income taxation will not be required to include in their California
gross income that portion of their federal exempt-interest dividends which the
Fund clearly and accurately identifies as directly attributable to interest
earned on obligations the interest on which is exempt from California personal
income taxation, provided that at least 50 percent of the value of the Fund's
total assets at the close of each quarter of its taxable year consists of such
obligations. Distributions to individual shareholders derived from interest on
Tax-Exempt Securities issued by governmental authorities in states other than
California or on other obligations or investments the interest or other income
on which is not exempt from California personal income taxation and short-term
capital gains will be taxed as dividends for purposes of California personal
income taxation. The Fund's long-term capital gains for Federal income tax
purposes that are distributed to the shareholders will be taxed as long-term
capital gains to individual shareholders of the Fund for purposes of California
personal income taxation. Gain or loss, if any, resulting from a sale or
redemption of shares will be recognized in the year of the sale or redemption.
Present California law taxes both long-term and short-term capital gains at the
rates applicable to ordinary income. Interest on indebtedness incurred or
continued by a shareholder in connection with the purchase of shares of the Fund
will not be deductible for California personal income tax purposes.
Generally, corporate shareholders of the Fund subject to the California
franchise tax will be required to include any gain on a sale or redemption of
shares and all distributions of exempt interest, capital gains and other taxable
income, if any, as income subject to such tax.
The Fund will not be subject to California franchise or corporate
income tax on interest income or net capital gain distributed to the
shareholders.
Shares of the Fund will be exempt from local property taxes in
California.
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Shares of the Fund will not be excludable from the taxable estates of
deceased California resident shareholders for purposes of the California estate
and generation skipping taxes. California estate and generation skipping taxes
are creditable against the corresponding Federal taxes.
The foregoing is a general, abbreviated summary of certain of the
provisions of California law presently in effect as it directly governs the
taxation of the shareholders of the Fund. These provisions are subject to change
by legislative or administrative action, and any such change may be retroactive
with respect to the Fund's transactions. Shareholders are advised to consult
with their own tax advisers for more detailed information concerning California
tax matters.
CALCULATION OF PERFORMANCE
For the 30-day period ended August 31, 1996, the annualized yields of
the Fund's Class A Shares and Class B Shares were 5.15% and 4.63%, respectively.
As of August 31, 1996, the average annual total returns of the Class A Shares of
the Fund for the one and five year periods and since inception on December 29,
1989 were 2.72%, 6.56% and 6.99%, respectively As of August 31, 1996, the
average annual returns for the Fund's Class B Shares for the one year period and
since inception on December 31, 1991 were 1.87% and 5.99%, respectively. Without
taking into account the expense limitation arrangements, the foregoing total
return performance would have been lower.
The Fund advertises yield, where appropriate. The Fund's yield is
computed by dividing net investment income per share determined for a 30-day
period by the maximum offering price per share (which includes the full sales
charge) on the last day of the period, according to the following standard
formula:
Yield = 2([(a - b) + 1] 6 - 1)
---
cd
Where:
a= dividends and interest earned during the period.
b= net expenses accrued during the period.
c= the average daily number of fund shares outstanding during the
period that would be entitled to receive dividends.
d= the maximum offering price per share on the last day of the
period (NAV where applicable).
The Fund may advertise a tax-equivalent yield, which is computed by
dividing that portion of the yield of the Fund which is tax-exempt by one minus
a stated income tax rate and adding the product to that portion, if any, of the
yield of the Fund that is not tax-exempt. The tax equivalent yields for the
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Fund's Class A and Class B Shares at the combined maximum federal and California
tax rates, which assumes the full deductibility of state income taxes on the
federal income tax return, for the 30-day period ended August 31, 1996 were
9.58% and 8.61%, respectively.
The Fund's total return is computed by finding the average annual
compounded rate of return over the 1-year, 5-year, and 10-year periods that
would equate the initial amount invested to the ending redeemable value
according to the following formula:
n _____
T = \ /ERV/P - 1
Where:
P = a hypothetical initial investment of $1,000.
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 investment
made at the beginning of the 1-year and life-of-fund periods.
Because each share has its own sales charge and fee structure, the
classes have different performance results. In the case of Class A Shares or
Class B Shares, this calculation assumes the maximum sales charge is included in
the initial investment or the CDSC is applied at the end of the period. This
calculation also assumes that all dividends and distributions are reinvested at
net asset value on the reinvestment dates during the period. The "distribution
rate" is determined by annualizing the result of dividing the declared dividends
of the Fund during the period stated by the maximum offering price or net asset
value at the end of the period.
In addition to average annual total returns, the Fund may quote
unaveraged or cumulative total returns reflecting the simple change in value of
an investment over a stated period. Cumulative total returns may be quoted as a
percentage or as a dollar amount, and may be calculated for a single investment,
a series of investments, and/or a series of redemptions, over any time period.
Total returns may be quoted with or without taking the Fund's maximum sales
charge on Class A Shares or the CDSC on Class B Shares into account. Excluding
the Fund's sales charge on Class A Shares and the CDSC on Class B Shares from a
total return calculation produces a higher total return figure.
In the case of a tax-exempt obligation issued without original issue
discount and having a current market discount, the coupon rate of interest is
used in lieu of the yield to maturity. Where, in the case of a tax-exempt
obligation with original issue discount, the discount based on the current
market value exceeds the then-remaining portion of original issue discount
(market discount), the yield to maturity is the imputed rate based on the
original issue discount calculation. Where, in the case of a tax-exempt
obligation with original issue discount, the discount based on the current
market value is less than the then-remaining portion of original issue discount
(market premium), the yield to maturity is based on the market value.
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From time to time, in reports and promotional literature, the Fund's
yield and total return will be compared to indices of mutual funds and bank
deposit vehicles such as Lipper Analytical Services, Inc.'s "Lipper - Fixed
Income Fund Performance Analysis," a monthly publication which tracks net
assets, total return, and yield on fixed income mutual funds in the United
States. Ibottson and Associates, CDA Weisenberger and F.C. Towers are also used
for comparison purposes, as well as the Russell and Wilshire Indices.
Performance rankings and ratings reported periodically in national
financial publications such as MONEY Magazine, FORBES, BUSINESS WEEK, THE WALL
STREET JOURNAL, MICROPAL, INC., MORNINGSTAR, STANGER'S and BARRON'S, etc. will
also be utilized. The Fund's promotional and sales literature may make reference
to the Fund's "beta." Beta is a reflection of the market-related risk of the
Fund by showing how responsive the fund is to the market.
The performance of the Fund is not fixed or guaranteed. Performance
quotations should not be considered to be representations of performance of the
Fund for any period in the future. The performance of the Fund is a function of
many factors including its earnings, expenses and number of outstanding shares.
Fluctuating market conditions; purchases, sales and maturities of portfolio
securities; sales and redemptions of shares of beneficial interest; and changes
in operating expenses are all examples of items that can increase or decrease
the Fund's performance.
BROKERAGE ALLOCATION
Decisions concerning the purchase and sale of portfolio securities and
the allocation of brokerage commissions are made by the Adviser pursuant to
recommendations made by an investment committee of the Adviser, which consists
of officers and directors of the Adviser and affiliates and officers and
Trustees who are interested persons of the Fund. Orders for purchases and sales
of securities are placed in a manner which, in the opinion of the officers of
the Fund, will offer the best price and market for the execution of each such
transaction. Purchases from underwriters of portfolio securities may include a
commission or commissions paid by the issuer and transactions with dealers
serving as market makers reflect a "spread." Investments in debt securities are
generally traded on a net basis through dealers acting for their own account as
principals and not as brokers; no brokerage commissions are payable on these
transactions.
The Fund's primary policy is to execute all purchases and sales of
portfolio instruments at the most favorable prices consistent with best
execution, considering all of the costs of the transaction including brokerage
commissions. This policy governs the selection of brokers and dealers and the
market in which a transaction is executed. Consistent with the foregoing primary
policy, the Rules of Fair Practice of the National Association of Securities
Dealers, Inc. and other policies that the Trustees may determine, the Adviser
may consider sales of shares of the Fund as a factor in the selection of
broker-dealers to execute the Fund's portfolio transactions.
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To the extent consistent with the foregoing, the Fund will be governed
in the selection of brokers and dealers, and the negotiation of brokerage
commission rates and dealer spreads, by the reliability and quality of the
services, including primarily the availability and value of research information
and to a lesser extent statistical assistance furnished to the Adviser of the
Fund, and their value and expected contribution to the performance of the Fund.
It is not possible to place a dollar value on information and services to be
received from brokers and dealers, since it is only supplementary to the
research efforts of the Adviser. The receipt of research information is not
expected to reduce significantly the expenses of the Adviser. The research
information and statistical assistance furnished by brokers and dealers may
benefit the Life Company or other advisory clients of the Adviser, and
conversely, brokerage commissions and spreads paid by other advisory clients of
the Adviser may result in research information and statistical assistance
beneficial to the Fund. The Fund will make no commitments to allocate portfolio
transactions upon any prescribed basis. While the Fund's officers will be
primarily responsible for the allocation of the Fund's brokerage business, their
policies and practices in this regard must be consistent with the foregoing and
will at all times be subject to review by the Trustees. For the period ended
August 31, 1996 the Fund paid negotiated brokerage commissions of $18,144 and
for the fiscal years ended December 31, 1995 and 1994, no negotiated brokerage
commissions were paid on portfolio transactions.
As permitted by Section 28(e) of the Securities Exchange Act of 1934,
the Fund may pay to a broker which provides brokerage and research services to
the Fund an amount of disclosed commission in excess of the commission which
another broker would have charged for effecting that transaction. This practice
is subject to a good faith determination by the Trustees that the price is
reasonable in light of the services provided and to policies that the Trustees
may adopt from time to time. For the period ended August 31, 1996, the Fund did
not pay commissions as compensation to any brokers for research services such as
industry, economic and company reviews and evaluations of securities.
The Adviser's indirect parent, the Life Company, is the indirect sole
shareholder of John Hancock Distributors, Inc. ("John Hancock Distributors" or
Affiliated Broker"). Pursuant to procedures determined by the Trustees and
consistent with the above policy of obtaining best net results, the Fund may
execute portfolio transactions with or through Affiliated Brokers. For the
period ended August 31, 1996, the Fund did not execute any portfolio
transactions with the Affiliated Brokers.
Any of the Affiliated Brokers may act as broker for the Fund on
exchange transactions, subject, however, to the general policy of the Fund set
forth above and the procedures adopted by the Trustees pursuant to the 1940 Act.
Commissions paid to an Affiliated Broker must be at least as favorable as those
which the Trustees believe to be contemporaneously charged by other brokers in
connection with comparable transactions involving similar securities being
purchased or sold. A transaction would not be placed with an Affiliated Broker
if the Fund would have to pay a commission rate less favorable than the
Affiliated Broker's contemporaneous charges for comparable transactions for its
other most favored, but unaffiliated, customers, except for accounts for which
the Affiliated Broker acts as a clearing broker for another brokerage firm, and
any customers of the Affiliated Broker not comparable to the Fund as determined
by a majority of the Trustees who are not interested persons (as defined in the
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1940 Act) of the Fund, the Adviser or the Affiliated Brokers. Because the
Adviser, which is affiliated with the Affiliated Brokers, has, as an investment
adviser to the Fund, the obligation to provide investment management services,
which includes elements of research and related investment skills, such research
and related skills will not be used by the Affiliated Brokers as a basis for
negotiating commissions at a rate higher than that determined in accordance with
the above criteria.
Other investment advisory clients advised by the Adviser may also
invest in the same securities and the Fund. When these clients buy or sell the
same securities at substantially the same time, the Adviser may average the
transaction as to price and allocate the amount of available investments in a
manner which the Adviser believes to be equitable to each client, including the
Fund. In some instances, this investment procedure may adversely affect the
price paid or received by the Fund or the size of the position obtainable for
it. On the other hand, to the extent permitted by law, the adviser may aggregate
the securities to be sold or purchased for the Fund with those to be sold or
purchased for other clients managed by it in order to obtain best execution.
TRANSFER AGENT SERVICES
John Hancock Signature Services, Inc., P.O. Box 9116, Boston, MA
02205-9116, a wholly owned indirect subsidiary of the Life Company, is the
transfer and dividend paying agent for the Fund. The Fund pays a monthly
transfer agent fee of $20 per account for the Class A Shares and $22.50 per
account for the Class B Shares, plus out-of-pocket expenses. These expenses are
aggregated and charged to the Fund and allocated to each class on the basis of
the related net asset values.
CUSTODY OF PORTFOLIO
Portfolio securities of the Fund are held pursuant to a custodian
agreement between the Fund and Investors Bank & Trust Company, 89 South Street,
Boston, Massachusetts 02111. Under the custodian agreement, Investors Bank &
Trust Company performs custody, portfolio and fund accounting services.
INDEPENDENT AUDITORS
Ernst & Young LLP, 200 Clarendon Street, Boston, Massachusetts 02116,
has been selected as the independent auditors of the Fund. The financial
statements of the Fund included in the Prospectus and this Statement of
Additional Information have been audited by Ernst & Young LLP for the periods
indicated in their report thereon appearing elsewhere herein, and are included
in reliance upon such report given upon the authority of such firm as experts in
accounting and auditing.
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APPENDIX A
TAX EXEMPT BOND RATINGS
Below is a description of the five ratings that may apply to the Fund's
investments in Tax-Exempt Bonds.
Tax-Exempt Bond Ratings
Moody's describes its five highest ratings for Tax-Exempt Bonds as
follows:
Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
'gilt edge'. Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long term risks appear somewhat larger than in Aaa securities.
Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate but elements may be
present which suggest a susceptibility to impairment some time in the future.
Bonds which are rated Baa are considered as medium grade obligations;
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
The five highest ratings of Standard & Poor's for Tax-Exempt Bonds are
AAA (Prime), AA (High Grade), A (Good Grade), BBB (Medium Grade) and BB:
AAA This is the highest rating assigned by Standard & Poor's to a
debt obligation and indicates an extremely strong capacity to
pay principal and interest.
A-1
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AA Bonds rated AA also qualify as high-quality debt obligations.
Capacity to pay principal and interest is very strong, and in
the majority of instances they differ from AAA issues only in
small degree.
A Bonds rated A 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.
BBB Bonds rated BBB are regarded as having an adequate capacity to
pay principal and interest. Whereas they normally exhibit
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity
to pay principal and interest for bonds in this category than
for bonds in the A category.
BB Debt rated BB has less near-term vulnerability to default than
other speculative issues. However, it faces major ongoing
uncertainties or exposure to adverse business, financial, or
economic conditions which could lead to inadequate capacity to
meet timely interest and principal payments. The BB rating
category is also used for debt subordinated to senior debt
that is assigned an actual or implied BBB-rating.
Fitch describes its ratings for Tax-Exempt Bonds as follows:
AAA Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong
ability to pay interest and repay principal, which is unlikely
to be affected by reasonably foreseeable events.
AA Bonds considered to be investment grade and of very high
credit quality. The obligor's ability to pay interest and
repay principal is very strong, although not quite as strong
as bonds rated "AAA". Because bonds rated in the "AAA" and
"AA" categories are not significantly vulnerable to foresee
future developments, short-term debt of these issuers is
generally rated F-1+.
A Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay
principal is considered strong, but may be more vulnerable to
adverse changes in economic conditions and circumstances than
bonds with higher ratings.
BBB Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and
repay principal is considered to be adequate. Adverse changes
in economic conditions and circumstances, however, are more
likely to have adverse impact on these bonds and, therefore,
impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than
for bonds with higher ratings.
BB Bonds are considered speculative. The obligor's ability to pay
interest and repay principal may be affected over time by
adverse economic changes. However, business and financial
A-2
<PAGE>
alternatives can be identified that could assist the obligor
in satisfying its debt service requirements.
Moody's ratings for state and municipal notes and other short-term
loans are designated Moody's Investment Grade (MIG). This distinction is in
recognition of the differences between short-term credit risk and long-term
risk. Factors affecting the liquidity of the borrower are uppermost in
importance in short-term borrowing, while various factors of the first
importance in bond risk are of lesser importance in the short-term run. Symbols
used will be as follows:
MIG 1 Loans bearing this designation are of the best quality,
enjoying strong protection from established cash flows of
funds for their servicing or from established and broad-based
access to the market for refinancing, or both.
MIG 2 Loans bearing this designation are of high quality, with
margins of protection ample although not so large as in the
preceding group.
MIG 3 Loans bearing this designation are of favorable quality, with
all securities elements accounted for but lacking the
undeniable strength of the preceding grades. Market access for
refinancing, in particular, is likely to be less well
established.
Standard & Poor's ratings for state and municipal notes and other
short-term loans are designated Standard & Poor's Grade (SP).
SP-1 Very strong or strong capacity to pay principal and interest.
Those issues determined to possess overwhelming safety
characteristics will be given a plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest.
SP-3 Speculative capacity to pay principal and interest.
Fitch Ratings for short-term debt obligations that are payable on
demand or have original maturities of up to three years including commercial
paper, certificates of deposits, medium term notes and municipal and investment
notes are designated by the following ratings:
F-1+ Exceptionally Strong Credit Quality. Issues assigned this
rating are regarded as having the strongest degree of
assurance for timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating
reflect an assurance of timely payment only slightly less in
degree than issues rated F-1+.
F-2 Good Credit Quality. Issues assigned this rating have a
satisfactory degree of assurance for timely payment, but the
margin for safety is not as great as for issues assigned F-1+
and F-1 ratings.
F-S Weak Credit Quality. Issues assigned this rating have
characteristics suggesting a minimal degree of assurance for
timely payment and are vulnerable to near-term adverse changes
in financial and economic conditions.
A-3
<PAGE>
EQUIVALENT YIELDS:
Tax Exempt Versus Taxable Income for 1996
The table below shows the effect of the tax status of California Tax
Exempt Securities on the yield received by their holders under the regular
federal income tax and California personal income tax laws. It gives the
approximate yield a taxable security must earn at various income brackets to
produce after-tax yields equivalent to those of California Tax Exempt Securities
yielding from 4.0% to 10.0%.
<TABLE>
<CAPTION>
IN CALIFORNIA, A TAX-EXEMPT YIELD OF:
------------------------------------------------------------------------------------
Marginal
Combined
California
and Federal
Single Return Joint Return Income Tax
(Taxable Income) Bracket* 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0%
---------------- -------- ---- ---- ---- ---- ---- ---- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
IS EQUIVALENT TO A TAXABLE YIELD OF:
$0-4,908 $0-9,816 15.85% 4.75% 5.94% 7.13% 8.32% 9.51% 10.70% 11.88%
$ 4,909- $ 9,817- 16.70% 4.80% 6.00% 7.20% 8.40% 9.60% 10.80% 12.00%
11,632 23,264
$ 11,633- $ 23,264- 18.40% 4.90% 6.13% 7.35% 8.58% 9.80% 11.03% 12.25%
18,357 36,714
$ 18,358- $ 36,715- 20.10% 5.01% 6.26% 7.51% 8.76% 10.01% 11.26% 12.52%
24,000 40,100
$ 24,001 $ 40,101- 32.32% 5.91% 7.39% 8.87% 10.34% 11.82% 13.30% 14.78%
25,484 50,968
$ 25,485- $ 50,969- 33.76% 6.04% 7.55% 9.06% 10.57% 12.08% 13.59% 15.10%
32,207 64,414
$ 32,208- $ 64,415- 34.70% 6.13% 7.66% 9.19% 10.72% 12.25% 13.78% 15.31%
58,150 96,900
$ 58,151- $ 96,901- 37.42% 6.39% 7.99% 9.59% 11.19% 12.78% 14.38% 15.98%
111,695 147,700
$111,696- --- 37.90% 6.44% 8.05% 9.66% 11.27% 12.88% 14.49% 16.10%
212,300
$ --- $147,701- 41.95% 6.89% 8.61% 10.34% 12.06% 13.78% 15.50% 17.23%
223,390
$121,301- $223,391- 42.40% 6.94% 8.68% 10.42% 12.15% 13.89% 15.63% 17.36%
223,390 263,750
$223,391- $ --- 43.04% 7.02% 8.78% 10.53% 12.29% 14.04% 15.80% 17.56%
263,750
$ --- $263,751- 45.64% 7.36% 9.20% 11.04% 12.88% 14.72% 16.56% 18.40%
446,780
$263,751- $446,781- 46.24% 7.44% 9.30% 11.16% 13.02% 14.88% 16.74% 18.60%
OVER OVER
</TABLE>
- ----------
* The marginal combined bracket includes the effect of deducting state taxes on
your federal tax return.
A-4
<PAGE>
The chart is for illustrative purposes only and is not intended to
project performance of the Fund.
While the Fund principally invests in obligations exempt from federal
and California state income taxes, a portion of the Fund's distributions may be
subject to these taxes or to the alternative minimum tax.
California state income tax rates and brackets have not yet been set
for 1997. This may result in higher or lower actual rates. The above chart is
intended for estimation only.
A-5
<PAGE>
FINANCIAL STATEMENTS
F-1
