Prospectus
WESTERN ASSET TRUST, INC.
CORPORATE SECURITIES PORTFOLIO
MORTGAGE SECURITIES PORTFOLIO
INTERNATIONAL SECURITIES PORTFOLIO
Western Asset Trust, Inc. ("Fund") is a no-load, open-end,
management investment company currently consisting of nine
separate professionally managed investment portfolios. The three
portfolios described in this prospectus ("Portfolios") are
offered only to clients of Western Asset Management Company
("Western Asset") and its affiliates. Western Asset serves as
investment adviser to the Corporate Securities and Mortgage
Securities Portfolios ("Domestic Portfolios") and to the
International Securities Portfolio ("International Portfolio").
Each Portfolio seeks maximum total return, consistent with
prudent investment management, by investing primarily in
securities of the types specified for that Portfolio. The
Domestic Portfolios are diversified Portfolios. The
International Portfolio is non-diversified.
This Prospectus sets forth concisely the information about
the Fund that a prospective investor ought to know before
investing. It should be read and retained for future reference.
A Statement of Additional Information about the Fund dated
December 31, 1994, has been filed with the Securities and
Exchange Commission and, as amended from time to time, is
incorporated herein by reference. The Statement of Additional
Information is available without charge upon request from Western
Asset Trust, Inc., (818) 584-4300.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE
SECURITIES COMMISSION NOR HAS THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
Dated: December 31, 1994<PAGE>
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TABLE OF CONTENTS
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Page
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Prospectus Summary 1
Expense Information 3
Financial Highlights 5
Investment Objectives and Policies 7
Description of Securities and Investment Techniques 9
Purchase of Shares 23
Redemption of Shares 24
How Net Asset Value is Determined 25
Dividends and Other Distributions 26
Federal Tax Treatment of Dividends and Other Distributions 26
Management of the Fund 28
Other Information 31
Appendix A-1<PAGE>
</TABLE>
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PROSPECTUS SUMMARY
THE FUND
Western Asset Trust, Inc. is a no-load, open-end management
investment company that was organized as a Maryland corporation
on May 16, 1990. The Fund consists of nine separate
professionally managed investment Portfolios, each with its own
investment objective and policies. The three Portfolios
described in this prospectus are available only to clients
maintaining separately managed accounts with Western Asset or its
affiliates.
INVESTMENT OBJECTIVES
The investment objective of each Portfolio is to maximize
total return, consistent with prudent investment management, by
investing primarily in securities of the type specified for that
Portfolio. The Portfolios differ in the proportion of their
assets invested in certain types of fixed income securities and,
therefore, their relative risk. See "Investment Objectives and
Policies," page 7.
The CORPORATE SECURITIES PORTFOLIO seeks to achieve its
objective by investing at least 75% of its total assets in U.S.
dollar-denominated debt securities of non-governmental domestic
issuers rated Baa or better by Moody's Investors Service Inc.
("Moody's") or BBB or better by Standard & Poor's Ratings Group
("S&P") or, if unrated, judged by Western Asset to be of
comparable quality. Western Asset expects that, under normal
circumstances, this Portfolio will invest substantially all of
its assets in such securities.
The MORTGAGE SECURITIES PORTFOLIO seeks to achieve its
objective by investing at least 75% of its total assets in
mortgage-related securities. The mortgage-related securities
purchased by this Portfolio must be either (1) issued or
guaranteed as to principal and interest by the U.S. Government,
its agencies or instrumentalities or (2) rated A or better by
Moody's or A or better by S&P or, if unrated, judged by Western
Asset to be of comparable quality. Western Asset anticipates
that, under normal circumstances, substantially all of this
Portfolio's assets will be invested in mortgage-related
securities.
The INTERNATIONAL SECURITIES PORTFOLIO seeks to achieve its
objective by investing at least 75% of its total assets in debt
or fixed-income securities denominated in major foreign
currencies and in baskets of currencies (which may include U.S.
and foreign currencies). Western Asset anticipates that, under
normal circumstances, substantially all of this Portfolio's
assets will be invested in securities of foreign issuers. Under
normal circumstances, the Portfolio's assets will be invested in
securities of foreign issuers representing at least three foreign
countries.
There can be no assurance that any Portfolio will achieve its
investment objective. Because the market value of each
Portfolio's investments will change, the net asset value per
share of each Portfolio also will vary.
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INVESTMENT RISKS AND CONSIDERATIONS
All Portfolios may invest in U.S. Government securities, some
of which may not be backed by the full faith and credit of the
United States. While principal and interest payments on
government securities, including some mortgage-related
securities, may be guaranteed by the U.S. Government, government
agencies or other guarantors, the market value of the securities
is not guaranteed. Events such as prepayments on underlying
mortgage loans also may adversely affect the return from
mortgage-related securities. Stripped mortgage-backed securities
generally are more sensitive to changes in prepayment and
interest rates than traditional debt securities and mortgage-
backed securities. Securities rated Baa by Moody's are deemed by
that agency to have speculative characteristics.
The International Portfolio may invest in securities of
foreign issuers, including foreign governments, which are
generally subject to additional risk factors not applicable to
securities of U.S. issuers, including risks arising from changes
in currency exchange rates, confiscatory taxation, taxes on
purchases, sales, interest and dividend income, political and
economic developments abroad and differences in the regulation of
issuers or securities markets. Securities of foreign issuers may
also be less liquid and their prices more volatile than
securities of U.S. issuers. The economy of a foreign nation may
be more or less favorable than the U.S. economy.
The International Portfolio is "non-diversified" within the
meaning of the Investment Company Act of 1940 (the "Investment
Company Act" or the "Act"). Accordingly, the International
Portfolio may be more susceptible to risks associated with
economic, political or regulatory issues in a particular country
or group of countries than would a more diversified Portfolio.
All Portfolios may invest in repurchase agreements, which
entail a risk of loss if the seller defaults on its obligations
and the Portfolio involved is delayed or prevented from
exercising its rights to dispose of the collateral securities.
All Portfolios may purchase securities on a when-issued basis.
Securities purchased on a when-issued basis may decline or
appreciate in market value prior to delivery.
All of the Portfolios may use options, futures contracts and
options on futures for hedging purposes and may use options to
enhance income. The International Portfolio may also use forward
currency contracts for hedging and income purposes. Use of these
instruments involves certain costs and risks, including the risk
that a Portfolio could not close out a futures or option position
when it would be most advantageous to do so, and the risk of an
imperfect correlation between the value of the security being
hedged and the value of the particular derivative instrument.
See "Investment Objectives and Policies," page 7, and
"Description of Securities and Investment Techniques," page 9.
INVESTMENT ADVISER AND FUND ADMINISTRATOR
Western Asset serves as investment adviser to all of the
Portfolios. Legg Mason Fund Adviser, Inc. serves as the Fund's
administrator ("Administrator"). Western Asset renders
2<PAGE>
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investment advice to registered investment company portfolios
that, as of September 30, 1994, had approximately $2.1 billion in
aggregate assets under management and private accounts totaling
approximately $10.3 billion. The Administrator also serves as
investment adviser, manager or consultant to fourteen investment
companies with assets of approximately $4.0 billion as of that
date. See "The Fund's Investment Adviser," page 28, and "The
Fund's Administrator," page 29.
PURCHASE OF SHARES
Shares of each Portfolio are offered without a sales charge at
the net asset value per share of the Portfolio next determined
after receipt of a purchase order and payment in proper form.
The Fund has no plan under Rule 12b-1 imposing fees for
distribution expenses. See "Purchase of Shares," page 23.
REDEMPTION OF SHARES
Shares of each Portfolio may be redeemed without charge at the
net asset value per share of the Portfolio next determined after
receipt of a redemption request in proper form. See "Redemption
of Shares," page 24.
DIVIDENDS AND OTHER DISTRIBUTIONS
Each Portfolio will declare and pay dividends quarterly out of
its net investment income. Each will also make an annual
distribution of any net capital gain (the excess of long-term
capital gain over short-term capital loss), net short-term
capital gain, and, in the case of the International Portfolio,
gains from certain foreign currency transactions. The Portfolios
may make an additional distribution if necessary to avoid a 4%
excise tax on certain undistributed income and capital gain. All
dividends and other distributions will be automatically
reinvested, unless cash payment is requested. See "Dividends and
Other Distributions," and "Federal Tax Treatment of Dividends and
Other Distributions," page 26.
EXPENSE INFORMATION
The purpose of the following table is to assist investors in
understanding the various costs and expenses that they will bear
directly or indirectly. "Management Fees" and "Other Expenses"
for the International Securities Portfolio are based on its fees
and expenses for the fiscal year ended June 30, 1994. For the
other Portfolios, "Management Fees" are based on the Fund's
current contracts, and "Other Expenses" are estimates for their
initial year of operations.
3<PAGE>
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SHAREHOLDER TRANSACTION EXPENSES*
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Sales load imposed on purchases None
Sales load imposed on reinvested distributions None
Deferred sales load None
Redemption fees None
Exchange fees None
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Annual Fund Operating Expenses (After Fee Waivers and Reimbursements):
(as a percentage of average net assets)
Domestic International
Portfolios Portfolio
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Management Fees .125%* .000%*
Other Expenses, comprised of:
Administrative Fees .025% .075%
Other .100% .225%
Total Other Expenses .125% .300%
Total Fund Operating Expenses .250%* .300%*
</TABLE>
* The expenses of the Portfolios for the current year have been
reduced by voluntary fee waivers and reimbursement agreements of
Western Asset. See "Fee Waivers," page 5. The Portfolios are
offered only to clients of Western Asset, who are required to pay
separate fees for advisory services provided by Western Asset
based on the amount of assets under management. However, such
fees are not charged against assets invested in the Portfolios.
The following example illustrates the expenses that an investor
would pay on a $1,000 investment over various time periods
assuming (1) a 5% annual rate of return and (2) redemption at the
end of each time period.
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1 Year 3 Years 5 Years 10 Years
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Domestic Portfolios $ 3 $ 8 N/A N/A
International Portfolio $ 3 $10 $17 $38
</TABLE>
This example assumes that all dividends and other
distributions are reinvested and that the percentage amounts
listed under Annual Fund Operating Expenses remain the same over
the time periods shown. The above tables and the assumptions in
the example of a $1,000 investment and a 5% annual return are
required by regulations of the Securities and Exchange Commission
("SEC") applicable to all mutual funds. THE ASSUMED 5% ANNUAL
RETURN IS NOT A PREDICTION OF, AND DOES NOT REPRESENT, ANY
PORTFOLIO'S PROJECTED OR ACTUAL PERFORMANCE. THE ABOVE TABLES
SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE
EXPENSES. ACTUAL EXPENSES MAY BE
4<PAGE>
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HIGHER OR LOWER THAN THOSE SHOWN. A Portfolio's actual expenses
will depend upon, among other things, the level of average net
assets, the levels of sales and redemptions of shares, the extent to
which a Portfolio incurs variable expenses, such as transfer agency
costs, and whether a Portfolio's adviser reimburses all or a portion of
the Portfolio's expenses and/or waives all or a portion of its
advisory and other fees. See "Fee Waivers" below, for a
description of annual operating expenses before any fee waiver or
reimbursement.
FEE WAIVERS
Western Asset has voluntarily undertaken to waive its fees
and/or reimburse each Domestic Portfolio to the extent a
Portfolio's expenses (exclusive of taxes, interest, brokerage and
other transaction expenses and any extraordinary expenses) exceed
during any month an annual rate of 0.25% of average daily net
assets for such month. If the adviser had not undertaken to
limit expenses as described above, the projected total expenses
of each Domestic Portfolio would be .28% of average daily net
assets. Western Asset has also voluntarily undertaken to waive
fees and/or reimburse the International Portfolio to the extent
that Portfolio's expenses (exclusive of taxes, interest,
brokerage and other transaction expenses and any extraordinary
expenses) exceed during any month an annual rate of 0.85% of
average daily net assets for such month. These waiver and
reimbursement agreements expired on June 30, 1994, but were
extended by Western Asset to December 31, 1994. In addition,
Western Asset has voluntarily waived for calendar year 1994 its
fee for services to the International Portfolio under its
management agreement, other than a portion of such fee equal to
the fee paid by Western Asset to the Administrator for services
to the International Portfolio under the administration
agreement. If Western Asset had not waived its fees as described
above, management fees for the International Portfolio would have
been .400% rather than .000% of average daily net assets and
total expenses for that Portfolio would have been .700% rather
than .300% of average daily net assets. See "Management and
Other Expenses," page 29. These agreements are voluntary and may
be terminated by the Adviser at any time.
FINANCIAL HIGHLIGHTS
INTERNATIONAL SECURITIES PORTFOLIO
The information in the financial highlights for the year
ended June 30, 1994, and for the period January 7, 1993
(Commencement of Operations) through June 30, 1993, has been
obtained from the financial statements which have been audited by
Price Waterhouse LLP, independent accountants. The International
Portfolio's financial statements for the year ended June 30,
1994, and the report of Price Waterhouse LLP thereon, are
included in the International Portfolio's 1994 Annual Report to
Shareholders and incorporated by reference in the Statement of
Additional Information, which is available upon request.
Investors should understand that all the following information
should be read in conjunction with such audited financial
statements and related notes.
5<PAGE>
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The Domestic Portfolios have not commenced operations.
Accordingly, no condensed financial information with respect to
those portfolios is included in the following table. The
Statements of Assets and Liabilities for the Domestic Portfolios
as of June 30, 1994 and related notes, audited by Price
Waterhouse LLP, independent accountants, and the report of Price
Waterhouse LLP thereon, are included in the Statement of
Additional Information, which is available upon request.
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For the Period
For the January 7, 1993(dagger)
Year Ended to
June 30, 1994 June 30, 1993
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $105.53 $100.00
Net investment income 6.94(ddagger) 3.21
Net realized and unrealized gain (loss) on investments
and forward currency contracts (7.36) 2.59
Total from investment operations (0.42) 5.80
Distributions to shareholders from:
Net investment income (8.64) (0.27)
Net realized capital gain (2.71) 0
Total Distributions (11.35) (0.27)
Net asset value, end of period $ 93.76 $105.53
Total return (1.14)% 5.81%**
RATIOS / SUPPLEMENTAL DATA:
RATIOS TO AVERAGE NET ASSETS:
Expenses 0.30%(ddagger) 0.45%(ddagger)*
Net investment income 5.53% 6.08%(ddagger)*
Portfolio turnover rate 571.18% 249.94%*
Net assets, end of period (in thousands) $106,806 $93,288
</TABLE>
(dagger) Commencement of operations.
(ddagger) Net of voluntary waiver of investment advisory fees. Pursuant
to this waiver, advisory fees of $572,322 and $136,356 were waived for
the year ended June 30, 1994 and the period January 7, 1993 (commencement
of operations) to June 30, 1993. In the absence of this waiver, the
ratio of expenses to average net assets would have been 0.70% for the
year ended June 30, 1994 and 0.85% for the period January 7, 1993
(commencement of operations) to June 30, 1993.
* Determined on an annualized basis.
** Not annualized.
6<PAGE>
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INVESTMENT OBJECTIVES AND POLICIES
The investment objective of each Portfolio is to maximize
total return, consistent with prudent investment management, by
investing primarily in securities of the types specified below
for each respective Portfolio. "Total return" includes interest
from underlying securities, capital gains and appreciation on the
securities held in the Portfolio, and gains from the use of
futures and options and, in the case of the International
Portfolio, from favorable changes in foreign currency exchange
rates. As set forth below, the Portfolios differ from one
another primarily in the proportion of assets invested in certain
types of fixed income securities.
The MORTGAGE SECURITIES PORTFOLIO invests at least 75% of its
total assets in U.S. dollar-denominated, mortgage-related
securities of domestic issuers. The mortgage-related securities
purchased by this Portfolio must be either (1) issued or
guaranteed as to principal and interest by the U.S. Government,
its agencies or instrumentalities or (2) rated A or better by
Moody's or A or better by S&P or, if unrated, judged by Western
Asset to be of comparable quality. Western Asset expects that,
under normal circumstances, this Portfolio will invest
substantially all of its assets in such securities.
The CORPORATE SECURITIES PORTFOLIO invests at least 75% of its
total assets in U.S. dollar-denominated debt securities of non-
governmental domestic issuers rated Baa or better by Moody's or
BBB or better by S&P or, if unrated, judged by Western Asset to
be of comparable quality. Western Asset expects that, under
normal circumstances, this Portfolio will invest substantially
all of its assets in such securities. Securities rated Baa by
Moody's are deemed by that agency to have speculative
characteristics.
The INTERNATIONAL SECURITIES PORTFOLIO invests at least 75% of
its total assets in securities denominated in major foreign
currencies and in baskets of currencies (which may include U.S.
and foreign currencies), such as the European Currency Unit, or
"ECU," or as they may further develop. Western Asset anticipates
that, under normal circumstances, substantially all of this
Portfolio's assets will be invested in securities of foreign
issuers. Western Asset will manage the investments of the
Portfolio across different international bond markets so that,
under normal circumstances, the Portfolio's assets will be
invested in securities of foreign issuers representing at least
three foreign countries. The adviser will select the Portfolio's
foreign country and currency composition based on its evaluation
of relative interest rates, inflation rates, exchange rates,
monetary and fiscal policies, trade and current account balances,
and any other specific factors the adviser believes relevant.
INVESTMENT POLICIES
In selecting securities for each Portfolio, the adviser may
utilize economic forecasting, interest rate anticipation, credit
and call risk analysis, and other security selection techniques.
The proportion of each Portfolio's assets committed to investment
in securities with particular characteristics (such as maturity,
type, and coupon rate) will vary based on its adviser's outlook
for the U.S. economy (and, in the case of the International
7<PAGE>
<PAGE>
Portfolio, foreign economies), the financial markets, and other
factors. There is no assurance that any Portfolio will achieve
its investment objective.
Within the limits described above, the Portfolios may invest
in the following types of securities: obligations issued or
guaranteed by the U.S. Government, its agencies or
instrumentalities; U.S. dollar-denominated debt securities of
domestic issuers rated Baa or better by Moody's or BBB or better
by S&P or, if unrated, judged by the adviser to be of comparable
quality; mortgage- and other asset-backed securities; variable
and floating rate debt securities; high quality commercial paper;
and corporate obligations (including preferred stock, convertible
securities, zero coupon securities and pay-in-kind securities)
rated Baa or higher by Moody's or BBB or higher by S&P, issued by
domestic entities and denominated in U.S. dollars, or unrated
securities judged by the adviser to be of comparable quality;
certificates of deposit, fixed time deposits and bankers'
acceptances issued by domestic banks and denominated in U.S.
dollars; and repurchase agreements collateralized by any security
in which it may invest. The Portfolios may also engage in reverse
repurchase agreements and dollar roll transactions.
The International Portfolio may invest in the above types of
securities whether denominated in U.S. dollars or foreign
currencies, and whether issued by domestic or foreign issuers.
It may also invest in U.S. dollar-denominated or foreign
currency-denominated obligations of foreign governments or their
subdivisions, agencies and instrumentalities, international
agencies (such as the World Bank) or supranational entities; and
foreign currency exchange-related securities, including foreign
currency warrants. In evaluating the credit risk of a foreign
debt security, the International Portfolio may use ratings
assigned by rating agencies recognized in the primary market for
those securities.
The International Portfolio is "non-diversified" within the
meaning of the Investment Company Act. Accordingly, the
International Portfolio may invest a greater percentage of its
total assets in securities of a particular foreign issuer, or may
invest in a smaller number of different foreign issuers, than it
would if it were a "diversified" company under the Act. The
International Portfolio may be more susceptible to risks
associated with economic, political or regulatory issues in a
particular country or group of countries than would a more
diversified portfolio.
The Portfolios may also buy or sell interest rate futures
contracts, options on interest rate futures contracts and options
on debt securities and bond indices to hedge against changes in
the value of securities which the Portfolio owns or anticipates
purchasing due to anticipated changes in interest rates. The
Portfolios may also use options on debt securities for non-
hedging purposes, in an effort to enhance income. The
International Portfolio may buy or sell foreign currencies,
foreign currency options, or foreign currency futures and related
options, and may enter into foreign currency forward contracts
for the purpose of hedging against foreign exchange risk arising
from the Portfolio's investment or anticipated investment in
securities denominated in foreign currencies. The International
Portfolio also may enter into foreign currency forward contracts
and buy or sell foreign currencies or foreign currency options
for purposes of increasing exposure to a particular foreign
currency or to shift exposure to foreign currency fluctuations from one
8<PAGE>
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country to another. See "Options and Futures; Forward
Currency Exchange Contracts," page 20 and "Risks of Futures,
Options and Forward Contracts," page 22. Each Portfolio may
purchase securities on a when-issued basis and enter into forward
commitments to purchase securities; lend its securities to
brokers, dealers and other financial institutions to earn income;
and borrow money for temporary or emergency purposes. See "When-
Issued Securities," page 19.
See "Description of Securities and Investment Techniques,"
below, and the Statement of Additional Information for a
description of securities and investment techniques listed above
and restrictions generally applicable to a Portfolio's investment
in or use of them. See the Appendix to the Statement of
Additional Information for a description of Moody's and S&P's
ratings applicable to fixed-income securities.
INVESTMENT RESTRICTIONS
The investment objective of each Portfolio may not be changed
without the affirmative vote of a majority of outstanding shares
(as defined in the Investment Company Act) of the affected
Portfolio. Except for the investment objectives and those
restrictions or policies specifically identified as
"fundamental," the investment policies and practices described in
this Prospectus and in the Statement of Additional Information
may be changed by the Fund's Board of Directors without
shareholder approval.
The fundamental restrictions applicable to all Portfolios
include a prohibition on investing 25% or more of total assets in
the securities of issuers in a particular industry (with the
exception of securities issued or guaranteed by the U.S.
Government, its agencies or instrumentalities and repurchase
agreements with respect thereto). However, the Mortgage
Securities Portfolio will under normal circumstances invest more
than 25% of its total assets in mortgage-backed and other asset-
backed securities (including, for this purpose, securities issued
or guaranteed by the U.S. Government, its agencies or
instrumentalities, and repurchase agreements with respect
thereto). Investments in those securities involve special risks.
See "Mortgage-Related and Other Asset-Backed Securities,"
page 10. The Mortgage Securities Portfolio's policy of so
concentrating its investments has the effect of increasing its
exposure to those risks and might cause the value of its
securities to fluctuate more than would otherwise be the case.
Additional fundamental and non-fundamental investment
restrictions are set forth in the Statement of Additional
Information.
DESCRIPTION OF SECURITIES AND INVESTMENT TECHNIQUES
The following describes in greater detail different types of
securities and investment techniques used by the individual
Portfolios, as described in the preceding section.
U.S. GOVERNMENT SECURITIES
9
<PAGE>
Each Portfolio may purchase U.S. Government securities, which
include (1) U.S. Treasury bills (maturity of one year or less),
U.S. Treasury notes (maturity of one to ten years) and U.S.
Treasury bonds (maturities generally greater than ten years) and
(2) obligations issued or guaranteed by U.S. Government agencies
or instrumentalities which are supported by any of the following:
(a) the full faith and credit of the U.S. Government (such as
certificates of the Government National Mortgage Association
("GNMA")); (b) the right of the issuer to borrow an amount
limited to a specific line of credit from the U.S. Government
(such as obligations of the Federal Home Loan Banks);
(c) discretionary authority of the U.S. Government to purchase
certain obligations of agencies or instrumentalities (such as the
Federal National Mortgage Association ("FNMA")); or (d) only the
credit of the instrumentality (such as the Student Loan Marketing
Association). In the case of obligations not backed by the full
faith and credit of the United States, a Portfolio must look
principally to the agency or instrumentality issuing or
guaranteeing the obligation for ultimate repayment and may not be
able to assert a claim against the United States itself in the
event the agency or instrumentality does not meet its
commitments.
MORTGAGE-RELATED AND OTHER ASSET-BACKED SECURITIES
Mortgage-related securities represent interests in pools of
mortgages made by lenders such as commercial banks, savings and
loan institutions, mortgage bankers and others. Mortgage-related
securities may be issued by governmental or government-related
entities or by non-governmental entities such as banks, savings
and loan institutions, private mortgage insurance companies,
mortgage bankers and other secondary market issuers.
Mortgage-related securities provide monthly payments which
consist of interest and, in most cases, principal. In effect,
these payments are a "pass-through" of the monthly payments made
by the individual borrowers on their residential mortgage loans,
net of any fees paid to the issuer or guarantor of such
securities. Additional payments to holders of mortgage-related
securities are caused by repayments resulting from the sale of
the underlying residential property, refinancing or foreclosure,
net of fees or costs which may be incurred.
GOVERNMENT MORTGAGE-RELATED SECURITIES. GNMA is the principal
federal government guarantor of mortgage-related securities.
GNMA is a wholly owned U.S. Government corporation within the
Department of Housing and Urban Development. GNMA pass-through
securities are considered to have a very low risk of default in
that (1) the underlying mortgage loan Portfolio is comprised
entirely of government-backed loans and (2) the timely payment of
both principal and interest on the securities is guaranteed by
the full faith and credit of the U.S. Government, regardless of
whether they have been collected. GNMA pass-through securities
are, however, subject to the same market risk as comparable debt
securities. Therefore, the market value of a Portfolio's GNMA
securities can be expected to fluctuate in response to changes in
interest rate levels.
10<PAGE>
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Residential mortgage loans are also pooled by the Federal Home
Loan Mortgage Corporation ("FHLMC"), a corporate instrumentality
of the U.S. Government. The mortgage loans in FHLMC's Portfolio
are not government backed; rather, the loans are either uninsured
with loan-to-value ratios of 80% or less or privately insured if
the loan-to-value ratio exceeds 80%. FHLMC, not the U.S.
Government, guarantees the timely payment of interest and
ultimate collection of principal on FHLMC participation
certificates. FHLMC also now issues guaranteed mortgage
certificates, on which it guarantees semi-annual interest
payments and a specified minimum annual payment of principal.
FNMA is a government-sponsored corporation owned entirely by
private stockholders. It is subject to general regulation by the
Secretary of Housing and Urban Development. FNMA purchases
residential mortgages from a list of approved seller/servicers,
which include savings and loan associations, savings banks,
commercial banks, credit unions and mortgage bankers. Pass-
through securities issued by FNMA are guaranteed as to timely
payment of principal and interest only by FNMA, not the U.S.
Government.
PRIVATELY ISSUED MORTGAGE-RELATED SECURITIES. Mortgage-
related securities offered by private issuers include pass-
through securities comprised of pools of residential mortgage
loans; mortgage-backed bonds which are considered to be debt
obligations of the institution issuing the bonds and are
collateralized by mortgage loans; and bonds and collateralized
mortgage obligations ("CMOs") which are collateralized by
mortgage-related securities issued by FHLMC, FNMA or GNMA or by
pools of mortgages. Any Portfolio may purchase privately issued
mortgage-related securities.
CMOs are typically structured with classes or series which
have different maturities and are generally retired in sequence.
In the most common arrangement, each class of obligations
receives periodic interest payments according to the coupon rate
on the obligations. However, all monthly principal payments and
any prepayments from the collateral pool are paid first to the
"Class 1" holders. Thereafter, all payments of principal are
allocated to the next most senior class of obligations until that
class of obligations has been fully repaid. Although full payoff
of each class of obligations is contractually required by a
certain date, any or all classes of obligations may be paid off
sooner than expected because of an increase in the payoff speed
of the pool. Other allocation methods may be used.
Mortgage-related securities created by non-governmental
issuers generally offer a higher rate of interest than government
and government-related securities because there are no direct or
indirect government guarantees of payment in the former
securities, resulting in higher risks. Timely payment of
interest and principal may be supported by various forms of
insurance, including individual loan, title, and hazard policies
on the mortgages in the pool, or by private guarantees of the
issuer of the mortgage-related securities. There can be no
assurance that the insurers will be able to meet their
obligations under the relevant insurance policies or that the
private issuers will be able to meet their obligations under the
relevant guarantees. Such guarantees and policies often do not
cover the full amount of the pool. Where privately issued
securities are collateralized by securities issued by FHLMC, FNMA
or GNMA, the timely payment of interest and principal is
supported by the government-related securities collateralizing
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such obligations. The market for private pools is smaller and
less liquid than the market for the government and government-
related mortgage pools.
STRIPPED MORTGAGE-BACKED SECURITIES. These securities are
interests in a pool of mortgage assets that receive interest and
principal distributions in different proportions from that
received by the underlying pool. They may be issued by agencies
or instrumentalities of the U.S. government or by private
mortgage lenders. Stripped mortgage-backed securities generally
are more sensitive to changes in prepayment and interest rates
and the market for such securities is less liquid than is the
case for traditional debt securities and mortgage-backed
securities.
Some stripped mortgage-backed securities receive only interest
payments. The yield on such securities is extremely sensitive to
the rate of principal payments (including prepayments) on the
underlying mortgage assets, and a rapid rate of repayment may
have a material adverse effect on such securities' yield to
maturity. If the underlying mortgage assets experience greater
than anticipated prepayments of principal, the Portfolio may fail
to recoup fully its initial investment in these securities, even
if they are rated high quality. When interest rate are
declining, such principal prepayments usually increase, and
reinvestments of such principal prepayments will be at a lower
rate than that on the original mortgage-related security.
ASSET-BACKED SECURITIES. Asset-backed securities refer to
securities that directly or indirectly represent a participation
in, or are secured by and payable from, assets such as motor
vehicle installment sales, installment loan contracts, leases of
various types of real and personal property and receivables from
revolving credit (credit card) agreements. Such assets are being
securitized through the use of trusts and special purpose
corporations. Asset-backed securities are backed by a pool of
assets often representing the obligations of a number of
different parties. Payments of principal and interest may be
guaranteed up to certain amounts and for a certain time period by
a letter of credit issued by a financial institution, usually
unaffiliated with the trust or corporation. Certain of such
securities may be illiquid, in that there is not a ready market
if a Portfolio wishes to resell the security.
PREPAYMENT RISK. The principal of most mortgage-backed and
other asset-backed securities may be prepaid at any time. As a
result, if such securities are purchased at a premium, a
prepayment rate that is faster than expected will reduce yield to
maturity, while a prepayment rate that is slower than expected
will have the opposite effect. Conversely, if the securities are
purchased at a discount, prepayments faster than expected will
increase yield to maturity and prepayments slower than expected
will decrease it. Accelerated prepayments also reduce the
certainty of the yield because the Portfolio must reinvest the
assets at the then-current rates. Accelerated prepayments on
securities purchased at a premium also impose a risk of loss of
principal because the premium may not have been fully amortized
at the time the principal is repaid in full. When interest rates
are declining, such prepayments usually increase, and
reinvestments of such principal prepayments will be at a lower
rate than that on the original mortgage-related security. The
rate of prepayment may also be affected by general economic
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conditions, the location and age of the mortgages, and other
social and demographic conditions.
New types of mortgage-backed and asset-backed securities,
derivative securities and hedging instruments are developed and
marketed from time to time. Consistent with their respective
investment policies and limitations, the Portfolios expect to
invest in those new types of securities and instruments that the
adviser believes may assist the Portfolios in achieving their
investment objectives.
The Portfolios will invest in mortgage-related or other asset-
backed securities only if they are either (1) issued or
guaranteed as to principal and interest by the U.S. Government,
its agencies or instrumentalities (currently GNMA, FHLMC and
FNMA) or (2) rated A or better by Moody's or A or better by S&P
or, if unrated, judged by the adviser to be of comparable
quality.
NON-GOVERNMENTAL DEBT SECURITIES
Each Portfolio may invest in investment grade corporate debt
obligations. Each Portfolio's adviser seeks to minimize the
risks of investing in all securities through diversification, in-
depth credit analysis and attention to current developments in
interest rates and market conditions.
Securities rated Baa and BBB are the lowest which are
considered "investment grade" obligations. Moody's describes
securities rated Baa as "medium-grade" obligations; they are
"neither highly protected nor poorly secured ... [I]nterest
payments and principal security appear adequate for the present
but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time.
Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well." S&P describes
securities rated BBB as "regarded as having an adequate capacity
to pay interest and repay principal. Whereas it normally
exhibits adequate protection parameters, adverse economic
conditions or changing circumstances are more likely to lead to a
weakened capacity . . . than in higher rated categories."
The adviser monitors the ratings of securities held by the
Portfolios and the creditworthiness of their issuers. If the
rating of a security in which a Portfolio has invested falls
below the minimum rating in which the Portfolio is permitted to
invest, the Portfolio will dispose of that security within a
reasonable time, having due regard for market conditions, tax
implications and other applicable factors. An issue given
different ratings by different rating agencies is evaluated by
the adviser to determine which is most appropriate. The
Portfolios will not hold more than 5% of their net assets in
below investment-grade securities.
A debt security may be callable, i.e., subject to redemption
at the option of the issuer at a price established in the
security's governing instrument. If a debt security held by a
Portfolio is called for redemption, the Portfolio will be
required to permit the issuer to redeem the security or sell it
to a third party. Either of these actions could have an adverse
effect ona Portfolio's abilityto achieve itsinvestment objective.
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FOREIGN SECURITIES
The International Portfolio may invest directly in U.S.
dollar-denominated or foreign currency-denominated foreign fixed-
income securities (including preferred or preference stock) of
non-governmental issuers, certificates of deposit, fixed time
deposits and bankers' acceptances issued by foreign banks, and
debt obligations of foreign governments or their subdivisions,
agencies and instrumentalities, international agencies and
supranational entities. Some securities issued by foreign
governments or their subdivisions, agencies and instrumentalities
may not be backed by the full faith and credit of the foreign
government.
The International Portfolio will limit its foreign investments
to fixed income and other debt securities of issuers based in
developed countries (including, but not limited to, countries in
the European Community, Canada, Japan, Australia, New Zealand and
newly industrialized countries, such as Singapore, Taiwan and
South Korea). Investing in the securities of issuers in any
foreign country nevertheless involves special risks and
considerations not typically associated with investing in U.S.
companies. These include risks resulting from differences in
accounting, auditing and financial reporting standards; lower
liquidity than U.S. fixed income or debt securities; the
possibility of nationalization, expropriation or confiscatory
taxation; adverse changes in investment or exchange control
regulations (which may include suspension of the ability to
transfer currency out of a country); and political instability
which could affect U.S. investments in foreign countries. There
may be less publicly available information concerning foreign
issuers of securities held by the Portfolios than is available
concerning U.S. issuers. Additionally, purchases and sales of
foreign securities and dividends and interest payable on those
securities may be subject to foreign taxes; taxes may be withheld
from dividend and interest payments on those securities. Foreign
securities often trade with less frequency and volume than
domestic securities and therefore may exhibit greater price
volatility and a greater risk of illiquidity. Additional costs
associated with an investment in foreign securities will
generally include higher custodial fees than apply to domestic
custodial arrangements and transaction costs of foreign currency
conversions. Changes in foreign exchange rates also will affect
the value of securities denominated or quoted in currencies other
than the U.S. dollar. The relative performance of various
countries' fixed income markets historically has reflected wide
variations relating to the unique characteristics of each
country's economy. Individual foreign economies may differ
favorably or unfavorably from the U.S. economy in such respects
as growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency and balance of payments
position. Bank deposit insurance regulations and limits may vary
widely in foreign countries.
Foreign securities purchased by the International Portfolio
may be listed on foreign exchanges or traded over-the-counter.
Transactions on foreign exchanges are usually subject to mark-ups
or commissions higher than negotiated commissions on U.S.
transactions, although the Portfolio will endeavor to obtain the
best net results in effecting transactions. There is generally
less government supervision and regulation of exchanges and
brokers in foreign countries than in the United States.
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It is anticipated that over 25% of the International
Portfolio's assets may be invested in securities of Japanese
issuers, and that over 25% of the Portfolio's assets may be
invested in securities of German issuers. Such issuers may
include the foreign governments of these countries and their
subdivisions, agencies, and instrumentalities, and also non-
governmental issuers. Whether the International Portfolio will
concentrate in foreign governmental issuers or other issuers of
these countries will depend on relative market and economic
circumstances from time to time. Among such circumstances are
the relative performance of these and other countries' fixed
income markets, expectations as to future relative performance of
those markets, relative foreign exchange rates, relative economic
performance and expectations for these and other foreign
countries, and similar investment factors. The International
Portfolio will concentrate in these countries when such
circumstances suggest the potential of a relative higher return
from such concentration.
The investment of a substantial amount of the Portfolio's
assets in securities of issuers from these two countries raises
special considerations for investors in addition to the
considerations generally applicable to foreign securities
described above.
Japan currently has the second largest GNP in the world.
While the Japanese economy has grown substantially over the last
three decades, with its growth rate averaging over 5% in the
1970s and 1980s, the growth rate in Japan slowed to 3.3% in 1991
and less than 1% in 1992. Japan is also heavily dependent upon
international trade and has recently suffered as a result of
trade frictions and delays in ratifying the recent GATT trade
agreements. During 1994, the economy began to show signs of
recovering from the slow-down in economic growth. The tentative
signs of recovery have been impressive given the recent strength
in the value of the Japanese Yen.
Germany currently has the third largest GNP in the world. It
too has grown substantially over the past few decades.
Reunification with the former East German economy had brought
many pressures to bear on monetary policy and financial markets,
as well as the redistributive impact of attempting to bring
living standards in the East up to those of the West. Following
a period of economic contraction, the German economy is now
showing signs of economic expansion. This comes after a decline
in both the level of inflation and the level of interest rates.
COMMERCIAL PAPER AND OTHER SHORT-TERM INSTRUMENTS
Commercial paper represents short-term unsecured promissory
notes issued in bearer form by banks or bank holding companies,
corporations and finance companies. The commercial paper
purchased by the Portfolios consists of U.S. dollar-denominated
or foreign currency-denominated obligations of domestic or
foreign issuers which, at the time of investment, is (1) rated
P-1 or P-2 by Moody's, A-1 or A-2 or better by S&P, or F-1 or F-2
by Fitch Investors Service, (2) issued or guaranteed as to
principal and interest by issuers or guarantors having an
existing debt security rating of A or better by Moody's or by S&P
or (3) if unrated, are judged to be of comparable quality by that
Portfolio's adviser.
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The Portfolios may purchase commercial paper issued pursuant
to the private placement exemption in Section 4(2) of the
Securities Act of 1933. Section 4(2) paper is restricted as to
disposition under the federal securities laws in that any resale
must similarly be made in an exempt transaction. The Fund may or
may not regard such securities as illiquid, depending on the
circumstances of each case. See "Restricted and Illiquid
Securities," page 23.
Any Portfolio may also invest in obligations (including
certificates of deposit, demand and time deposits and bankers'
acceptances) of U.S. banks and savings and loan institutions if
the issuer has total assets in excess of $1 billion at the time
of purchase or if the principal amount of the instrument is
insured by the Federal Deposit Insurance Corporation. A bankers'
acceptance is a time draft drawn on a commercial bank by a
borrower, usually in connection with an international commercial
transaction. Time deposits are non-negotiable deposits
maintained in a banking institution for a specified period of
time at a specified interest rate. Certificates of deposit are
negotiable short-term obligations issued by banks against funds
deposited in the issuing institution. The interest rate on some
certificates of deposit is periodically adjusted prior to the
stated maturity, based upon a specified market rate. While
domestic bank deposits are insured by an agency of the U.S.
Government, the Portfolios will generally assume positions
considerably in excess of the insurance limits.
PREFERRED STOCK
Any of the Portfolios may purchase preferred stock as a
substitute for debt securities of the same issuer when, in the
opinion of that Portfolio's adviser, the preferred stock is more
attractively priced in light of the risks involved. Preferred
stock pays dividends at a specified rate and generally has
preference over common stock in the payment of dividends and the
liquidation of the issuer's assets but is junior to the debt
securities of the issuer in those same respects. Unlike interest
payments on debt securities, dividends on preferred stock are
generally payable at the discretion of the issuer's board of
directors, although preferred shareholders may have certain
rights if dividends are not paid. Shareholders may suffer a loss
of value if dividends are not paid, and generally have no legal
recourse against the issuer. The market prices of preferred
stocks are subject to changes in interest rates and are more
sensitive to changes in the issuer's creditworthiness than are
the prices of debt securities. Under ordinary circumstances,
preferred stock does not carry voting rights.
CONVERTIBLE SECURITIES
A convertible security is a bond, debenture, note, preferred
stock or other security that may be converted into or exchanged
for a prescribed amount of common stock of the same or a
different issuer within a particular period of time at a
specified price or formula. A convertible security entitles the
holder to receive interest paid or accrued on debt or the
dividend paid on preferred stock until the convertible security
matures or is redeemed, converted or exchanged. Before
conversion, convertible securities ordinarily provide a stream of
income with generally higher yields than those of common stocks
of the same or similar issuers, but lower than the yield on non-
convertible debt. Convertible securities
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are usually subordinated to comparable-tier nonconvertible securities
but rank senior to common stock in a corporation's capital structure.
The value of a convertible security is a function of (1) its
yield in comparison with the yields of other securities of
comparable maturity and quality that do not have a conversion
privilege and (2) its worth, at market value, if converted into
the underlying common stock. Convertible securities are
typically issued by smaller capitalized companies whose stock
prices may be volatile. The price of a convertible security
often reflects such variations in the price of the underlying
common stock in a way that non-convertible debt does not. The
Portfolios have no current intention of converting any
convertible securities they may own into equity or holding them
as equity upon conversion, although they may do so for temporary
purposes. A convertible security may be subject to redemption at
the option of the issuer at a price established in the
convertible security's governing instrument. If a convertible
security held by a Portfolio is called for redemption, the
Portfolio will be required to permit the issuer to redeem the
security, convert it into the underlying common stock or sell it
to a third party. Any of these actions could have an adverse
effect on a Portfolio's ability to achieve its investment
objective.
VARIABLE AND FLOATING RATE SECURITIES
Any Portfolio may invest in variable and floating rate
securities. These securities provide for periodic adjustment in
the interest rate paid on the obligations. The terms of such
obligations must provide that interest rates are adjusted
periodically based upon some appropriate interest index. The
adjustment intervals may be event-based (floating), and range
from daily up to annually, or may be regular (variable). The
adviser believes that the variable or floating rate of interest
paid on these securities may reduce the wide fluctuations in
market value typical of fixed-rate long-term securities. The
yield available on floating rate securities is typically less
than that on fixed-rate notes of similar maturity issued by the
same company.
ZERO COUPON AND PAY-IN-KIND BONDS
A zero coupon bond is a security that makes no fixed interest
payments but instead is sold at a deep discount from its face
value. The bond is redeemed at its face value on the specified
maturity date. Zero coupon bonds may be issued as such, or they
may be created by a broker who strips the coupons from a bond and
separately sells the rights to receive principal and interest.
Pay-in-kind securities pay interest in the form of additional
securities, thereby adding additional debt to the issuer's
balance sheet. The prices of both types of bonds tend to
fluctuate more in response to changes in market interest rates
than do the prices of debt securities with similar maturities,
that pay interest in cash.
A Portfolio investing in zero coupon or pay-in-kind bonds
generally accrues income on such securities prior to the receipt
of cash payments. Since each Portfolio must distribute
substantially all of its income to shareholders to qualify for
pass-through treatment under the federal income tax laws, a
Portfolio investing in such bonds may have to dispose of other
securities to generate the cash necessary for the distribution of
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income attributable to its zero coupon or pay-in-kind bonds.
Such disposal could occur at a time which would be
disadvantageous to the Portfolio and when the Portfolio would not
otherwise choose to dispose of the assets.
REPURCHASE AGREEMENTS
A repurchase agreement is an agreement under which a Portfolio
acquires either U.S. Government obligations or high-quality
liquid debt securities from a securities dealer or bank subject
to resale at an agreed upon price and date. The securities are
held by the Portfolio as collateral until retransferred and will
be supplemented by additional collateral if necessary to maintain
a total market value equal to or in excess of the value of the
repurchase agreement. The Portfolio bears a risk that the
proceeds from any sale of collateral upon a default in the
obligation to repurchase will be less than the repurchase price.
A Portfolio also bears a risk that the other party to a
repurchase agreement will default on its obligations and the
Portfolio will be delayed or prevented from exercising its rights
to dispose of the collateral securities. A Portfolio will enter
into repurchase agreements only with financial institutions which
are deemed by its adviser to present minimal risk of default
during the term of the agreement based on guidelines which are
periodically reviewed by the Board of Directors.
REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWING
A reverse repurchase agreement is a portfolio management
technique in which a Portfolio temporarily transfers possession
of a portfolio instrument to another person, such as a financial
institution or broker-dealer, in return for cash. At the same
time, the Portfolio agrees to repurchase the instrument at an
agreed upon time (normally within seven days) and price,
including interest payment. A Portfolio may also enter into
dollar rolls, in which the Portfolio sells a fixed income
security for delivery in the current month and simultaneously
contracts to repurchase substantially similar (same type, coupon
and maturity) securities on a specified future date. During the
roll period, the Portfolio would forgo principal and interest
paid on such securities. The Portfolio would be compensated by
the difference between the current sales price and the forward
price for the future purchase, as well as by the interest earned
on the proceeds of the initial sale.
Any Portfolio may engage in reverse repurchase agreements,
dollar rolls and other borrowing as a means of raising cash to
satisfy redemption requests or for other temporary or emergency
purposes without selling portfolio instruments. While engaging
in reverse repurchase agreements and dollar rolls, each Portfolio
will maintain cash, U.S. Government securities or high-grade,
liquid debt securities in a segregated account at its custodian
bank with a value at least equal to the Portfolio's obligation
under the agreements, adjusted daily.
Reverse repurchase agreements and dollar rolls may expose a
Portfolio to greater fluctuations in value of its assets and
renders the segregated assets unavailable for sale or other
disposition. To avoid potential leveraging effects of borrowing
(including reverse repurchase agreements and dollar rolls), a
Portfolio will not purchase securities while such borrowing is in
excess of 5% of its total assets. Each Portfolio will limit its
borrowing to no more than one-third of its total assets.
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LOANS OF PORTFOLIO SECURITIES
Any Portfolio may lend portfolio securities to brokers or
dealers in corporate or government securities, banks or other
recognized institutional borrowers of securities, provided that
cash or equivalent collateral, equal to at least 100% of the
market value of the securities loaned is continuously maintained
by the borrower with the Portfolio. During the time securities
are on loan, the borrower will pay the Portfolio an amount
equivalent to any dividends or interest paid on such securities,
and the Portfolio may invest the cash collateral and earn
additional income, or it may receive an agreed upon amount of
interest income from the borrower who has delivered equivalent
collateral. These loans are subject to termination at the option
of the Portfolio or the borrower. A Portfolio may pay reasonable
administrative and custodial fees in connection with a loan and
may pay a negotiated portion of the interest earned on the cash
or equivalent collateral to the borrower or placing broker. No
Portfolio presently expects to have on loan at any given time
securities totaling more than one-third of its net asset value.
WHEN-ISSUED SECURITIES
Any Portfolio may enter into commitments to purchase U.S.
Government securities or other securities on a when-issued basis.
A Portfolio may purchase when-issued securities because such
securities are often the most efficiently priced and have the
best liquidity in the bond market. When a Portfolio purchases
securities on a when-issued basis, it assumes the risks of
ownership at the time of purchase, not at the time of receipt.
However, the Portfolio does not have to pay for the obligations
until they are delivered to it. This is normally seven to 15
days later, but could be considerably longer in the case of some
mortgage-backed securities. Depending on market conditions, the
Portfolio's when-issued purchases could, but will not
necessarily, cause its share value to be more volatile, because
they increase the amount by which the Portfolio's total assets,
including the value of the when-issued securities which the
Portfolio has contracted to purchase, exceed its net assets. The
Fund does not expect that any Portfolio's commitment to purchase
when-issued securities will at any time exceed, in the aggregate,
20% of that Portfolio's total assets.
To meet its payment obligation, each Portfolio will establish
a segregated account with its custodian and maintain liquid
assets, such as cash, U.S. Government securities or other
appropriate high-grade debt obligations, in an amount at least
equal in value to that Portfolio's commitments to purchase when-
issued securities. If the value of these assets declines, the
involved Portfolio will place additional liquid assets in the
account on a daily basis so that the value of the assets in the
account is equal to the amount of such commitments.
RESTRICTED AND ILLIQUID SECURITIES
Restricted securities are securities subject to legal or
contractual restrictions on their resale, such as private
placements. Such restrictions might prevent the sale of
restricted securities at a time when sale would otherwise be
desirable. No securities for which there is not a readily
available market ("illiquid assets") will be acquired by any Portfolio
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if such acquisition would cause the aggregate value of
illiquid assets to exceed 10% of the Portfolio's net assets.
Time deposits and repurchase agreements maturing in more than
seven days are also considered illiquid.
Under SEC regulations, certain securities acquired through
private placements can be traded freely among qualified
purchasers. The SEC has stated that an investment company's
board of directors, or its investment adviser acting under
authority delegated by the board, may determine that a security
eligible for trading under this rule is not "illiquid" for
purposes of the limit on the amount of a portfolio's net assets
which may be invested in illiquid assets. The Fund intends to
rely on this rule, to the extent appropriate, to deem specific
securities acquired through private placement as not "illiquid."
The Board has delegated to the adviser the responsibility for
determining whether a particular security eligible for trading
under this rule is illiquid. In making such determinations, the
adviser will consider the following factors the Board has deemed
relevant: the frequency of trades and quotes, the number of
dealers and potential purchasers, the existence of dealer
undertakings to make a market, and the nature of the security and
of marketplace trades. The adviser's consideration of these
factors and determination that a particular security is liquid
remains subject to the Board's continuing oversight. The Board
also reviews at least annually the continuing appropriateness of
these procedures.
Investing in securities eligible for trading under this Rule
could adversely affect the liquidity of a Portfolio, if the
newly-developing markets among qualified purchasers for such
securities do not develop as anticipated, or if such purchasers
become, for a time, uninterested in purchasing these securities.
OPTIONS AND FUTURES; FORWARD CURRENCY EXCHANGE CONTRACTS
The Portfolios may use options to attempt to enhance income
and may also use options and futures contracts for hedging
purposes. The International Portfolio may also use forward
currency contracts for hedging purposes or to attempt to enhance
income.
The Portfolios may purchase and sell call and put options on
bond indices and on securities in which the Portfolio is
authorized to invest for hedging purposes or to enhance income.
The Portfolios may also purchase and sell interest rate and bond
index futures contracts and options thereon for hedging purposes.
In addition, the Portfolios may purchase and sell covered
straddles on options on securities or bond indices or on options
on futures contract on securities or bond indices. The
International Portfolio may also purchase and sell covered
straddles on currency options or on options on currency futures.
The International Portfolio may enter into forward currency
contracts for the purchase or sale of a specified currency at a
specified future date either with respect to specified
transactions or with respect to its portfolio positions. For
example, when Western Asset anticipates making a currency
exchange transaction in connection with the purchase or sale of a
security, the Portfolio may enter into a forward contract in
order to set the exchange rate at which the transaction will be
made. The International Portfolio may enter in to a forward
contract to sell an amount of a foreign currency approximating the
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value of some or all of its security positions denominated in
such currency. It may also engage in cross-hedging by using a
forward contract in one currency to hedge against fluctuations in
the value of securities denominated in a different currency. The
purpose of these contracts is to minimize the risk to the
Portfolio from adverse changes in the relationship between two
currencies.
The International Portfolio may also purchase and sell foreign
currency futures contracts, options thereon and options on
foreign currencies to hedge against the risk of fluctuations in
the market value of foreign securities it holds or intends to
purchase, resulting from changes in foreign exchange rates. The
Portfolio may also purchase and sell options on foreign
currencies and use forward currency contracts to enhance income.
Many options on debt securities are traded primarily on the
over-the-counter ("OTC") market. OTC options differ from
exchange-traded options in that the former are two-party
contracts with price and other terms negotiated between buyer and
seller and generally do not have as much market liquidity as
exchange-traded options. Thus, when a Portfolio purchases an OTC
option, it relies on the dealer from which it has purchased the
option to make or take delivery of the securities underlying the
option. Failure by the dealer to do so would result in the loss
of the premium paid by the Portfolio as well as the loss of the
expected benefit of the transaction. OTC options may be
considered "illiquid securities" for purposes of the Portfolios'
investment limitations. Currency options traded on U.S. or other
exchanges may be subject to position limits which may limit the
ability of a Portfolio to reduce foreign currency risk using such
options.
Most futures exchanges and boards of trade limit the amount of
fluctuation permitted in futures contract prices during a single
day; once the daily limit has been reached on a particular
contract, no trades may be made that day at a price beyond that
limit. In addition, certain of these instruments are relatively
new and without a significant trading history. As a result,
there is no assurance that an active secondary market will
develop or continue to exist. Lack of a liquid market for any
reason may prevent a Portfolio from liquidating an unfavorable
position, and the Portfolio would remain obligated to meet margin
requirements until the position is closed. Purchase of such
instruments for which there is no liquid secondary market will be
subject to the Portfolio's investment limitation on "illiquid
securities."
Each Portfolio will establish segregated accounts or maintain
covering positions when engaging in the above strategies, to the
extent required by the SEC and staff positions. A Portfolio may
write a call or put option only if the option is "covered." A
call option is covered if, so long as the Portfolio is obligated
under the option, it will own an offsetting position in the
underlying security, currency or futures contract, or a right to
obtain the security, currency or futures contract. A put option
is covered if the Portfolio maintains in a segregated account
with the Fund's custodian, cash, or liquid high-quality debt
securities, with a value sufficient to cover its potential
obligations, as marked to market daily.
A Portfolio will incur brokerage fees and related transaction
costs when it purchases or sells futures contracts and premiums
and transaction costs when it buys options.
21<PAGE>
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When a Portfolio purchases or sells a futures contract, the Portfolio is
required to deposit with its custodian (or a broker, if legally permitted)
a specified amount of cash or U.S. Government securities
("initial margin"). A Portfolio will not enter into futures
contracts or commodities option positions if, immediately
thereafter, its initial margin deposits plus premiums paid by it,
less the amount by which any such options positions are "in-the-
money" at the time of purchase, would exceed 5% of the fair
market value of the Portfolio's total assets. If a Portfolio
writes an option or sells a futures contract and is not able to
close out that position prior to settlement date, the Portfolio
may be required to deliver cash or securities substantially in
excess of these amounts.
The Fund might not employ any of the strategies described
above, and there can be no assurance that any strategy used will
succeed. A Portfolio's ability to engage in these practices may
be limited by market conditions, the rules and regulations of the
Commodity Futures Trading Commission, tax considerations and
certain other legal considerations. Moreover, in the event that
an anticipated change in the price of the securities or
currencies that are the subject of the strategy does not occur,
it may be that a Portfolio would have been in a better position
had it not used that strategy at all.
RISKS OF FUTURES, OPTIONS AND FORWARD CONTRACTS. The use of
options, futures and forward currency exchange contracts involves
certain investment risks and transaction costs to which the
Portfolios might not be subject if they did not use such
instruments. These risks include (1) dependence on the adviser's
ability to predict movements in the prices of individual
securities, fluctuations in the general securities markets or in
market sectors and movements in interest rates and currency
markets; (2) imperfect correlation between movements in the price
of options, currencies, futures contracts, forward currency
exchange contracts or options thereon and movements in the price
of the securities or currencies hedged or used for cover; (3) the
fact that skills and techniques needed to trade options, futures
contracts and options thereon or to use forward currency exchange
contracts are different from those needed to select the
securities in which the Portfolios invest; (4) lack of assurance
that a liquid secondary market will exist for any particular
option, futures contract or option thereon at any particular
time; (5) the possibility that the use of cover or segregation
involving a large percentage of a Portfolio's assets could impede
portfolio management or the Portfolio's ability to meet
redemption requests or other short-term obligations; and (6) the
possible need to defer closing out certain options, futures
contracts and options thereon in order to continue to qualify for
the beneficial tax treatment afforded "regulated investment
companies" under the Internal Revenue Code of 1986, as amended
("Code") (see "Additional Tax Information" in the Statement of
Additional Information). The use of options and forward
contracts for speculative purposes, i.e., to enhance income or to
increase a Portfolio's exposure to a particular security or
foreign currency, subjects the Portfolio to additional risk. The
use of futures or forward contracts to hedge an anticipated
purchase (other than a when-issued or delayed delivery purchase),
also subjects the Portfolio to additional risk until the purchase
is completed or the position is closed out. Although the
Portfolio generally will not enter into such anticipatory hedges
without the expectation of completing the transaction, it is only
required to complete 75% of them. If the transaction is not
completed, the risk of the anticipatory hedge is the same as if
the Portfolio had entered into the transaction for speculative purposes.
22<PAGE>
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The Statement of Additional Information contains a more
detailed description of futures, options and forward strategies.
New futures contracts, options thereon and other financial
products and risk management techniques continue to be developed.
The Portfolios may use these investments or techniques to the
extent consistent with their investment objectives and regulatory
and federal tax considerations.
FOREIGN CURRENCY EXCHANGE-RELATED SECURITIES
The International Portfolio may purchase various fixed income
and debt securities, the return on which may be linked or indexed
to relative exchange rates between the U.S. dollar and a foreign
currency or currencies or between foreign currencies. Western
Asset will base its decision for the Portfolio to invest in any
such securities on the same general criteria applicable to the
adviser's decision for the Portfolio to invest in any fixed
income security, including the Portfolio's minimum ratings and
investment quality criteria, with the additional element of
foreign currency exchange rate exposure added to the adviser's
analysis of interest rates and other factors.
CAPITAL APPRECIATION AND RISK
The capital appreciation (or depreciation) of fixed income and
other debt securities is partially a function of changes in the
current level of interest rates. An increase in interest rates
generally reduces the market value of existing fixed income and
other debt securities, while a decline in interest rates
generally increases the market value of such securities. When
interest rates are falling, a Portfolio with a shorter maturity
generally will not generate as high a level of total return as a
portfolio with a longer maturity. Conversely, when interest
rates are rising, a Portfolio with a shorter maturity will
generally outperform longer maturity portfolios. When interest
rates are flat, shorter duration Portfolios generally will not
generate as high a level of total return as longer maturity
portfolios (assuming that long-term interest rates are higher
than short-term rates, which is commonly the case).
Changes in the creditworthiness, or the market's perception of
the creditworthiness, of the issuers of fixed income and other
debt securities will also affect their prices. The market value
of securities denominated in currencies other than the U.S.
dollar will be affected further by movements in foreign currency
exchange rates that may result in overall appreciation or
depreciation of a security regardless of the movement of interest
rates in its trading market.
PORTFOLIO TURNOVER
The turnover rate of the International Portfolio for the
fiscal year ended June 30, 1994 was 571.18%. The Fund
anticipates that the average turnover rate of each Domestic
Portfolio will not exceed 200%. The portfolio turnover rate is
calculated by dividing the lesser of the Portfolio's annual sales
or purchases of portfolio securities (exclusive of purchases or sales of
securities whose maturities at the time of acquisition were one year
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<PAGE>
or less) by the average market value of the
securities in the Portfolio during the year. A Portfolio may
frequently sell fixed income securities and buy ostensibly
similar securities to obtain yield and take advantage of changes
in securities prices, a practice which will tend to increase the
reported turnover rate of the Portfolio. The International
Portfolio's turnover rate for the fiscal year ended June 30, 1994
reflects the volatile nature of international securities markets
during such period. High turnover rates may result in increased
transaction costs and the realization of capital gains. Trading
in fixed income securities does not generally involve the payment
of brokerage commissions, but does involve indirect transaction
costs. For more information on the taxation of distributions
from a Portfolio's capital gains, see "Federal Tax Treatment of
Dividends and Other Distributions." Each Portfolio will take
these possibilities into account as part of its investment
strategy.
PURCHASE OF SHARES
Shares of the Portfolios described in this Prospectus are
available only to clients maintaining separate accounts with
Western Asset or its affiliates, which will place all purchase
orders for shares of the Portfolios on behalf of such clients.
Shares of each Portfolio are sold at the net asset value next
determined after a purchase order in proper form and payment in
federal funds are received by Boston Financial Data Services,
Inc. ("BFDS"), the Fund's transfer and dividend-disbursing agent.
There is no sales charge. Concurrent with the initial purchase
of shares in any Portfolio, Western Asset will open an account
with that Portfolio in the name of the client.
Federal funds purchases will be accepted only on days on
which the Fund and BFDS are open for business. The Fund is "open
for business" on each day the New York Stock Exchange
("Exchange") is open for trading. In past years, the Exchange
has observed the following holidays: New Year's Day, Presidents'
Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving and Christmas.
Shares may also be purchased and paid for by the contribution
of eligible portfolio securities, subject in each case to
approval by the Portfolio's adviser. Approval will depend on,
among other things, the nature and quality of the securities
offered and the current needs of the Portfolio in question.
Securities offered in payment for shares will be valued in the
same way and at the same time the Fund values its portfolio
securities for purposes of determining net asset value. See "How
Net Asset Value is Determined," page 25. Investors who wish to
purchase Fund shares through the contribution of securities
should contact the Fund at (818) 584-4300 for instructions.
Investors who purchase Fund shares through the contribution of
securities should realize that, although the Fund may under some
circumstances distribute portfolio securities rather than cash
upon redemption, they are not likely to receive upon redemption
the same securities that they contributed upon purchase.
Investors should also realize that at the time of contribution
they may be required to recognize a gain or loss for tax purposes
on securities contributed. The Portfolio's adviser will have
full discretion to reject any securities offered as payment for
shares.
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<PAGE>
Certificates for shares will not be issued unless specifically
requested in writing. There is no charge for certificates.
Requests for certificates should be addressed to the Fund.
The Fund reserves the right to reject any order for the
purchase of shares. In addition, the Fund may suspend the
offering of shares at any time and resume it at any time
thereafter.
REDEMPTION OF SHARES
Subject to the terms of each private account client's
investment management agreement with Western Asset Management
Company, Portfolio shares may be redeemed through three methods:
(1) by sending a written request for redemption to Western Asset
Trust, Inc., 117 East Colorado Boulevard, Pasadena, California
91105; (2) by calling the Fund at (818) 584-4300; or (3) by wire
communication with BFDS. No charge is made for redemptions.
Upon receipt of a request for redemption before the close of
business of the Exchange on any day when the Exchange is open,
BFDS, as transfer agent for the Fund, will redeem Portfolio
shares at the net asset value per share determined as of the
close of the Exchange on that day. Requests for redemption
received by the transfer agent after the close of business on the
Exchange will be executed at the net asset value determined as of
the close of the Exchange on its next trading day.
Requests for redemption should indicate:
1. The number of shares or dollar amount to be redeemed
and the investor's shareholder account number;
2. The investor's name and the names of any co-owner of
the account using exactly the same name or names used in
establishing the account;
3. Proof of authorization to request redemption on behalf
of any co-owner of the account (please contact the Fund for
further details); and
4. The name, address, and account number to which the
redemption payment should be sent.
Shares may not be redeemed by telephone or wire if held in
certificate form. Contact the Fund for more information. The
Fund reserves the right to modify or terminate the redemption
procedures upon notice to shareholders.
Payment of the redemption price normally will be made by wire
the next business day after receipt of a redemption request in
good order. However, the Fund reserves the right
25
<PAGE>
to postpone the payment date when the Exchange is closed, when trading is
restricted, or during other periods as permitted by federal
securities laws, or to take up to seven days to make payment upon
redemption if, in the judgment of the adviser, the Portfolio
involved could be adversely affected by immediate payment. Share
prices will fluctuate, and the proceeds of a redemption or
repurchase may be more or less than your original cost.
Shareholders of some investment companies have experienced
difficulty contacting their funds by telephone during periods of
intense market activity. Shareholders who are unable to contact
the Fund by telephone and wish to make a redemption should follow
the instructions for redeeming by mail or by wire.
Other supporting legal documents, such as copies of the trust
instrument or power of attorney, may be required from
corporations or other organizations, fiduciaries or persons other
than the shareholder of record making the request for redemption
or repurchase. If you have a question concerning the sale or
redemption of shares, please contact the Fund or State Street.
HOW NET ASSET VALUE IS DETERMINED
Net asset value per share is determined for each Portfolio
daily as of the close of regular trading on the Exchange
(normally 4:00 p.m., Eastern Time), on every day that the
Exchange is open, by subtracting the Fund's liabilities from its
total assets and dividing the result by the number of shares
outstanding. Portfolio securities are valued on the basis of
market quotations or at fair value as determined under the
guidance of the Board of Directors. Most securities held by the
Portfolios are valued at fair value, primarily on the basis of
valuations furnished by a pricing service which utilizes both
dealer-supplied valuations and electronic data processing
techniques which take into account appropriate factors such as
institutional-size trading in similar groups of securities,
yield, quality, coupon rate, maturity, type of issue, trading
characteristics and other data. Securities for which market
quotations are readily available are valued at the last sale
price of the day for a comparable position, or, in the absence of
any such sales, the last available bid price for a comparable
position. Where a security is traded on more than one market,
which may include foreign markets, the securities are generally
valued on the market considered by the adviser to be the primary
market. Securities with remaining maturities of 60 days or less
are valued at amortized cost. The International Portfolio values
its foreign securities in U.S. dollars on the basis of the then-
prevailing exchange rates.
DIVIDENDS AND OTHER DISTRIBUTIONS
Each Portfolio declares and pays a dividend following the end
of each calendar quarter out of its net investment income for
that quarter. Each will also make an annual distribution of any
net capital gain (the excess of long-term capital gain over
short-term capital loss), net short-term capital gain, and, in
the case of the International Portfolio, gains from certain
foreign currency transactions. The Portfolios may make an
additional distribution if necessary to avoid a 4% excise tax on
certain undistributed income and
26
<PAGE>
capital gain. Dividends paid by a Portfolio are automatically reinvested
in additional shares of that Portfolio, unless the investor requests
payments in cash.
An election to receive dividends or other distributions in
cash rather than additional shares may be made by notifying BFDS
in writing. The election must be received at least ten days
before the payment date in order to be effective for
distributions paid as of that date.
The Fund's Board of Directors reserves the right to revise the
dividend policy or postpone the payment of dividends if warranted
in its judgment due to unusual circumstances, such as an
unexpected large expense, loss or fluctuation in net asset value.
FEDERAL TAX TREATMENT OF DIVIDENDS AND OTHER DISTRIBUTIONS
Each Portfolio is treated as a separate corporation for
federal income tax purposes. Each Domestic Portfolio intends to
qualify, and the International Portfolio intends to continue to
qualify, as a regulated investment company ("RIC") under the Code
so that it will not be subject to federal income tax on that
part of its investment company taxable income (consisting
generally of net investment income, net gains from certain
foreign currency transactions and net short-term capital gain, if
any) and any net capital gain (the excess of net long-term
capital gain over net short-term capital loss) that is
distributed to its shareholders.
Dividends from a Portfolio's investment company taxable income
(whether paid in cash or reinvested in additional Portfolio
shares) are taxable to its shareholders (other than tax-exempt
investors) as ordinary income to the extent of the Portfolio's
earnings and profits. Distributions of a Portfolio's net capital
gain, when designated as such, whether paid in cash or reinvested
in additional Portfolio shares, are taxable to its shareholders
as long-term capital gain, regardless of how long they have held
their shares.
A Portfolio will be subject to a nondeductible 4% excise tax
to the extent it does not distribute by the end of any calendar
year substantially all of its ordinary income for that year and
capital gain net income for the one-year period ending on
October 31 of that year, plus certain other amounts. Each
Portfolio intends to make distributions in amounts that will
avoid imposition of the excise tax.
Each Portfolio sends a notice to each of its shareholders
following the end of each calendar year specifying the amounts of
all income dividends and capital gain distributions paid (or
deemed paid) during that year. Each Portfolio is required to
withhold 31% of all dividends, capital gain distributions and
redemption proceeds payable to any individuals and certain other
noncorporate shareholders who do not provide the Portfolio with a
correct taxpayer identification number or who otherwise are
subject to backup withholding.
A redemption of shares may result in taxable gain or loss to
the redeeming shareholder, depending on whether the redemption
proceeds are more or less than the shareholder's adjusted basis
for the redeemed shares.
27
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The requirements for qualification as a RIC may limit the
extent to which a Portfolio will be able to engage in
transactions in options, futures contracts or forward contracts.
The International Portfolio's dividend and interest income,
and gains realized from disposition of foreign securities, may be
subject to income, withholding or other taxes imposed by foreign
countries and U.S. possessions that would reduce the yield on the
Portfolio's securities. Tax conventions between certain
countries and the United States may reduce or eliminate these
foreign taxes, however, and foreign countries generally do not
impose taxes on capital gains in respect of investments by
foreign investors.
If more than 50% of the value of the International Portfolio's
total assets at the close of its taxable year consists of
securities of foreign corporations, the Portfolio will be
eligible to, and expects to, file an election with the Internal
Revenue Service that will enable its taxable shareholders, in
effect, to receive the benefit of the foreign tax credit with
respect to certain foreign and U.S. possessions income taxes that
may be paid by the Portfolio. Pursuant to the election, the
Portfolio will treat those taxes as dividends paid to its
shareholders and each shareholder will be required to (1) include
in gross income, and treat as paid by him or her, his or her
proportionate share of those taxes, (2) treat his or her share of
those taxes and any dividend paid by the Portfolio that
represents income from foreign or U.S. possessions sources as his
or her own income from those sources and (3) either deduct the
taxes deemed paid by him or her in computing his or her taxable
income or, alternatively, use the foregoing information in
calculating the foreign tax credit against his or her federal
income tax. Not all foreign taxes may be deductible or
creditable, however, because the Portfolio may invest in
securities of companies that are located in countries that impose
taxes for which a federal income tax deduction or credit is not
available. If the Portfolio makes the described election, it
will report to its shareholders shortly after each taxable year
their respective shares of the Portfolio's income from sources
within, and taxes paid to, foreign countries and U.S.
possessions. There can be no assurance, however, that the
Portfolio will be eligible to make such an election.
The foregoing is only a summary of some of the important
federal tax considerations generally affecting the Portfolios and
their shareholders; see the Statement of Additional Information
for a further discussion. In addition to the federal tax
considerations described above, which are applicable to any
investment in a Portfolio, there may be other federal, state or
local tax considerations applicable to a particular investor.
Prospective shareholders are therefore urged to consult their tax
advisers with respect to the effects of this investment on their
own tax situations.
MANAGEMENT OF THE FUND
THE FUND'S INVESTMENT ADVISER
The business and affairs of the Fund are managed under the
direction of its Board of Directors. Pursuant to an investment
advisory and administration agreement with the Fund ("Advisory
Agreement"), which was approved by the Fund's Board of Directors,
Western Asset serves as investment adviser and portfolio manager
for all of the Portfolios
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and is responsible for the day-to-day investment management of the assets
of the Portfolios, including the responsibility for making decisions and
placing orders to buy, sell or hold a particular security.
Western Asset also renders investment advice to the four port-
folios of Legg Mason Income Trust, Inc., to Legg Mason Cash
Reserve Trust, to the Full Range Duration Portfolio and the
Intermediate Duration Portfolio of Western Asset Trust, Inc., to
American Odyssey Long Term Bond Fund, to SEI Limited Volatility
Bond Fund, and to the Capital Market Fund, Inc. U.S. Treasury
Money Market Series, which are registered open-end investment
companies, and to Pacific American Income Shares, a registered
closed-end investment company and Obliflex B fund, registered in
Jersey, Channel Islands. Together, these funds had assets under
management of approximately $2.1 billion as of September 30,
1994. Western Asset also renders investment advice to private
accounts with fixed income assets under management of
approximately $10.3 billion as of that date. Western Asset is a
subsidiary of Legg Mason, Inc., a financial services holding
company, which is also the parent of Legg Mason Fund Adviser,
Inc. The address of Western Asset is 117 East Colorado
Boulevard, Pasadena, California 91105.
Western Asset's International Investment Strategy Group is
responsible for the day-to-day management of the International
Portfolio. The Group has held such responsibility since December
31, 1994.
Portfolio managers have not been appointed for the Domestic
Portfolios, which have not commenced operations (i.e. first begun
to invest their assets in accordance with their investment
objectives) as of the date of this Prospectus.
THE FUND'S ADMINISTRATOR
Legg Mason Fund Adviser, Inc., the Administrator, serves as
the Fund's administrator, pursuant to administration agreements
with Western Asset, which were approved by the Fund's Board of
Directors ("Administration Agreement"). The Administrator
manages the non-investment affairs of the Fund, directs matters
related to the operation of the Fund and provides office space
and administrative staff for the Fund. The Administrator manages
or renders investment advice to nine other open-end investment
companies with a total of fourteen portfolios. These fourteen
funds had aggregate assets under management of about $4.0 billion
as of September 30, 1994. The Administrator also serves as
investment consultant and administrator to Worldwide Value Fund,
Inc., a closed-end investment company with assets of
approximately $54 million as of that date. The Administrator's
address is 111 South Calvert Street, Baltimore, Maryland 21202.
MANAGEMENT AND OTHER EXPENSES
For services under its management agreement, each of the
Domestic Portfolios pays Western Asset a fee, computed daily and
payable monthly, at an annual rate equal to .150% of the
Portfolio's average daily net assets. For services under its
management agreement, the International Portfolio is obligated to
pay Western Asset a fee, computed daily and payable monthly, at
an annual rate equal to .475% of the Portfolio's average
29
<PAGE>
daily net assets. However, Western Asset has waived a portion of such
fees. See "Expense Limitation," page 29. For services under the
Administration Agreements, Western Asset (not the Fund) pays the
Administrator a fee, calculated daily and payable monthly, at an
annual rate equal to .025% of the average daily net assets of
each Domestic Portfolio, and an annual rate of .075% of the
average net assets of the International Portfolio.
Each Portfolio pays all its other expenses which are not
assumed by its adviser or the Administrator. These expenses
include, among others, expenses of preparing and printing
prospectuses, statements of additional information, proxy
statements and reports and of distributing them to existing
shareholders, custodian charges, transfer agency fees,
organizational expenses, compensation of the directors who are
not "interested persons" of the adviser, Administrator or
Distributor as that term is defined in the Investment Company
Act, legal and audit expenses, insurance expenses, expenses of
registering and qualifying shares of the Portfolio for sale under
federal and state law, distribution fees, governmental fees,
expenses incurred in connection with membership in investment
company organizations, interest expense, taxes and brokerage fees
and commissions. The Portfolios also are liable for such
nonrecurring expenses as may arise, including litigation to which
a Portfolio or the Fund may be a party. The Fund may also have
an obligation to indemnify its directors and officers with
respect to litigation.
EXPENSE LIMITATION. Western Asset has voluntarily agreed to
waive its fees or reimburse each of the Domestic Portfolios to
the extent the Portfolio's expenses (exclusive of taxes,
interest, brokerage and other transaction expenses and any
extraordinary expenses) exceed during any month an annual
percentage rate equal to .25% of the Portfolio's average daily
net assets, and Western Asset has voluntarily agreed to waive its
fees or reimburse the International Portfolio to the extent that
Portfolio's expenses (exclusive of taxes, interest, brokerage and
other transaction expenses and any extraordinary expenses) exceed
during any month an annual percentage rate equal to .85% of that
Portfolio's average daily net assets. These waiver and
reimbursement agreements expired June 30, 1994, but were extended
by Western Asset until December 31, 1994. In addition, Western
Asset has voluntarily waived for calendar year 1994 all of its
fees for services to the International Portfolio under its
management agreement, other than the portion of such fee equal to
the fee paid by Western Asset to the Administrator (at an annual
rate of .075% of average net assets) for services to the
International Portfolio under the Administration Agreement.
A Portfolio may reimburse its adviser for fees foregone or
expenses reimbursed by them pursuant to the expense limitation if
expenses fall below the limit prior to the end of the fiscal
year.
THE FUND'S DISTRIBUTOR
Legg Mason Wood Walker, Incorporated ("Distributor") is
authorized to distribute the Portfolios' shares pursuant to an
underwriting agreement with the Fund which was approved by the
Board of Directors ("Underwriting Agreement"). The Distributor
or its affiliates is obligated to pay all expenses in connection
with the offering of Fund shares,
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including any compensation to its investment brokers, the printing and
distribution of prospectuses, statements of additional information and
periodic reports used in connection with the offering to prospective
investors, after the prospectuses and statements of additional
information have been prepared, set in type and mailed to
existing shareholders at the Fund's expense, and for
supplementary sales literature and advertising costs. The
Distributor receives no direct compensation from the Fund for
these expenses. The Distributor is a wholly owned subsidiary of
Legg Mason, Inc.
THE FUND'S CUSTODIAN AND TRANSFER AGENT
State Street Bank and Trust Company ("State Street") serves as
custodian of the Fund's assets and BFDS serves as its transfer
agent and dividend disbursing agent. The duties of State Street
and BFDS include processing requests for the purchase or
redemption of shares and performing other administrative services
on behalf of the Fund.
Pursuant to rules adopted under Section 17(f) of the
Investment Company Act, the International Portfolio may maintain
foreign securities and cash in the custody of certain eligible
foreign banks and securities depositories. Selection of these
foreign custodial institutions is made by the Board of Directors
in accordance with SEC rules. The Board of Directors will
consider a number of factors, including, but not limited to, the
relationship of the institution to State Street, the reliability
and financial stability of the institution, the ability of the
institution to capably perform custodial services for the Fund,
the reputation of the institution in its national market, the
political and economic stability of the countries in which the
sub-custodians will be located and risks of potential
nationalization or expropriation of Fund assets. No assurance
can be given that the Board of Directors' appraisal of the risks
in connection with foreign custodial arrangements will always be
correct or that expropriation, nationalization, freezes, or
confiscation of Fund assets will not occur.
OTHER INFORMATION
DESCRIPTION OF THE FUND
The Fund may establish additional Portfolios in the future.
The Fund has authorized capital of a total of five billion shares
of common stock at par value $0.001. Each of the Portfolios
described herein has an initial authorized capital of one billion
shares. All shares are the same class, and each share is entitled
to one vote on any matter submitted to a shareholder vote.
Fractional shares have fractional voting rights. Voting rights
are not cumulative. Voting on matters pertinent only to a
particular Portfolio, such as the adoption of an investment
advisory contract for that Portfolio, is limited to that
Portfolio's shareholders. All shares of the Fund are fully paid
and nonassessable and have no preemptive or conversion rights.
Although the Fund does not intend to hold annual shareholder meetings,
it will hold a special meeting of shareholders when the Investment
Company Act requires a shareholder vote on certain matters (including
the election of directors or approval of an advisory contract). The Fund
will also call a special meeting of shareholders at the
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request of 25% or more of the shares entitled
to vote thereat, or, as required by the Act, at the request of
10% of the shareholders for the purpose of considering the
removal of one or more directors. Shareholders wishing to call
such a meeting should submit a written request to the Fund at 117
East Colorado Blvd., Pasadena, California 91105, stating the
purpose of the proposed meeting and the matters to be acted upon.
As of October 3, 1994, Northern Trust Company, as trustee, and
Bankers Trust Company of California, N.A., may be deemed to
"control" the International Securities Portfolio, as that term is
defined in the 1940 Act. Prior to the initial public offering of
a Portfolio's shares, the adviser will be the sole shareholder of
each Portfolio and is thus a controlling person, as that term is
defined in the 1940 Act, of each Portfolio.
CONFIRMATIONS AND REPORTS
BFDS will send to each shareholder or its agent monthly
confirmations showing all purchases and redemptions of shares
made, and all dividends and other distributions paid, during the
previous month. Reports will be sent to shareholders or their
agents at least semiannually showing the Fund's investments and
other information. Shareholders or their agents will also
receive each year an annual report containing financial
statements audited by the Fund's independent accountants.
Shareholder inquiries should be addressed to "Western Asset
Trust, Inc., 117 East Colorado Blvd., Pasadena, California
91105."
PERFORMANCE INFORMATION
From time to time, each Portfolio may quote its total return
in marketing materials or in reports or other communications to
shareholders. A mutual fund's "total return" is a measurement of
the overall change in value, including changes in share price and
assuming reinvestment of dividends and capital gain
distributions, of an investment in the fund. "Cumulative total
return" shows a fund's performance over a specific period of
time. "Average annual total return" is the average annual
compounded return that would have produced the same cumulative
total return if the fund's performance had been constant over the
entire period. Because average annual returns tend to smooth out
variations in a fund's return, they differ from actual year-by-
year results.
Investors should consider all performance information in light
of a Portfolio's investment objectives and policies,
characteristics of the Portfolio and the existing market
conditions during the time period indicated. Performance
information is based on historical performance only and should
not be viewed as representative of the Portfolio's future
performance. The investment return and principal value of an
investment in a Portfolio will fluctuate so that an investor's
shares, when redeemed, may be worth more or less than their
original cost.
Performance information for a Portfolio may be compared to
various unmanaged indices, such as the Salomon Brothers Corporate
Index, the Salomon Brothers Mortgage
32
<PAGE>
Index and the Salomon Brothers World Government Bond Index (Ex U.S.).
Such indices of securities prices generally do not reflect deductions for
administrative and management costs and expenses.
33<PAGE>
<PAGE>
INVESTMENT ADVISER
Western Asset Management Company
117 East Colorado Boulevard
Pasadena, CA 91105
ADMINISTRATOR
Legg Mason Fund Adviser, Inc.
111 South Calvert Street
Baltimore, MD 21202
DISTRIBUTOR
Legg Mason Wood Walker, Inc.
111 South Calvert Street
Baltimore, MD 21202
CUSTODIAN
State Street Bank & Trust Company
P.O. Box 1790
Boston, MA 02105
TRANSFER AGENT
Boston Financial Data Services, Inc
2 Heritage Drive
North Quincy, MA 02171
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
7 St. Paul Street
Baltimore, MD 21202
LEGAL COUNSEL
Munger, Tolles & Olson
355 South Grand Avenue, 35th Floor
Los Angeles, CA 90071-1560
Prospectus
December 31, 1994
34<PAGE>
<PAGE>
APPENDIX
The Fund may use the following hedging instruments:
OPTIONS ON DEBT SECURITIES AND FOREIGN CURRENCIES - A call
option is a short-term contract pursuant to which the purchaser
of the option, in return for a premium, has the right to buy the
security or currency underlying the option at a specified price
at any time during the term of the option. The writer of the
call option, who receives the premium, has the obligation, upon
exercise of the option during the option term, to deliver the
underlying security or currency against payment of the exercise
price. A put option is a similar contract that gives its
purchaser, in return for a premium, the right to sell the
underlying security or currency at a specified price during the
option term. The writer of the put option, who receives the
premium, has the obligation, upon exercise of the option during
the option term, to buy the underlying security or currency at
the exercise price.
INTEREST RATE AND FOREIGN CURRENCY FUTURES CONTRACTS -
Interest rate and foreign currency futures contracts are
bilateral agreements pursuant to which one party agrees to make,
and the other party agrees to accept, delivery of a specified
type of debt security or currency at a specified future time and
at a specified price. Although such futures contracts by their
terms call for actual delivery or acceptance of debt securities
or currency, in most cases the contracts are closed out before
the settlement date without the making or taking of delivery.
OPTIONS ON FUTURES CONTRACTS - Options on futures contracts
are similar to options on securities or currency, except that an
option on a futures contract gives the purchaser the right, in
return for the premium, to assume a position in a futures
contract (a long position if the option is a call and a short
position if the option is a put), rather than to purchase or sell
a security or currency, at a specified price at any time during
the option term. Upon exercise of the option, the delivery of
the futures position to the holder of the option will be
accompanied by delivery of the accumulated balance that
represents the amount by which the market price of the futures
contract exceeds, in the case of a call, or is less than, in the
case of a put, the exercise price of the option on the future.
The writer of an option, upon exercise, will assume a short
position in the case of a call and a long position in the case of
a put.
FORWARD CURRENCY CONTRACTS - A forward currency contract
involves an obligation to purchase or sell a specific currency at
a specified future date, which may be any fixed number of days
from the contract date agreed upon by the parties, at a price set
at the time the contract is entered into.
A-1<PAGE>
<PAGE>
WESTERN ASSET TRUST, INC.
CORPORATE SECURITIES PORTFOLIO
MORTGAGE SECURITIES PORTFOLIO
INTERNATIONAL SECURITIES PORTFOLIO
STATEMENT OF ADDITIONAL INFORMATION
Western Asset Trust, Inc. ("Fund") is a no-load, open-end
management investment company currently consisting of nine
separate professionally managed investment portfolios. Each of
the three Portfolios described in this Statement of Additional
Information ("Portfolios") seeks maximum total return, consistent
with prudent investment management by investing primarily in
securities of the types specified for that Portfolio. The
Portfolios differ from one another primarily in the proportion of
assets invested in certain types of securities. Also, the
Corporate Securities and Mortgage Securities Portfolios
("Domestic Portfolios") are diversified Portfolios. The
International Portfolio is non-diversified.
This Statement of Additional Information is not a prospectus
and should be read in conjunction with the Prospectus for the
Portfolios, dated December 31, 1994, which has been filed with
the Securities and Exchange Commission ("SEC"). Copies of the
Fund's Prospectus are available without charge from the Fund at
(818) 584-4300.
Dated: December 31, 1994<PAGE>
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
Additional Information About Investment Limitations and Policies 3
Valuation of Portfolio Shares 23
Management of the Fund 24
Principal Holders of Securities 30
Purchases and Redemptions 32
Portfolio Transactions and Brokerage 32
Additional Tax Information 33
Other Information 36
Financial Statements 37
Appendix A - Ratings of Securities A-1
</TABLE>
2<PAGE>
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ADDITIONAL INFORMATION ABOUT INVESTMENT LIMITATIONS AND POLICIES
In addition to the investment objective of each Portfolio
described in the Prospectus, the Fund has adopted certain
fundamental investment limitations for each Portfolio that cannot
be changed except by vote of the holders of a majority of the
outstanding voting securities of the affected Portfolio. No
Portfolio may:
1. Borrow money or issue senior securities, except that
a Portfolio may borrow from banks or enter into reverse
repurchase agreements and dollar rolls, provided that,
immediately after such borrowing, the total amount borrowed by
the Portfolio, including reverse repurchase agreements and dollar
rolls, does not exceed 33 1/3% of its total assets (including the
amount borrowed) less liabilities (other than the borrowings);
and provided further that any Portfolio may enter into
transactions in options, futures, options on futures and forward
foreign currency contracts;
2. Mortgage, pledge, hypothecate or in any manner
transfer, as security for indebtedness, any securities owned or
held by the Portfolio, except as may be necessary in connection
with permitted borrowings, provided that this limitation does not
prohibit escrow, collateral or margin arrangements in connection
with the Portfolio's use of options, futures contracts, options
on futures contracts, forward foreign currency contracts, when-
issued securities, reverse repurchase agreements, dollar rolls,
or similar investment techniques;
3. Invest more than 5% of its total assets (taken at
market value) in securities of any one issuer, or buy 10% or more
of all the securities of any one issuer, except that up to 25% of
a Domestic Portfolio's total assets and up to 50% of the
International Portfolio's total assets may be invested without
regard to this limitation, and provided that this limitation does
not apply to securities issued or guaranteed by the U.S.
Government, its agencies and instrumentalities;
4. Purchase securities on margin, except for short-term
credits necessary for clearance of Portfolio transactions and
except that a Portfolio may make margin deposits in connection
with its use of options, futures contracts, options on futures
contracts and forward foreign currency contracts;
5. Invest 25% or more of its total assets (taken at
market value) in any one industry, provided that this limitation
does not apply to securities issued or guaranteed by the U.S.
Government, its agencies or instrumentalities, or repurchase
agreements thereon. The Mortgage Securities Portfolio will under
normal circumstances invest more than 25% of its total assets in
mortgage-backed and other asset-backed securities (including, for
this purpose, securities issued or guaranteed by the U.S.
Government, its agencies and instrumentalities, and repurchase
agreements with respect thereto);
6. Purchase or sell commodities or commodity contracts, except
that a Portfolio may purchase or sell futures on securities and bond
indices, options on the foregoing, and options on securities and
bond indices; and except that the International Securities
3
<PAGE>
Portfolio may also purchase and sell foreign currencies, forward
foreign currency contracts, options and futures on foreign currencies
and options on such futures;
7. Underwrite securities of other issuers, except to the
extent that, in connection with the disposition of portfolio
securities, a Portfolio may be deemed an underwriter under the
federal securities laws;
8. Make loans, except loans of portfolio securities and
except to the extent that the purchase of an issue of debt
securities, other evidences of indebtedness or deposits with
banks and other financial institutions may be considered loans;
9. Purchase or sell real estate or interests in real
estate limited partnerships, provided that a Portfolio may invest
in securities secured by, or issued by companies that invest in,
real estate or interests therein, including real estate
investment trusts; or
10. Invest in oil, gas or mineral-related programs or
leases, provided that a Portfolio may invest in securities issued
by companies that engage in such activities.
The foregoing investment limitations cannot be changed
without the affirmative vote of the lesser of (1) more than 50%
of the outstanding shares of the affected Portfolio or (2) 67% or
more of the shares of the affected Portfolio present at a
shareholders' meeting if more than 50% of the outstanding shares
of that Portfolio are represented at the meeting in person or by
proxy. Except with respect to investment limitation number 1, if
a percentage restriction is adhered to at the time of an
investment or transaction, a later increase or decrease in
percentage resulting from a change in the value of portfolio
securities or amount of total assets will not be considered a
violation of any of the foregoing limitations.
Except as otherwise specified, the investment limitations
and policies which follow may be changed by the Fund's Board of
Directors without shareholder approval.
RATINGS OF DEBT OBLIGATIONS
Moody's Investors Service, Inc. ("Moody's"), Standard &
Poor's Ratings Group ("S&P") and other nationally recognized or
foreign statistical rating organizations ("SROs") are private
organizations that provide ratings of the credit quality of debt
obligations. A description of the ratings assigned to corporate
debt obligations by Moody's and S&P is included in Appendix A. A
Portfolio may consider these ratings in determining whether to
purchase, sell or hold a security. Ratings are not absolute
assurances of quality. Consequently, securities with the same
maturity, interest rate and rating may have different market
prices. Credit rating agencies attempt to evaluate the safety of
principal and interest payments and do not evaluate the risks of
fluctuations in market value. Also, rating agencies may fail to
make timely changes in credit ratings in response to subsequent
events, so that an issuer's current financial condition may be better
or worse than the rating indicates. Subsequent to its purchase by a
Portfolio, an issue of securities may cease to be rated or its rating may
be reduced below the minimum rating required for purchase by the
Portfolio. Western Asset Management Company ("Western Asset"),
4<PAGE>
<PAGE>
adviser to the Portfolios, will consider such an event in determining
whether the Portfolio should continue to hold the obligation.
MORTGAGE-RELATED SECURITIES
Mortgage-related securities represent participations in,
or are secured by and payable from, mortgage loans secured by
real property. These securities are designed to provide monthly
payments of interest and, in most instances, principal to the
investor. The mortgagor's monthly payments to his/her lending
institution are "passed through" to investors such as the
Portfolios. Many issuers or poolers provide guarantees of
payments, regardless of whether the mortgagor actually makes the
payment. These guarantees are often backed by various forms of
credit, insurance and collateral, although these may be in
amounts less than the full obligation of the pool to its
shareholders.
Pools consist of whole mortgage loans or participations
in loans. The majority of these loans are made to purchasers of
one- to four-family homes. The terms and characteristics of the
mortgage instruments are generally uniform within a pool but may
vary among pools. In addition to fixed-rate, fixed-term
mortgages, the Portfolios may purchase pools of variable-rate
mortgages, growing-equity mortgages, graduated-payment mortgages
and other types.
All poolers apply standards for qualification to lending
institutions which originate mortgages for the pools. Poolers
also establish credit standards and underwriting criteria for
individual mortgages included in the pools. In addition, many
mortgages included in pools are insured through private mortgage
insurance companies.
The average life of mortgage-related securities varies
with the maturities and the nature of the underlying mortgage
instruments. For example, securities issued by the Government
National Mortgage Association ("GNMAs") tend to have a longer
average life than participation certificates ("PCs") issued by
the Federal Home Loan Mortgage Corporation ("FHLMC") because
there is a tendency for the conventional and privately-insured
mortgages underlying FHLMC PCs to repay at faster rates than the
Federal Housing Administration and Veterans Administration loans
underlying GNMAs. In addition, the term of a security may be
shortened by unscheduled or early payments of principal and
interest on the underlying mortgages. The occurrence of mortgage
prepayments is affected by factors including the level of
interest rates, general economic conditions, the location and age
of the mortgage and other social and demographic conditions.
Yields on mortgage-related securities are typically
quoted based on the maturity of the underlying instruments and
the associated average life assumption. Actual prepayment
experience may cause the yield to differ from the yield expected
on the basis of average life. The compounding effect from
reinvestments of monthly payments received by each Portfolio will
increase the yield to shareholders compared to bonds that pay
interest semi-annually.
5<PAGE>
<PAGE>
PRIVATE MORTGAGE-RELATED SECURITIES
Certain private mortgage pools are organized in such a
way that the SEC staff considers them to be closed-end investment
companies. Each Portfolio's investment in such pools is
constrained by federal statute, which restricts investments in
the shares of other investment companies.
The private mortgage-related securities in which the
International Securities Portfolio may invest include foreign
mortgage pass-through securities ("Foreign Pass-Throughs"), which
are structurally similar to the pass-through instruments
described above. Such securities are issued by originators of
and investors in mortgage loans, including savings and loan
associations, mortgage bankers, commercial banks, investment
bankers, specialized financial institutions and special purpose
subsidiaries of the foregoing. Foreign Pass-Throughs usually are
backed by a pool of fixed rate or adjustable-rate mortgage loans.
The Foreign Pass-Throughs in which the International Portfolio
may invest typically are not guaranteed by an entity having the
credit status of the Government National Mortgage Association,
but generally utilize various types of credit enhancement.
ASSET-BACKED SECURITIES
Asset-backed securities are structurally similar to
mortgage-backed securities, but are secured by interests in a
different type of receivable. Asset-backed securities therefore
present certain risks that are not presented by mortgage-related
debt securities or other securities in which the Fund may invest.
Primarily, these securities do not have the benefit of the same
security interest in the related collateral. Credit card
receivables are generally unsecured and the debtors are entitled
to the protection of a number of state and federal consumer
credit laws, many of which give such debtors the right to set off
certain amounts owed on the credit cards, thereby reducing the
balance due. Most issuers of automobile receivables permit the
servicers to retain possession of the underlying obligations. If
the servicer were to sell these obligations to another party,
there is a risk that the purchaser would acquire an interest
superior to that of the holders of the related automobile
receivables. In addition, because of the large number of
vehicles involved in a typical issuance and technical
requirements under state laws, the trustee for the holders of the
automobile receivables may not have proper security interest in
all of the obligations backing such receivables. Therefore,
there is the possibility that recoveries on repossessed
collateral may not, in some cases, be available to support
payments on these securities. Because asset-backed securities
are relatively new, the market experience in these securities is
limited and the market's ability to sustain liquidity through all
phases of the market cycle has not been tested.
NON-GOVERNMENTAL FIXED INCOME AND OTHER DEBT SECURITIES
A Portfolio's investments in U.S. dollar-denominated or foreign
currency-denominated fixed income and other debt securities of
non-governmental domestic or foreign issuers are limited to fixed
income or other debt securities (bonds, debentures, notes and other
similar instruments) which meet the minimum ratings criteria set forth for
6<PAGE>
<PAGE>
the Portfolio or, if unrated, are judged by that Portfolio's adviser
to be of comparable quality to fixed income or other debt securities in
which the Portfolio may invest. The rate of return or return of
principal on some obligations may be linked or indexed to the
level of exchange rates between the U.S. dollar and a foreign
currency or currencies.
Where one rating organization has assigned an investment
grade rating to an instrument and others have given it a lower
rating, the Fund may consider the instrument to be investment
grade. The market for lower-rated securities may be thinner and
less active than that for higher-rated securities, which can
adversely affect the prices at which these securities can be
sold, and may make it difficult for a Portfolio to obtain market
quotations daily. If market quotations are not available, these
securities will be valued by a method that the Fund's Board of
Directors believes accurately reflects fair market value.
Judgment may play a greater role in valuing lower-rated debt
securities than is the case with respect to securities for which
a broader range of dealer quotations and last-sale information
are available.
Although the prices of lower-rated bonds are generally
less sensitive to interest rate changes than are higher-rated
bonds, the prices of lower-rated bonds may be more sensitive to
adverse economic changes and developments regarding the
individual issuer. Although the market for lower-rated debt
securities is not new, and the market has previously weathered
economic downturns, there has been in recent years a substantial
increase in the use of such securities to fund corporate
acquisitions and restructurings. Accordingly, the past
performance of the market for such securities may not be an
accurate indication of its performance during future economic
downturns or periods of rising interest rates.
BANK OBLIGATIONS
Bank obligations in which the Portfolios may invest
include certificates of deposit, bankers' acceptances and time
deposits in U.S. banks (including foreign branches) which have
more than $1 billion in total assets at the time of investment
and are members of the Federal Reserve System or are examined by
the Comptroller of the Currency or whose deposits are insured by
the Federal Deposit Insurance Corporation. A Portfolio also may
invest in certificates of deposit of savings and loan
associations (federally or state chartered and federally insured)
having total assets in excess of $1 billion.
The International Portfolio may invest in obligations of
domestic or foreign branches of foreign banks and foreign
branches of domestic banks. These investments involve risks that
are different from investments in securities of domestic branches
of domestic banks. These risks include seizure of foreign
deposits, currency controls, interest limitations or other
governmental restrictions which might affect the payment of
principal or interest on the bank obligations held by the
Portfolio.
The International Securities Portfolio limits its investments
in foreign bank obligations to U.S. dollar-denominated or foreign
currency-denominated obligations of foreign banks (including U.S.
branches of foreign banks) which at the time of investment
7<PAGE>
<PAGE>
(1) have more than $10 billion, or the
equivalent in other currencies, in total assets; (2) have
branches or agencies (limited purpose offices which do not offer
all banking services) in the United States; and (3) are judged by
Western Asset to be of comparable quality to obligations of U.S.
banks in which the Portfolios may invest. Subject to the
limitation on concentration of less than 25% of the Portfolio's
assets in the securities of issuers in a particular industry,
there is no limitation on the amount of the International
Portfolio's assets which may be invested in obligations of
foreign banks which meet the conditions set forth herein.
Foreign banks are not generally subject to examination by any
U.S. Government agency or instrumentality.
RESTRICTED AND ILLIQUID SECURITIES
Each Portfolio is authorized to invest up to 10% of its
net assets in securities for which no readily available market
exists, which for this purpose includes, among other things,
repurchase agreements maturing in more than seven days, OTC
options and securities used as cover for such options.
Restricted securities may be sold only (1) pursuant to SEC Rule
144A or other exemption, (2) in privately negotiated transactions
or (3) in public offerings with respect to which a registration
statement is in effect under the Securities Act of 1933. Such
securities may include those that are subject to restrictions
contained in the securities laws of other countries. Securities
that are freely marketable in the country where they are
principally traded, but would not be freely marketable in the
United States, will not be subject to this 10% limit. Where
registration is required, a Portfolio 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 Portfolio may be permitted to sell a security under an
effective registration statement. If, during such a period,
adverse market conditions were to develop, the Portfolio might
obtain a less favorable price than prevailed when it decided to
sell.
REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWING
Each Portfolio may borrow for temporary or emergency
purposes. This borrowing may be unsecured. The Investment
Company Act of 1940 ("1940 Act") requires a Portfolio to maintain
continuous asset coverage (that is, total assets including
borrowings, less liabilities exclusive of borrowings) of at least
300% of the amount borrowed. If the asset coverage should
decline below 300% as a result of market fluctuations or for
other reasons, a Portfolio may be required to sell some of its
holdings within three days (exclusive of Sundays and holidays) to
reduce the debt and restore the 300% asset coverage, even though
it may be disadvantageous from an investment standpoint to sell
securities at that time. Borrowing may exaggerate the effect on
net asset value of any increase or decrease in the market value
of the Portfolio. To avoid the potential leveraging effects of a
Portfolio's borrowings, a Portfolio will not make investments
while borrowings are in excess of 5% of the Portfolio's assets. Money
borrowed will be subject to interest costs which may or may not be
recovered by appreciation of the securities purchased. A Portfolio also
may be required to maintain minimum average balances in connection with
such borrowing or to pay a commitment or other fee to maintain a line
of credit; either of these requirements would increase the
8<PAGE>
<PAGE>
cost of borrowing over the stated interest rate. For purposes of its
borrowing limitation and policies, the Fund considers reverse
repurchase agreements to be borrowing.
SHORT SALES
The Portfolios do not currently intend to sell securities
short, other than through the use of futures and options as
described in the Prospectus. No Portfolio is permitted to engage
in short sales unless it simultaneously owns, or has the right to
acquire, securities identical in kind and amount to those sold
short.
SOVEREIGN DEBT
Investments in debt securities issued by foreign
governments and their political subdivisions or agencies
("Sovereign Debt") involve special risks. The issuer of the debt
or the governmental authorities that control the repayment of the
debt may be unable or unwilling to repay principal and/or
interest when due in accordance with the terms of such debt, and
the International Portfolio may have limited legal recourse in
the event of a default.
Sovereign Debt differs from debt obligations issued by
private entities in that, generally, remedies for defaults must
be pursued in the courts of the defaulting party. Legal recourse
is therefore somewhat diminished. Political conditions,
especially a sovereign entity's willingness to meet the terms of
its debt obligations, are of considerable significance. Also,
there can be no assurance that the holders of commercial bank
debt issued by the same sovereign entity may not contest payments
to the holders of Sovereign Debt in the event of default under
commercial bank loan agreements.
A sovereign debtor's willingness or ability to repay
principal and interest due in a timely manner may be affected by,
among other factors, its cash flow situation, the extent of its
foreign reserves, the availability of sufficient foreign exchange
on the date a payment is due, the relative size of the debt
service burden to the economy as a whole, the sovereign debtor's
policy toward principal international lenders and the political
constraints to which a sovereign debtor may be subject.
Increased protectionism on the part of a country's trading
partners, or political changes in those countries, could also
adversely affect its exports. Such events could diminish a
country's trade account surplus, if any, or the credit standing
of a particular local government or agency.
The occurrence of political, social or diplomatic changes
in one or more of the countries issuing Sovereign Debt could
adversely affect the International Portfolio's investments.
Political changes or a deterioration of a country's domestic
economy or balance of trade may affect the willingness of
countries to service their Sovereign Debt. While Western Asset
intends to manage investments in a manner that will minimize the
exposure to such risks, there can be no assurance that adverse
political changes will not cause the Portfolio to suffer a loss
of interest or principal on any of its holdings.
9<PAGE>
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OPTIONS AND FUTURES
In pursuing their individual investment objectives the
Portfolios may, as described in the Prospectus, purchase and sell
(write) both put options and call options on securities and bond
indices, may enter into futures contracts on fixed income
instruments and may purchase and sell options on such futures
contracts ("futures options") for hedging purposes or in other
circumstances permitted by the Commodity Futures Trading
Commission ("CFTC") as part of each Portfolios' investment
strategy. In addition, the International Portfolio may purchase
and sell put and call options on foreign currencies, may enter
into futures contracts on foreign currencies and purchase and
sell options on such futures contracts. If other types of
options, futures contracts or options on futures are traded in
the future, a Portfolio may also use those investment strategies.
OPTIONS ON SECURITIES
A Portfolio may purchase call options on securities that
its adviser intends to include in the Portfolio's investment
portfolio in order to fix the cost of a future purchase. Call
options also may be used as a means of participating in an
anticipated price increase of a security on a more limited risk
basis than would be possible if the security itself were
purchased. In the event of a decline in the price of the
underlying security, use of this strategy would serve to limit
the Portfolio's potential loss to the option premium paid;
conversely, if the market price of the underlying security
increases above the exercise price and the Portfolio either sells
or exercises the option, any profit realized will be reduced by
the premium.
A Portfolio may purchase put options in order to hedge
against a decline in the market value of securities held in its
portfolio or to enhance income. The put option enables a
Portfolio to sell the underlying security at the predetermined
exercise price; thus the potential for loss to the Portfolio
below the exercise price is limited to the option premium paid.
If the market price of the underlying security is higher than the
exercise price of the put option, any profit the Portfolio
realizes on the sale of the security would be reduced by the
premium paid for the put option less any amount for which the put
option may be sold.
A Portfolio may write covered call options on securities
in which it is authorized to invest. Because it can be expected
that a call option will be exercised if the market value of the
underlying security increases to a level greater than the
exercise price, a Portfolio might write covered call options on
securities generally when its adviser believes that the premium
received by the Portfolio will exceed the extent to which the
market price of the underlying security will exceed the exercise
price. The strategy may be used to provide limited protection
against a decrease in the market price of the security, in an
amount equal to the premium received for writing the call option
less any transaction costs. Thus, in the event that the market
price of the underlying security held by the Portfolio declines,
the amount of such decline will be offset wholly or in part by
the amount of the premium received by the Portfolio. If,
however, there is an increase in the market price of the
underlying security and the option is exercised, the Portfolio would be
10<PAGE>
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obligated to sell the security at less than its market
value. The Portfolio would give up the ability to sell the
portfolio securities used to cover the call option while the call
option was outstanding. Such securities would also be considered
illiquid in the case of over-the-counter ("OTC") options written
by a Portfolio, and therefore subject to a Portfolio's limitation
on investing no more than 10% of its total assets in illiquid
securities. In addition, a Portfolio could lose the ability to
participate in an increase in the value of such securities above
the exercise price of the call option because such an increase
would likely be offset by an increase in cost of closing out the
call option (or could be negated if the buyer chose to exercise
the call option at an exercise price below the securities'
current market value).
A Portfolio may purchase put and call options and write
covered put and call options on bond indices in much the same
manner as securities options, except that bond index options may
serve as a hedge against overall fluctuations in the debt
securities markets (or a market sector) rather than anticipated
increases or decreases in the value of a particular security. A
bond index assigns a value to the securities included in the
index and fluctuates with changes in such values. Settlements of
bond index options are effected with cash payments and do not
involve the delivery of securities. Thus, upon settlement of a
bond index option, the purchaser will realize, and the writer
will pay, an amount based on the difference between the exercise
price and the closing price of the bond index. The effectiveness
of hedging techniques using bond index options will depend on the
extent to which price movements in the bond index selected
correlate with price movements of the securities in which the
Portfolio invests.
A Portfolio may purchase and write covered straddles on
securities, currencies or bond indices. A long straddle is a
combination of a call and a put option purchased on the same
security where the exercise price of the put is less than or
equal to the exercise price of the call. A Portfolio would enter
into a long straddle when its adviser believes that it is likely
that interest rates or currency exchange rates will be more
volatile during the term of the options than the option pricing
implies. A short straddle is a combination of a call and a put
written on the same security where the exercise price of the put
is less than or equal to the exercise price of the call and where
the same issue of security or currency is considered cover for
both the put and the call. A Portfolio would enter into a short
straddle when its adviser believes that it is unlikely that
interest rates or currency exchange rates will be as volatile
during the term of the options as the option pricing implies. In
such case, the Portfolio will set aside cash and/or liquid, high
grade debt securities in a segregated account with its custodian
equivalent in value to the amount, if any, by which the put is
in-the-money, that is, the amount by which the exercise price of
the put exceeds the current market value of the underlying
security.
FOREIGN CURRENCY OPTIONS AND RELATED RISKS.
The International Portfolio may purchase and write (sell)
options on foreign currencies in order to hedge against the risk
of foreign exchange rate fluctuation on foreign securities the
Portfolio holds or which it intends to purchase. For example, if
the Portfolio enters into a contract to purchase securities
denominated in a foreign currency, it could effectively fix the
maximum U.S. dollar cost of the securities by purchasing call
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options on that foreign currency. Similarly, if the Portfolio
held securities denominated in a foreign currency and anticipated
a decline in the value of that currency against the U.S. dollar,
it could hedge against such a decline by purchasing a put option
on the currency involved. The purchase of an option on foreign
currency may be used to hedge against fluctuations in exchange
rates although, in the event of exchange rate movements adverse
to the Portfolio's position, it may forfeit the entire amount of
the premium plus related transaction costs. In addition, the
Portfolio may purchase call options on foreign currency to
enhance income when its adviser anticipates that the currency
will appreciate in value, but the securities denominated in that
currency do not present attractive investment opportunities.
If the International Portfolio writes an option on
foreign currency, it will constitute only a partial hedge, up to
the amount of the premium received, and the Portfolio could be
required to purchase or sell foreign currencies at
disadvantageous exchange rates, thereby incurring losses. The
Portfolio may use options on currency to cross-hedge, which
involves writing or purchasing options on one currency to hedge
against changes in exchange rates of a different, but related,
currency.
The International Portfolio's ability to establish and
close out positions on such options is subject to the maintenance
of a liquid secondary market. Although many options on foreign
currencies are exchange trades, the majority are traded on the
OTC market. The Portfolio will not purchase or write such
options unless, in the opinion of its adviser, the market for
them has developed sufficiently. The Portfolio may use foreign
currency options traded on a commodities exchange only for
hedging purposes or in other circumstances permitted by the CFTC.
There can be no assurance that a liquid secondary market will
exist for a particular option at any specific time. In addition,
options on foreign currencies are affected by all of those
factors that influence foreign exchange rates and investments
generally. These OTC options also involve credit risks which may
not be present in the case of exchange-traded currency options.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
Each Portfolio will limit its use of futures contracts
and futures options to hedging transactions or other
circumstances permitted by regulatory authorities. For example,
a Portfolio might use futures contracts to attempt to hedge
against anticipated changes in interest rates that might
adversely affect either the value of the Portfolio's securities
or the price of the securities which the Portfolio intends to
purchase. A Portfolio's hedging may include sales of futures
contracts as an offset against the effect of expected increases
in interest rates, and purchases of futures contracts as an
offset against the effect of expected declines in interest rates.
Although other techniques could be used to reduce exposure to
interest rate fluctuations, a Portfolio may be able to hedge its
exposure more effectively and perhaps at a lower cost by using
futures contracts and options on futures contracts.
The International Portfolio may also purchase call or put
options on foreign currency futures contracts to obtain a fixed
foreign exchange rate at limited risk. The Portfolio may
purchase a call option on a foreign currency futures contract to hedge
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against a rise in the foreign exchange rate while intending
to invest in a foreign security of the same currency. The
International Portfolio may purchase put options on foreign
currency futures contracts as a partial hedge against a decline
in the foreign exchange rates or the value of its foreign
portfolio securities. The Portfolio may write a call option on a
foreign currency futures contract as a partial hedge against the
effects of declining foreign exchange rates on the value of
foreign securities.
A Portfolio also may use futures contracts on fixed
income instruments and options thereon to hedge its investment
portfolio against changes in the general level of interest rates.
A futures contract on a fixed income instrument is a bilateral
agreement pursuant to which one party agrees to make, and the
other party agrees to accept, delivery of the specified type of
fixed income security called for in the contract at a specified
future time and at a specified price. A Portfolio may purchase a
futures contract on a fixed income security when it intends to
purchase fixed income securities but has not yet done so. This
strategy may minimize the effect of all or part of an increase in
the market price of the fixed income security that a Portfolio
intends to purchase in the future. A rise in the price of the
fixed income security prior to its purchase may be either offset
by an increase in the value of the futures contract purchased by
a Portfolio or avoided by taking delivery of the fixed income
securities under the futures contract. Conversely, a fall in the
market price of the underlying fixed income security may result
in a corresponding decrease in the value of the futures position.
A Portfolio may sell a futures contract on a fixed income
security in order to continue to receive the income from a fixed
income security, while endeavoring to avoid part or all of the
decline in the market value of that security that would accompany
an increase in interest rates.
A Portfolio may purchase a call option on a futures
contract to hedge against a market advance in fixed income
securities which the Portfolio plans to acquire at a future date.
The purchase of a call option on a futures contract is analogous
to the purchase of a call option on an individual fixed income
security which can be used as a temporary substitute for a
position in the security itself. A Portfolio also may write
covered call options on futures contracts as a partial hedge
against a decline in the price of fixed income securities held in
the Portfolio's investment portfolio, or purchase put options on
futures contracts in order to hedge against a decline in the
value of fixed income securities held in the Portfolio's
investment portfolio. A Portfolio may write a covered put option
as a partial anticipatory hedge.
A Portfolio may sell bond index futures contracts in
anticipation of a general market or market sector decline that
could adversely affect the market value of its investments. To
the extent that a portion of the Portfolio's investments
correlate with a given index, the sale of futures contracts on
that index could reduce the risks associated with a market
decline and thus provide an alternative to the liquidation of
securities positions. For example, if a Portfolio correctly
anticipates a general market decline and sells bond index futures
to hedge against this risk, the gain in the futures position
should offset some or all of the decline in the value of the
portfolio. A Portfolio may purchase bond index futures contracts
if a significant market or market sector advance is anticipated.
Such a purchase of a futures contract would serve as a temporary
substitute for the purchase of individual debt securities, which
debt securities may then be
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purchased in an orderly fashion. This strategy may minimize the effect
of all or part of an increase in the market price of securities that the
Fund intends to purchase. A rise in the price of the securities should be
partly or wholly offset by gains in the futures position.
As in the case of a purchase of a bond index futures
contract, a Portfolio may purchase a call option on a bond index
futures contract to hedge against a market advance in securities
that the Portfolio plans to acquire at a future date. A
Portfolio may write covered put options on bond index futures as
a partial anticipatory hedge and may write covered call options
on bond index futures as a partial hedge against a decline in the
prices of bonds held in its portfolio. This is analogous to
writing covered call options on securities. A Portfolio also may
purchase put options on bond index futures contracts. The
purchase of put options on bond index futures contracts is
analogous to the purchase of protective put options on individual
securities where a level of protection is sought below which no
additional economic loss would be incurred by the Portfolio.
The International Portfolio may also purchase and sell
futures contracts on a foreign currency. The Portfolio may sell
a foreign currency futures contract to hedge against possible
variations in the exchange rate of the foreign currency in
relation to the U.S. dollar. In addition, the International
Portfolio may sell a foreign currency futures contract when the
adviser anticipates a general weakening of the foreign currency
exchange rate that could adversely affect the market values of
the Portfolio's foreign securities holdings. In this case, the
sale of futures contracts on the underlying currency may reduce
the risk to the Portfolio caused by foreign currency variations
and, by so doing, provide an alternative to the liquidation of
securities positions in the Portfolio and resulting transaction
costs. When the adviser anticipates a significant foreign
exchange rate increase while intending to invest in a foreign
currency, the Portfolio may purchase a foreign currency futures
contract to hedge against a rise in foreign exchange rates
pending completion of the anticipated transaction. Such a
purchase would serve as a temporary measure to protect the
Portfolio against any rise in the foreign exchange rate which may
add additional costs to acquiring the foreign security position.
The International Portfolio may also purchase call or put
options on foreign currency futures contracts to obtain a fixed
foreign exchange rate at limited risk. The Portfolio may
purchase a call option or write a put option on a foreign
currency futures contract to hedge against a rise in the foreign
exchange rate while intending to invest in a foreign security of
the same currency. The Portfolio may purchase put options on
foreign currency futures contracts as a partial hedge against a
decline in the foreign exchange rates or the value of its foreign
portfolio securities. It may also write a call option on a
foreign currency futures contract as a partial hedge against the
effects of declining foreign exchange rates on the value of
foreign securities.
A Portfolio may also write put options on interest rate,
bond index or foreign currency futures contracts while, at the
same time, purchasing call options on the same interest rate,
bond index or foreign currency futures contract in order
synthetically to create a long interest rate, bond or foreign
currency futures contract position. The options will have the
same strike prices and expiration dates. A Portfolio will engage in this
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strategy only when its adviser believes it is more
advantageous to the Portfolio to do so as compared to purchasing
the futures contract.
A Portfolio may also purchase and write covered straddles
on interest rate, foreign currency or bond index futures
contracts. A long straddle is a combination of a call and a put
purchased on the same futures contract where the exercise price
of the put option is less than the exercise price of the call
option. A Portfolio would enter into a long straddle when it
believes that it is likely that interest rates or foreign
currency exchange rates will be more volatile during the term of
the options than the option pricing implies. A short straddle is
a combination of a call and put written on the same futures
contract where the exercise price of the put option is less than
the exercise price of the call option and where the same security
or futures contract is considered "cover" for both the put and
the call. A Portfolio would enter into a short straddle when it
believes that it is unlikely that interest rates or foreign
currency exchange rates will be as volatile during the term of
the options as the option pricing implies. In such case, the
Portfolio will set aside cash and/or liquid, high grade debt
securities in a segregated account with its custodian equal in
value to the amount, if any, by which the put is "in-the-money",
that is, the amount by which the exercise price of the put
exceeds the current market value of the underlying futures
contract.
When a purchase or sale of a futures contract is made by
a Portfolio, the Portfolio is required to deposit with its
custodian (or a broker, if legally permitted) a specified amount
of cash or U.S. Government securities ("initial margin"). The
margin required for a futures contract is set by the exchange on
which the contract is traded and may be modified during the term
of the contract. The initial margin is in the nature of a
performance bond or good faith deposit on the futures contract
which is returned to the Portfolio upon termination of the
contract, assuming all contractual obligations have been
satisfied. Under certain circumstances, such as periods of high
volatility, a Portfolio may be required by an exchange to
increase the level of its initial margin payment. Additionally,
initial margin requirements may be increased generally in the
future by regulatory action. Each Portfolio expects to earn
interest income on its initial margin deposits. A futures
contract held by a Portfolio is valued daily at the official
settlement price of the exchange on which it is traded. Each day
the Portfolio pays or receives cash, called "variation margin,"
equal to the daily change in value of the futures contract. This
process is known as "marking to market." Variation margin does
not represent a borrowing or loan by a Portfolio but is instead
settlement between the Portfolio and the broker of the amount one
would owe the other if the futures contract expired. In
computing daily net asset value, each Portfolio will mark to
market its open futures positions.
A Portfolio is also required to deposit and maintain
margin with respect to put and call options on futures contracts
written by it. Such margin deposits will vary depending on the
nature of the underlying futures contract (and the related
initial margin requirements), the current market value of the
option and other futures positions held by the Portfolio.
Although some futures contracts call for making or taking
delivery of the underlying securities, generally those contracts
are closed out prior to delivery by
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<PAGE>
offsetting purchases or sales of matching futures contracts (involving
the same currency or underlying security and delivery month). If an
offsetting purchase price is less than the original sale price, the
Portfolio realizes a gain, or if it is more, the Portfolio
realizes a loss. If an offsetting sale price is more than the
original purchase price, the Portfolio realizes a gain, or if it
is less, the Portfolio realizes a loss. The Portfolio will also
bear transaction costs for each contract which will be included
in these calculations.
A Portfolio will not enter into futures contracts or
commodities option positions if, immediately thereafter, the
initial margin deposits plus premiums paid by it, less the amount
by which any such options positions are "in-the-money" at the
time of purchase, would exceed 5% of the fair market value of the
Portfolio's total assets. A call option is "in-the-money" if the
value of the futures contract that is the subject of the option
exceeds the exercise price. A put option is "in-the-money" if
the exercise price exceeds the value of the futures contract that
is the subject of the option. Foreign currency options traded on
a commodities exchange are considered commodity options for this
purpose.
The requirements for qualification as a regulated
investment company also may limit the extent to which a Portfolio
may engage in transactions in futures, options on futures or
forward contracts. See "Taxation."
RISKS ASSOCIATED WITH FUTURES AND OPTIONS
In considering the Portfolios' use of futures contracts
and options, particular note should be taken of the following:
(1) Positions in futures contracts may be closed out
only on an exchange or board of trade which provides a secondary
market for such futures contracts. Futures exchanges may limit
the amount of fluctuation permitted in certain futures contract
prices during a single trading day. The daily limit establishes
the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the
end of the current trading session. Once the daily limit has
been reached in a futures contract subject to the limit, no more
trades may be made on that day at a price beyond that limit. The
daily limit governs only price movements during a particular
trading day and therefore does not limit potential losses because
the limit may work to prevent the liquidation of unfavorable
positions. For example, futures prices have occasionally moved
to the daily limit for several consecutive trading days with
little or no trading, thereby preventing prompt liquidation of
positions and subjecting some holders of futures contracts to
substantial losses.
(2) The ability to establish and close out positions in
either futures contracts or exchange-listed options is also
subject to the maintenance of a liquid secondary market.
Consequently, it may not be possible for a Portfolio to close a
position and, in the event of adverse price movements, the
Portfolio would have to make daily cash payments of variation
margin (except in the case of purchased options). However, in the event
futures contracts or options have been used to hedge portfolio
securities, such securities will not be sold until the contracts can be
terminated. In such circumstances, an increase in the price of the
securities, if any, may partially or completely offset losses
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on the futures contract. However, there is no guarantee that the price of
the securities will, in fact, correlate with the price movements in the
contracts and thus provide an offset to losses on the contracts.
(3) Successful use by a Portfolio of futures contracts
and options will depend upon the adviser's ability to predict
movements in the direction of the overall securities, currency
and interest rate markets, which may require different skills and
techniques than predicting changes in the prices of individual
securities. Moreover, futures contracts relate not to the
current level of the underlying instrument but to the anticipated
levels at some point in the future. There is, in addition, the
risk that the movements in the price of the futures contract will
not correlate with the movements in prices of the securities or
currencies being hedged. For example if the price of the futures
contract moves less than the price of the securities or
currencies that are subject to the hedge, the hedge will not be
fully effective; however, if the price of securities or
currencies being hedged has moved in an unfavorable direction,
the Portfolio would be in a better position than if it had not
hedged at all. If the price of the securities or currencies
being hedged has moved in a favorable direction, this advantage
may be partially offset by losses in the futures position. In
addition, if the Portfolio has insufficient cash, it may have to
sell assets from its investment portfolio to meet daily variation
margin requirements. Any such sale of assets may or may not be
made at prices that reflect the rising market; consequently, a
Portfolio may need to sell assets at a time when such sales are
disadvantageous to the Portfolio. If the price of the futures
contract moves more than the price of the underlying securities
or currencies, the Portfolio will experience either a loss or a
gain on the futures contract that may or may not be completely
offset by movements in the price of the securities or currencies
that are the subject of the hedge.
(4) The value of an option position will reflect, among
other things, the current market price of the underlying
security, futures contract or currency, the time remaining until
expiration, the relationship of the exercise price to the market
price, the historical price volatility of the underlying
security, futures contract or currency and general market
conditions. For this reason, the successful use of options as a
hedging strategy depends upon the adviser's ability to forecast
the direction of price fluctuations in the underlying market or
market sector.
(5) In addition to the possibility that there may be an
imperfect correlation, or no correlation at all, between price
movements in the futures position and the securities or
currencies being hedged, movements in the prices of futures
contracts may not correlate perfectly with movements in the
prices of the hedged securities or currencies due to price
distortions in the futures market. There may be several reasons
unrelated to the value of the underlying securities or currencies
which cause this situation to occur. First, as noted above, all
participants in the futures market are subject to initial and
variation margin requirements. If, to avoid meeting additional
margin deposit requirements or for other reasons, investors
choose to close a significant number of futures contracts through
offsetting transactions, distortions in the normal price
relationship between the securities or currencies and the futures
markets may occur. Second, because the margin deposit requirements
in the futures market are less onerous than margin requirements in
the securities market, there may be increased participation
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by speculators in the futures market; such speculative
activity in the futures market also may cause
temporary price distortions. Third, participants could make or
take delivery of the underlying securities or currencies instead
of closing out their contracts. As a result, a correct forecast
of general market trends may not result in successful hedging
through the use of futures contracts over the short term. In
addition, activities of large traders in both the futures and
securities markets involving arbitrage and other investment
strategies may result in temporary price distortions.
(6) Options normally have expiration dates of up to
three years. The exercise price of the options may be below,
equal to or above the current market value of the underlying
security, futures contract or currency. Options that expire
unexercised have no value, and the Portfolio will realize a loss
in the amount paid plus any transaction costs.
(7) Like options on securities and currencies, options
on futures contracts have a limited life. The ability to
establish and close out options on futures will be subject to the
development and maintenance of liquid secondary markets on the
relevant exchanges or boards of trade. There can be no certainty
that liquid secondary markets for all options on futures
contracts will develop.
(8) Purchasers of options on futures contracts pay a
premium in cash at the time of purchase. This amount and the
transaction costs are all that is at risk. Sellers of options on
futures contracts, however, must post an initial margin and are
subject to additional margin calls which could be substantial in
the event of adverse price movements. In addition, although the
maximum amount at risk when the Portfolio purchases an option is
the premium paid for the option and the transaction costs, there
may be circumstances when the purchase of an option on a futures
contract would result in a loss to the Portfolio when the use of
a futures contract would not, such as when there is no movement
in the value of the securities or currencies being hedged.
(9) A Portfolio's activities in the futures and options
markets may result in a higher portfolio turnover rate and
additional transaction costs in the form of added brokerage
commissions; however, a Portfolio also may save on commissions by
using such contracts as a hedge rather than buying or selling
individual securities or currencies in anticipation or as a
result of market movements.
(10) A Portfolio may purchase and write both exchange-
traded options and options traded on the OTC market. Exchange
markets for options on debt securities and foreign currencies
exist but are relatively new, and the ability to establish and
close out positions on the exchanges is subject to the
maintenance of a liquid secondary market. Although the
Portfolios intend to purchase or write only those exchange-traded
options for which there appears to be an active secondary market,
there is no assurance that a liquid secondary market will exist
for any particular option at any specific time. Closing
transactions may be effected with respect to options traded in
the OTC markets (currently the primary markets for options on
debt securities and foreign currencies) only by negotiating
directly with the other party to the option contract, or in a
secondary market for the option if such market exists. Although
the Portfolios will enter into OTC options
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only with dealers which agree to enter into, and which are expected
to be capable of entering into, closing transactions with the Portfolios,
there can be no assurance that a Portfolio will be able to liquidate an
OTC option at a favorable price at any time prior to expiration.
In the event of insolvency of the contra-party, a Portfolio may
be unable to liquidate an OTC option. Accordingly, it may not be
possible to effect closing transactions with respect to certain
options, with the result that the Portfolio would have to
exercise those options which it has purchased in order to realize
any profit. With respect to options written by a Portfolio, the
inability to enter into a closing transaction may result in
material losses to the Portfolio. For example, because a
Portfolio must maintain a covered position with respect to any
call option it writes on a security, futures contract or
currency, the Portfolio may not sell the underlying security,
futures contract or currency or invest any cash, U.S. Government
securities or liquid high quality debt securities used as cover
during the period it is obligated under such option. This
requirement may impair a Portfolio's ability to sell a portfolio
security or make an investment at a time when such a sale or
investment might be advantageous.
(11) Bond index options are settled exclusively in cash.
If a Portfolio writes a call option on an index, the Portfolio
will not know in advance the difference, if any, between the
closing value of the index on the exercise date and the exercise
price of the call option itself and thus will not know the amount
of cash payable upon settlement. In addition, a holder of a bond
index option who exercises it before the closing index value for
that day is available runs the risk that the level of the
underlying index may subsequently change.
SPECIAL RISKS RELATED TO FOREIGN CURRENCY FUTURES CONTRACTS AND OPTIONS ON
SUCH CONTRACTS AND OPTIONS ON FOREIGN CURRENCIES
Buyers and sellers of foreign currency futures contracts
are subject to the same risks that apply to the use of futures
generally. In addition, there are risks associated with foreign
currency futures contracts and their use as a hedging device
similar to those associated with options on foreign currencies
described below. Further, settlement of a foreign currency
futures contract must occur within the country issuing the
underlying currency. Thus, the Portfolio must accept or make
delivery of the underlying foreign currency in accordance with
any U.S. or foreign restrictions or regulations regarding the
maintenance of foreign banking arrangements by U.S. residents and
may be required to pay any fees, taxes or charges associated with
such delivery that are assessed in the issuing country.
Options on foreign currency futures contracts may involve
certain additional risks. Trading options on foreign currency
futures contracts is relatively new. The ability to establish
and close out positions on such options is subject to the
maintenance of a liquid secondary market. To reduce this risk,
the Portfolio will not purchase or write options on foreign
currency futures contracts unless and until, in the opinion of
Western Asset, the market for such options has developed
sufficiently that the risks in connection with such options are
not greater than the risks in connection with transactions in the
underlying foreign currency futures contracts. Compared to the
purchase or sale of foreign currency futures contracts, the
purchase of call or put options on futures contracts
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involves less potential risk to the Portfolio because the maximum amount
at risk is the premium paid for the option (plus transaction
costs). However, there may be circumstances when the purchase of
a call or put option on a futures contract would result in a
loss, such as when there is no movement in the price of the
underlying currency or futures contract, when the purchase of the
underlying futures contract would not result in a loss.
The value of a foreign currency option depends upon the
value of the underlying currency relative to the U.S. dollar. As
a result, the price of the option position may vary with changes
in the value of either or both currencies and may have no
relationship to the investment merits of a foreign security.
Because foreign currency transactions occurring in the interbank
market involve substantially larger amounts than those that may
be involved in the use of foreign currency options, investors may
be disadvantaged by having to deal in an odd lot market
(generally consisting of transactions of less than $1 million)
for the underlying foreign currencies at prices that are less
favorable than for round lots.
There is no systematic reporting of last sale information
for foreign currencies or any regulatory requirement that
quotations available through dealers or other market sources be
firm or revised on a timely basis. Quotation information
available is generally representative of very large transactions
in the interbank market and thus may not reflect relatively
smaller transactions (i.e., less than $1 million) where rates may
be less favorable. The interbank market in foreign currencies is
a global, around-the-clock market. To the extent that the U.S.
options markets are closed while the markets for the underlying
currencies remain open, significant price and rate movements may
take place in the underlying markets that cannot be reflected in
the options markets until they reopen.
ADDITIONAL RISKS OF OPTIONS ON SECURITIES, FUTURES CONTRACTS, OPTIONS ON
FUTURES AND FORWARD CURRENCY EXCHANGE CONTRACTS AND OPTIONS THEREON
TRADED ON FOREIGN EXCHANGES
Options on securities, futures contracts, options on
futures contracts, currencies and options on currencies may be
traded on foreign exchanges. Such transactions may not be
regulated as effectively as similar transactions in the United
States, may not involve a clearing mechanism and related
guarantees and are subject to the risk of governmental actions
affecting trading in, or the price of, foreign securities. The
value of such positions also could be adversely affected by (1)
other complex foreign political, legal and economic factors, (2)
lesser availability than in the United States of data on which to
make trading decisions, (3) delays in the Portfolios' ability to
act upon economic events occurring in foreign markets during non-
business hours in the United States, (4) the imposition of
different exercise and settlement terms and procedures and margin
requirements than in the United States and (5) lesser trading
volume.
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COVER FOR STRATEGIES INVOLVING OPTIONS, FUTURES AND FORWARD CONTRACTS
A Portfolio will not use leverage in its hedging
strategies. A Portfolio will not enter into an options, futures
or forward currency strategy that exposes it to an obligation to
another party unless it owns either (1) an offsetting
("covering") position in securities, currencies or other options,
futures or forward contracts or (2) cash, receivables and liquid
high quality debt securities with a value sufficient to cover its
potential obligations. In the case of transactions entered into
as a hedge, a Portfolio will hold securities, currencies or other
options, futures or forward currency positions whose values are
expected to offset ("cover") its obligations under the hedging
strategies. Each Portfolio will comply with guidelines
established by the SEC with respect to coverage of these
strategies by mutual funds, and, if the guidelines so require,
will set aside cash and/or liquid, high-grade debt securities in
a segregated account with its custodian in the amount prescribed,
as marked to market daily. Securities, currencies or other
options or futures positions used for cover and securities held
in a segregated account cannot be sold or closed out while the
strategy is outstanding, unless they are replaced with similar
assets. As a result, there is a possibility that the use of
cover or segregation involving a large percentage of a
Portfolio's assets could impede portfolio management or a
Portfolio's ability to meet redemption requests or other current
obligations.
FORWARD CURRENCY EXCHANGE CONTRACTS
The International Portfolio may use forward currency
exchange contracts to hedge against uncertainty in the level of
future exchange rates or to enhance income.
The International Portfolio may enter into forward
currency exchange contracts with respect to specific
transactions. For example, when the Portfolio anticipates
purchasing or selling a security denominated in a foreign
currency, or when it anticipates the receipt in a foreign
currency of dividend or interest payments on a security that it
holds, the Portfolio may desire to "lock-in" the U.S. dollar
price of the security or the U.S. dollar equivalent of such
payment, as the case may be, by entering into a forward contract
for the purchase or sale, for a fixed amount of U.S. dollars or
foreign currency, of the amount of foreign currency involved in
the underlying transaction. The Portfolio will thereby attempt
to protect itself against a possible loss resulting from an
adverse change in the relationship between the currency exchange
rates during the period between the date on which the security is
purchased or sold, or on which the payment is declared, and the
date on which such payments are made or received.
The International Portfolio also may use forward currency
exchange contracts to lock in the U.S. dollar value of its
portfolio positions, to increase the Portfolio's exposure to
foreign currencies that Western Asset believes may rise in value
relative to the U.S. dollar or to shift the Portfolio's exposure
to foreign currency fluctuations from one country to another.
For example, when the adviser believes that the currency of a
particular foreign country may suffer a substantial decline
relative to the U.S. dollar or another currency, it may enter
into a forward contract to sell the amount of the former foreign
currency approximating the value of some or all of the
Portfolio's securities denominated in such foreign currency.
These investment practices generally are referred to as "cross-
currency hedging" when two foreign currencies is involved.
21
<PAGE>
The precise matching of the forward contract amount and
the value of the securities involved will not generally be
possible because the future value of such securities in foreign
currencies will change as a consequence of market movements in
the value of those securities between the date the forward
contract is entered into and the date it matures. Accordingly,
it may be necessary for the Portfolio to purchase additional
foreign currency on the spot (i.e., cash) market (and bear the
expense of such purchase) if the market value of the security is
less than the amount of foreign currency the Portfolio is
obligated to deliver and if a decision is made to sell the
security and make delivery of the foreign currency. Conversely,
it may be necessary to sell on the spot market some of the
foreign currency received upon the sale of the portfolio security
if its market value exceeds the amount of foreign currency the
Portfolio is obligated to deliver.
The projection of short-term currency market movements is
extremely difficult, and the successful execution of a short-term
hedging strategy is highly uncertain. Forward contracts involve
the risk that anticipated currency movements will not be
accurately predicted, causing the Portfolio to sustain losses on
these contracts and transaction costs. The International
Portfolio may enter into forward contracts or maintain a net
exposure to such contracts only if (1) the consummation of the
contracts would not obligate the Portfolio to deliver an amount
of foreign currency in excess of the value of the Fund's
portfolio securities or other assets denominated in that currency
or (2) the Portfolio maintains cash, U.S. Government securities
or liquid, high-grade debt securities in a segregated account
with the Fund's custodian, marked to market daily, in an amount
not less than the value of the Portfolio's total assets committed
to the consummation of the contract. Under normal circumstances,
consideration of the prospect for currency parities will be
incorporated into the longer term investment decisions made with
regard to overall diversification strategies. However, the
Portfolio's adviser believes that it is important to have the
flexibility to enter into such forward contracts when it
determines that the best interests of the Portfolio will be
served.
At or before the maturity date of a forward contract
requiring the International Portfolio to sell a currency, the
Portfolio may either sell a portfolio security and use the sale
proceeds to make delivery of the currency or retain the security
and offset its contractual obligation to deliver the currency by
purchasing a second contract pursuant to which the Portfolio will
obtain, on the same maturity date, the same amount of the
currency that it is obligated to deliver. Similarly, the
Portfolio may close out a forward contract requiring it to
purchase a specified currency by entering into a second contract
entitling it to sell the same amount of the same currency on the
maturity date of the first contract. The Portfolio would realize
a gain or loss as a result of entering into such an offsetting
forward contract under either circumstance to the extent the
exchange rate or rates between the currencies involved moved
between the execution dates of the first contract and the
offsetting contract.
The cost to the International Portfolio of engaging in
forward contracts varies with factors such as the currencies
involved, the length of the contract period and the market
conditions then prevailing. Because forward contracts are
usually entered into on a principal basis, no fees or commissions
are involved. The use of forward contracts
22
<PAGE>
does not eliminate fluctuations in the prices of the underlying
securities the Portfolio owns or intends to acquire, but it does fix a
rate of exchange in advance. In addition, although forward contracts
limit the risk of loss due to a decline in the value of the
hedged currencies, at the same time they limit any potential gain
that might result should the value of the currencies increase.
Although the International Portfolio values its assets
daily in terms of U.S. dollars, it does not intend to convert its
holdings of foreign currencies into U.S. dollars on a daily
basis. The Portfolio may convert foreign currency from time to
time, and investors should be aware of the costs of currency
conversion. Although foreign exchange dealers do not charge a
fee for conversion, they do realize a profit based on the
difference between the prices at which they are buying and
selling various currencies. Thus, a dealer may offer to sell a
foreign currency to the Portfolio at one rate, while offering a
lesser rate of exchange should the Portfolio desire to resell
that currency to the dealer.
FOREIGN CURRENCY EXCHANGE-RELATED SECURITIES AND FOREIGN CURRENCY
WARRANTS
Foreign currency warrants entitle the holder to receive
from their issuer an amount of cash (generally, for warrants
issued in the United States, in U.S. dollars) which is calculated
pursuant to a predetermined formula and based on the exchange
rate between a specified foreign currency and the U.S. dollar as
of the exercise date of the warrant. Foreign currency warrants
generally are exercisable upon their issuance and expire as of a
specified date and time. Foreign currency warrants have been
issued in connection with U.S. dollar-denominated debt offerings
by major corporate issuers in an attempt to reduce the foreign
currency exchange risk which is inherent in the international
fixed income/debt marketplace. The formula used to determine the
amount payable upon exercise of a foreign currency warrant may
make the warrant worthless unless the applicable foreign currency
exchange rate moves in a particular direction.
Foreign currency warrants are severable from the debt
obligations with which they may be offered and may be listed on
exchanges. Foreign currency warrants may be exercisable only in
certain minimum amounts, and an investor wishing to exercise
warrants who possesses less than the minimum number required for
exercise may be required either to sell the warrants or to
purchase additional warrants, thereby incurring additional
transaction costs. In the case of any exercise of warrants,
there may be a time delay between the time a holder of warrants
gives instructions to exercise and the time the exchange rate
relating to exercise is determined, during which time the
exchange rate could change significantly, thereby affecting both
the market and cash settlement values of the warrants being
exercised.
The expiration date of the warrants may be accelerated if
the warrants are delisted from an exchange or if their trading is
suspended permanently, which would result in the loss of any
remaining "time value" of the warrants (i.e., the difference
between the current market value and the exercise value of the
warrants) and, in the case where the warrants were "out-of-the-money,"
in a total loss of the purchase price of the warrants. Warrants are
generally unsecured obligations of their issuers and are not standardized
foreign currency options issued by the Options Clearing Corporation
23
<PAGE>
("OCC"). Unlike foreign currency options issued by OCC, the terms of
foreign currency warrants generally will not be amended in the event of
governmental or regulatory actions affecting exchange rates or in the
event of the imposition of other regulatory controls affecting the
international currency markets. The initial public offering
price of foreign currency warrants is generally considerably in
excess of the price that a commercial user of foreign currencies
might pay in the interbank market for a comparable option
involving significantly larger amounts of foreign currencies.
Foreign currency warrants are subject to significant foreign
exchange risk, including risks arising from complex political and
economic factors.
VALUATION OF PORTFOLIO SHARES
As described in the Prospectus, securities for which
market quotations are readily available are valued at current
market value. Securities are valued at the last sale price for a
comparable position on the day the securities are being valued
or, lacking any sales on such day, at the last available bid
price. In cases where securities are traded on more than one
market, the securities are generally valued on the market
considered by the adviser as the primary market.
All investments valued in foreign currency are valued
daily in U.S. dollars on the basis of the foreign currency
exchange rate prevailing at the time such valuation is
determined. Foreign currency exchange rates are generally
determined prior to the close of trading on the New York Stock
Exchange. Occasionally, events affecting the value of foreign
investments and such exchange rates occur between the time at
which they are determined and the close of trading on the
Exchange. Such investments will be valued at their fair value,
as determined in good faith by or under the direction of the
Board of Directors. Foreign currency exchange transactions of a
Portfolio occurring on a spot basis are valued at the spot rate
for purchasing or selling currency prevailing on the foreign
exchange market.
MANAGEMENT OF THE FUND
DIRECTORS AND OFFICERS
The Fund's officers are responsible for the operation of
the Fund under the direction of the Board of Directors. The
officers and directors of the Fund and their principal
occupations during the past five years are set forth below. An
asterisk (*) indicates officers and/or directors who are
"interested persons" of the Fund as defined in the 1940 Act. The
address of each officer and director is 117 East Colorado Blvd.,
Pasadena, CA 91105.
William G. McGagh, (1) (2) Chairman of the Board and
Director; Consultant, McGagh Associates (corporate financial
consulting), January 1989-present; Director of Pacific American
Income Shares, Inc.; formerly: Senior Vice-President, Chief
Financial Officer and Director of Northrop Corporation (military
aircraft).
24<PAGE>
<PAGE>
Dr. Richard C. Gilman, (1) (2) Director; President
Emeritus of Occidental College, 1988-present; Director of Pacific
American Income Shares, Inc.; formerly: President and Chief
Executive Officer of Occidental College.
Gordon L. Hough, (1) Director; Director of Pacific
American Income Shares, Inc., Ameron, Inc. (construction
products) and the Chronicle Publishing Company; formerly:
Director of First Interstate Bank.
*Ronald L. Olson, (2) (3) Director; Senior Partner,
Munger, Tolles & Olson (a law partnership); Director of Pacific
American Income Shares, Inc.
*W. Curtis Livingston, III, (1) President and Director;
President, Director and Chief Executive Officer of Western Asset
Management Company (investment management firm), December 1980-
present; President, Pacific American Income Shares, Inc.
Norman Barker, Jr., Director; Director of American Health
Properties (real estate investment trust), Southern California
Edison Company, SPI Pharmaceuticals, Inc., ICN Pharmaceutical,
Inc., and TCW Convertible Securities Fund, Inc. (management
investment company); formerly: Chairman of the Board of First
Interstate Bancorp.
*Kent S. Engel, Vice-President; Director and Chief
Investment Officer of Western Asset Management Company 1969 -
present; Vice-President and Portfolio Manager of Pacific American
Income Shares, Inc.
*Scott F. Grannis, Vice President; Director and
Economist, Western Asset Management Company, 1989 - present;
Director, Supershares Services Corp. (investment company
services); formerly: Vice-President, Leland O'Brien Rubinstein
(investment advisory firm), 1986-89.
*Stephen A. Walsh, Vice-President: Director and Senior
Portfolio Manager, Western Asset Management Company; formerly:
Portfolio Manager and Trader of Security Pacific Investment
Managers, Inc. (investment management company), 1989-1991;
Portfolio Manager of Atlantic Richfield Company (petroleum
company), 1981-1988.
*Ilene S. Harker, Vice President and Secretary; Director
of Administration and Controls, Western Asset Management Company
1978 - present; Secretary, Pacific American Income Shares, Inc.,
1993 - present.
*James W. Hirschmann, III, Vice-President; Director of
Marketing, Western Asset Management Company, April 1989-present;
formerly: Vice-President and Director of Marketing, Financial
Trust Corporation (bank holding company), January 1988 - April
1989; Vice-President of Marketing, Atalanta/Sosnoff Capital
(investment management company), January 1986 - January 1988.
25<PAGE>
<PAGE>
*Marie K. Karpinski, Vice-President and Treasurer; Vice-
President and Treasurer of Legg Mason Value Trust, Inc., Legg
Mason Total Return Trust, Inc., Legg Mason Special Investment
Trust, Inc., Legg Mason Income Trust, Inc., Legg Mason Tax-Exempt
Trust, Inc., Legg Mason Tax-Free Income Fund, Legg Mason Cash
Reserve Trust, Inc., Legg Mason Global Trust, Inc. and Legg Mason
Investors Trust, Inc. (open-end investment companies);
Secretary/Treasurer of Worldwide Value Fund, Inc. (closed-end
investment company); Treasurer of Legg Mason Fund Adviser, Inc.,
March 1986-present; Vice-President of Legg Mason Wood Walker,
Inc., February 1992 - present; Assistant Vice-President of Legg
Mason Wood Walker, Inc., March 1989- February 1992.
*Randolph L. Kohn, Vice-President; Director of Client
Services, Western Asset Management Company, 1984 - present.
*S. Kenneth Leech, Vice-President; Director of Portfolio
Management, Western Asset Management Company, May 1990-present;
formerly: Senior Trader of Greenwich Capital, 1988-1990; Fixed
Income Manager of The First Boston Corporation (holding company;
stock and bond dealers), 1985-1987.
*Edward A. Moody, Vice-President; Director of Investment
Systems, Western Asset Management Company.
*Joseph L. Orlando, Vice-President; Senior Marketing
Manager of Western Asset Management Company; formerly: Regional
Manager of T. Rowe Price Associates (investment management firm),
January 1988 - July 1992.
*James A. Walsh, Assistant Treasurer; Controller, Western
Asset Management Company, 1987 - present.
*Donna A. Barnes, Assistant Secretary; Assistant
Secretary, Pacific American Income Shares, Inc., 1993 - present;
employee of Western Asset Management Company 1991 - present.
Formerly: Personnel Officer, First Interstate Bank, Ltd. (1982-
1989).
(1) Member of the Executive Committee of the Board. When the
full Board is not in session, the Executive Committee may
exercise all the powers held by the Board in the management of
the business and affairs of the Fund that may be lawfully
exercised by the full Board, except the power to declare a
dividend, authorize the issuance of stock, recommend to
stockholders any matter requiring stockholders' approval, amend
the By-Laws, or approve any merger or share exchange which does
not require shareholder approval.
(2) Member of the Audit Committee of the Board. The Audit
Committee meets with the Fund's independent accountants to review
the financial statements of the Fund, the arrangements for
special and annual audits, the adequacy of internal controls, the
Fund's periodic reporting process, material contracts entered
into by the Fund, the services provided by the accountants, any
proposed changes in accounting practices or principles and the
independence of the accountants; and reports on such matters to
the Board.
26
<PAGE>
The Fund has no nominating or compensation committee.
(3) Mr. Olson is an interested director because the law firm
in which he is a partner has provided certain services to the
Fund and its investment adviser.
Officers and directors of the Fund who are affiliated
persons of the investment adviser, Administrator or Distributor
receive no salary or fees from the Fund. Independent directors
of the Fund receive a fee of $2,000 annually for serving as a
director, and a fee of $500 per Portfolio for each meeting of the
Board of Directors attended by him. The Chairman of the Board
receives an additional $1,000 per year for serving in that
capacity. For the year ended June 30, 1994, the present non-
affiliated directors as a group received a total of $38,259.
THE PORTFOLIOS' INVESTMENT ADVISER
Western Asset Management Company ("Western Asset"), 117
East Colorado Boulevard, Pasadena, CA 91105, serves as investment
adviser to the Corporate, Mortgage and International Securities
Portfolios under an investment advisory and administration
agreement dated June 30, 1992, between Western Asset and the Fund
("Advisory Agreement").
The Advisory Agreement was most recently approved by the
Board of Directors, including a majority of the directors who are
not "interested persons" (as defined in the 1940 Act) of the
Fund, the advisers or their affiliates, on April 14, 1994. Under
the Advisory Agreement, Western Asset is responsible, subject to
the general supervision of the Fund's Board of Directors, for the
actual management of the assets of the Portfolios, including the
responsibility for making decisions and placing orders to buy,
sell or hold a particular security, consistent with the
investment objectives and policies described in the Portfolios'
Prospectus and this Statement of Additional Information. Western
Asset is also responsible for the compensation of directors and
officers of the Fund who are employees of Western Asset or its
affiliates.
Western Asset receives for its services to the Fund an
advisory fee calculated daily and payable monthly, at an annual
rate equal to .150% of each Domestic Portfolio's average daily
net assets and .475% of the International Portfolio's average
daily net assets. For the International Portfolio, Western Asset
received $572,322 (prior to fees waived of $572,322) for the year
ended June 30, 1994 and $136,356 (prior to fees waived of
$136,356) for the period January 7, 1993 (Commencement of
Operations) to June 30, 1993.
Each Portfolio pays all of its other expenses which are
not assumed by the adviser or the Administrator. These expenses
include, among others, expenses of preparing and printing
prospectuses, statements of additional information, proxy
statements and reports and of distributing them to existing
shareholders, custodian charges, transfer agency fees,
organizational expenses, compensation of the directors who are
not "interested persons" of the adviser, Administrator or
Distributor, as that term is defined in the 1940 Act, legal and
audit expenses, insurance expenses, expenses of
27
<PAGE>
registering and qualifying shares of the Portfolio for sale under federal
and state law, distribution fees, governmental fees, expenses
incurred in connection with membership in investment company
organizations, interest expense, taxes and brokerage fees and
commissions. The Portfolios also are liable for such
nonrecurring expenses as may arise, including litigation to which
a Portfolio or the Fund may be a party. The Fund may also have
an obligation to indemnify its directors and officers with
respect to litigation.
Under the Advisory Agreement, Western Asset will not be
liable for any error of judgment or mistake of law or for any
loss suffered by the Fund in connection with the performance of
the Advisory Agreement, except a loss resulting from a breach of
fiduciary duty with respect to the receipt of compensation for
services or a loss resulting from willful misfeasance, bad faith
or gross negligence on its part in the performance of its duties
or from reckless disregard by it of its obligations or duties
thereunder.
The Advisory Agreement terminates automatically upon
assignment and is terminable with respect to any Portfolio at any
time without penalty by vote of the Fund's Board of Directors, by
vote of a majority of that Portfolio's outstanding voting
securities, or by the adviser, on not less than 60 days' notice
to the other party, and may be terminated immediately upon the
mutual written consent of the parties.
THE FUND'S ADMINISTRATOR
Legg Mason Fund Adviser, Inc. ("Administrator"), 111
South Calvert Street, Baltimore, MD 21202, serves as the
administrator for the Fund under Administration Agreements with
Western Asset dated June 30, 1992 ("Administration Agreements").
The Administration Agreements were most recently approved by the
Fund's Board of Directors, including a majority of the directors
who are not "interested persons" (as defined in the 1940 Act) of
the Fund, the Administrator or its affiliates on April 14, 1994.
Under the Administration Agreements, the Administrator is
obligated to provide the Portfolios with office space and certain
officers, to oversee accounting and recordkeeping services
provided by the Fund's custodian and transfer and dividend-
disbursing agent, and to provide shareholder services not
provided by the Fund's transfer and dividend disbursing agent.
The Administrator receives for its services to the Fund
an administrative fee, calculated daily and payable monthly, at
an annual rate equal to 0.075% of the Portfolio's average daily
net assets. For the year ended June 30, 1994 and for the period
January 7, 1993 (Commencement of Operations) to June 30, 1993,
the Administrator received administrative fees from the
International Portfolio of $107,311 and $25,567, respectively.
THE FUND'S DISTRIBUTOR
Legg Mason Wood Walker, Incorporated ("Legg Mason" or "Distributor"),
111 South Calvert Street, Baltimore, MD 21202, acts as a distributor of
the shares of the Fund pursuant to an Underwriting Agreement with the
Fund dated August 24, 1990 ("Underwriting Agreement"). This Agreement
was most recently approved by the Fund's
28
<PAGE>
Board of Directors, including a majority of the directors who are not
"interested persons" (as defined in the 1940 Act) of the Fund, Legg Mason
or its affiliates, on April 14, 1994.
The Distributor is not obligated to sell any specific
amount of Fund shares and receives no compensation pursuant to
the Underwriting Agreement. The Underwriting Agreement is
terminable with respect to any Portfolio without penalty, at any
time, by vote of a majority of the Fund's disinterested
directors, or by vote of the holders of a majority of the shares
of that Portfolio, or by Legg Mason upon 60 days' notice to the
Fund.
EXPENSE LIMITATIONS
Western Asset has agreed to waive its fees or reimburse
each of the Corporate and Mortgage Portfolios to the extent a
Portfolio's expenses (exclusive of taxes, interest, brokerage and
other transaction expenses and any extraordinary expenses) exceed
during any month an annual percentage rate equal to .25% of the
Portfolio's average daily net assets. Western Asset has agreed
to waive its fees or reimburse the International Portfolio to the
extent the Portfolio's expenses (exclusive of taxes, interest,
brokerage and other transaction expenses and any extraordinary
expenses) exceed during any month an annual percentage rate equal
to .85% of the Portfolio's average daily net assets. These
voluntary expense limitations expired June 30, 1994, but were
extended by Western Asset to December 31, 1994. In addition,
Western Asset has voluntarily waived for calendar year 1994 all
of its fees for services to the International Portfolio under its
management agreement, other than the portion of such fee equal to
the fee paid by Western Asset to the Administrator (at an annual
rate of .075% of average net assets) for services to the
International Portfolio under the Administration Agreement.
29<PAGE>
<PAGE>
PRINCIPAL HOLDERS OF SECURITIES
Set forth below is a table which contains the name,
address and percentage of ownership of each person who is known
by the Fund to own beneficially five percent or more of the
outstanding shares of the International Portfolio as of October
3, 1994:
<TABLE>
<CAPTION>
NAME AND ADDRESS % OF OWNERSHIP
AS OF
OCT. 3, 1994
<S> <C>
AT&T 20.22%
One Oak Way, Room 3ED146
Berkeley Heights, N.J. 07922
FPL Group, Inc. 13.41%
FPL Group Pension Plan
11770 U.S. Highway One
North Palm Beach, FL 33408
Lockheed Corporation 18.05%
Salaried Pension Fixed Income
4500 Park Granada Boulevard
Calabasas, CA 91399-0222
Annuity Board of the Southern 6.20%
Baptist Convention
2401 Cedar Springs
Dallas, Texas 75221-2190
Unisys Corporation 7.61%
Township Line & Union Meeting Roads
Blue Bell, PA 19422
</TABLE>
30<PAGE>
<PAGE>
The following chart contains the name, address and
percentage of ownership of each person who is known by the Fund
to own of record five percent or more of the outstanding shares
of the International Portfolio as of October 3, 1994:
<TABLE>
<CAPTION>
NAME AND ADDRESS % OF OWNERSHIP
AS OF
OCTOBER 3, 1994
<S> <C>
Northern Trust Company 33.20%
10 S. LaSalle Street
Chicago, IL 60675
Bankers Trust Company of California, N.A. 25.10%
Arco Finance Station
Los Angeles, CA 90071
Mellon Bank N.A. 13.41%
One Mellon Bank Center
Room 151-0545
Pittsburgh, PA 15258-0001
Harris Trust & Savings Bank 7.61%
111 West Monroe Street
Chicago, IL 60690
Boston Safe Deposit & Trust 5.02%
1 Cabot Road
Medford, MA 02155
</TABLE>
31<PAGE>
<PAGE>
PURCHASES AND REDEMPTIONS
The Fund reserves the right to modify or terminate the mail,
telephone or wire redemption services described in the Prospectus
at any time. The Fund also reserves the right to suspend or
postpone redemptions (1) for any period during which the New York
Stock Exchange ("Exchange") is closed (other than for customary
weekend and holiday closings), (2) when trading in markets the
Fund normally utilizes is restricted or an emergency, as defined
by rules and regulations of the SEC, exists, making disposal of
the Fund's investments or determination of its net asset value
not reasonably practicable, or (3) for such other periods as the
SEC by regulation or order may permit for protection of the
Fund's shareholders. In the case of any such suspension, an
investor may either withdraw the request for redemption or
receive payment based upon the net asset value next determined
after the suspension is lifted.
The Fund agrees to redeem shares of each Portfolio solely in
cash up to the lesser of $250,000 or 1% of the Portfolio's net
assets during any 90-day period for any one shareholder. In
consideration of the best interests of the remaining
shareholders, the Fund reserves the right to pay any redemption
price exceeding this amount in whole or in part by a distribution
in kind of readily marketable securities held by a Portfolio in
lieu of cash. It is highly unlikely that shares would ever be
redeemed in kind. If shares are redeemed in kind, however, the
redeeming shareholder should expect to incur transaction costs
upon the disposition of the securities received in the
distribution.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The portfolio turnover rate is computed by dividing the
lesser of purchases or sales of securities for the period by the
average value of portfolio securities for that period. Short-
term securities are excluded from the calculation. For the year
ended June 30, 1994 and for the period January 7, 1993
(Commencement of Operations) to June 30, 1993, the International
Portfolio's annualized portfolio turnover rates were 571.18% and
249.94%, respectively.
Under the Advisory Agreement, the adviser is responsible for
the execution of that Portfolio's portfolio transactions. In
selecting brokers or dealers, the adviser must seek the most
favorable price (including the applicable dealer spread) and
execution for such transactions, subject to the possible payment
as described below of higher brokerage commissions or spreads to
brokers or dealers who provide research and analysis. The Fund
may not always pay the lowest commission or spread available.
Rather, in placing orders on behalf of the Fund, the adviser will
also take into account such factors as size of the order,
difficulty of execution, efficiency of the executing broker's or
dealer's facilities (including the services described below) and
any risk assumed by the executing broker or dealer.
Consistent with the policy of obtaining most favorable price
and execution, the adviser may give consideration to research,
statistical and other services furnished by broker-dealers to the
adviser for its use, may place orders with broker-dealers who
32
<PAGE>
provide supplemental investment and market research and
securities and economic analysis, and may pay to those broker-
dealers a higher brokerage commission or spread than may be
charged by other broker-dealers. In selecting a broker, the
adviser may consider that such research, analysis and other
services may be useful to it in connection with services to
clients other than the Fund. The adviser's fees are not reduced
by reason of its receiving such brokerage and research services.
The Fund may not buy securities from, or sell securities to,
the adviser, or affiliated persons of the adviser as principal,
except as permitted by the rules and regulations of the SEC.
Subject to certain conditions, the Fund may purchase securities
that are offered in underwritings in which an affiliate of the
adviser is a participant, although the Fund may not make such
purchases directly from such affiliate.
The adviser will select brokers to execute portfolio
transactions. In the over-the-counter market, the Fund generally
will deal with responsible primary market-makers unless a more
favorable execution can otherwise be obtained.
Investment decisions for the Fund are made independently
from those of other funds and accounts advised by the adviser.
However, the same security may be held in the portfolios of more
than one fund or account. When two or more accounts
simultaneously engage in the purchase or sale of the same
security, the prices and amounts will be equitably allocated to
each account. In some cases, this procedure may adversely affect
the price or quantity of the security available to a particular
account. In other cases, however, an account's ability to
participate in larger volume transactions may produce better
executions and prices. For the year ended June 30, 1994 and the
period January 7, 1993 (Commencement of Operations) to June 30,
1993, the International Portfolio paid no brokerage commissions.
ADDITIONAL TAX INFORMATION
GENERAL
In order to continue to qualify for treatment as a regulated
investment company ("RIC") under the Internal Revenue Code of
1986, as amended ("Code"), each Portfolio must distribute
annually to its shareholders at least 90% of its investment
company taxable income (consisting generally of net investment
income, net gains from certain foreign currency transactions and
net short-term capital gain, if any) ("Distribution Requirement")
and must meet several additional requirements. With respect to
each Portfolio, these requirements include the following: (1)
the Portfolio must derive at least 90% of its gross income each
taxable year from dividends, interest, payments with respect to
securities loans and gains from the sale or other disposition of
securities or foreign currencies, or other income (including
gains from options, futures or forward contracts) derived with
respect to its business of investing in securities or those
currencies ("Income Requirement"); (2) the Portfolio must derive
less than 30% of its gross income each taxable year from the sale
or other disposition of securities, or any of the following, that
were held for less than three months: options, futures or forward
33
<PAGE>
contracts (other than those on foreign currencies), or
foreign currencies (or options, futures or forward contracts
thereon) that are not directly related to the Portfolio's
principal business of investing in securities (or options and
futures with respect to securities) ("Short-Short Limitation");
(3) at the close of each quarter of the Portfolio's taxable year,
at least 50% of the value of its total assets must be represented
by cash and cash items, U.S. Government securities and other
securities, with those other securities limited, in respect of
any one issuer, to an amount that does not exceed 5% of the value
of the Portfolio's total assets; and (4) at the close of each
quarter of the Portfolio's taxable year, not more than 25% of its
total assets may be invested in securities (other than U.S.
Government securities) of any one issuer.
A distribution declared by a Portfolio in October, November
or December of any year and payable to shareholders of record on
a date in any of those months will be deemed to have been paid by
the Portfolio and received by the shareholders on December 31 of
that year if the distribution is paid by the Portfolio during the
following January. Such a distribution, therefore, will be
taxable to shareholders for the year in which that December 31
occurs, rather than the year in which it is received by them.
HEDGING TRANSACTIONS
The use of hedging and option income strategies, such as
writing and purchasing options and futures contracts and entering
into forward contracts, involves complex rules that will
determine for income tax purposes the character and timing of
recognition of the income received in connection therewith by a
Portfolio. Income from foreign currencies (except certain gains
therefrom that may be excluded by future regulations), and income
from transactions in options, futures and forward contracts
derived by a Portfolio with respect to its business of investing
in securities or foreign currencies, will qualify as permissible
income under the Income Requirement. However, income from the
disposition of options and futures contracts (other than those on
foreign currencies) will be subject to the Short-Short Limitation
if they are held for less than three months. Income from the
disposition of foreign currencies, and options, futures and
forward contracts on foreign currencies, that are not directly
related to a Portfolio's principal business of investing in
securities (or options and futures with respect to securities)
also will be subject to the Short-Short Limitation if they are
held for less than three months.
If a Portfolio satisfies certain requirements, any increase
in value on a position that is part of a "designated hedge" will
be offset by any decrease in value (whether realized or not) of
the offsetting hedging position during the period of the hedge
for purposes of determining whether the Portfolio satisfies the
Short-Short Limitation. Thus, only the net gain (if any) from
the designated hedge will be included in gross income for
purposes of that Limitation. Each Portfolio intends that, when
it engages in hedging transactions, they will qualify for this
treatment, but at the present time it is not clear whether this
treatment will be available for all of each Portfolio's hedging
transactions. To the extent this treatment is not available, a
Portfolio may be forced to defer the closing out of certain
options and futures contracts beyond the time when it otherwise
would be advantageous to do so, in order for the Portfolio to
qualify as a RIC.
34
<PAGE>
FOREIGN SECURITIES
The International Portfolio may invest in the stock of
"passive foreign investment companies" ("PFICs"). A PFIC is a
foreign corporation that, in general, meets either of the
following tests: (1) at least 75% of its gross income is passive
or (2) an average of at least 50% of its assets produce, or are
held for the production of, passive income. Under certain
circumstances, a RIC that holds stock of a PFIC will be subject
to federal income tax on a portion of any "excess distribution"
received on the stock or of any gain on disposition of the stock
(collectively "PFIC income"), plus interest thereon, even if the
RIC distributes the PFIC income as a taxable dividend to its
shareholders. The balance of the PFIC income will be included in
the RIC's investment company taxable income and, accordingly,
will not be taxable to it to the extent that income is
distributed to its shareholders.
If the International Portfolio invests in a PFIC and elects
to treat the PFIC as a "qualified electing fund," then in lieu of
the foregoing tax and interest obligation, the Portfolio would be
required to include in income each year its pro rata share of the
qualified electing fund's annual ordinary earnings and net
capital gain (the excess of net long-term capital gain over net
short-term capital loss) -- which would have to be distributed
because of the Distribution Requirement and to avoid imposition
of the 4% excise tax referred to in the Prospectus -- even if
those earnings and gain were not received by the Fund. In most
instances it will be very difficult, if not impossible, to make
this election because of certain requirements thereof.
ORIGINAL ISSUE DISCOUNT
A Portfolio may purchase zero coupon or other debt
securities issued with original issue discount. Original issue
discount that accrues in a taxable year must be included in a
Portfolio's income and therefore an equivalent amount must be
distributed to satisfy the Distribution Requirement and avoid
imposition of the 4% excise tax. Because the original issue
discount earned by a Portfolio in a taxable year may not be
represented by cash income, the Portfolio may have to dispose of
other securities and use the proceeds thereof to make the
necessary distributions. A Portfolio may realize capital gains
or losses from those dispositions, which would increase or
decrease the Portfolio's investment company taxable income and/or
net capital gain. In addition, any such gains may be realized on
the disposition of securities held for less than three months.
Because of the Short-Short Limitation, any such gains would
reduce the Portfolio's ability to sell other securities (and
certain options, futures, and, with respect to the International
Portfolio, forward contracts and foreign currencies) held for
less than three months that it might wish to sell in the ordinary
course of its portfolio management.
MISCELLANEOUS
If a Portfolio invests in shares of preferred stock or
otherwise holds dividend-paying securities as a result of
exercising a conversion privilege, a portion of the dividends
from the Portfolio's investment company taxable income (whether
paid in cash or reinvested in additional Portfolio shares) may be
eligible for the dividends-received deduction allowed
35
<PAGE>
to corporations. The eligible portion may not exceed the aggregate
dividends received by the Portfolio from U.S. corporations.
However, dividends received by a corporate shareholder and
deducted by it pursuant to the dividends-received deduction are
subject indirectly to the alternative minimum tax.
If shares of any Portfolio are sold at a loss after being
held for six months or less, the loss will be treated as long-
term, instead of short-term, capital loss to the extent of any
capital gain distributions received on those shares. Investors
should also be aware that if shares are purchased shortly before
the record date for any distribution, the shareholder will pay
full price for the shares and receive some portion of the price
back as a taxable dividend or capital gain distribution.
Dividends and interest received by a Portfolio, and gains
realized by a Portfolio on foreign securities, may be subject to
income, withholding or other taxes imposed by foreign countries
and U.S. possessions that would reduce the yield on the
Portfolio's securities. Tax conventions between certain
countries and the United States may reduce or eliminate these
foreign taxes, however, and foreign countries generally do not
impose taxes on capital gains in respect of investments by
foreign investors.
OTHER INFORMATION
The Fund is a Maryland corporation, incorporated on May 16,
1990. The capitalization of the Fund consists of five billion
shares of common stock with a par value of $0.001 each. The Fund
has six Portfolios in addition to the three Portfolios described
herein. The Board of Directors may establish additional
Portfolios (with different investment objectives and fundamental
policies) at any time in the future. Establishment and offering
of additional Portfolios will not alter the rights of the Fund's
shareholders. When issued, shares are fully paid, non-
assessable, redeemable and freely transferable. Shares do not
have preemptive rights or subscription rights. In liquidation of
a Portfolio, each shareholder is entitled to receive his or her
pro rata share of the net assets of that Portfolio.
PERFORMANCE INFORMATION
The Fund may, from time to time, include the total return of
its Portfolios in marketing materials or reports to shareholders
or prospective investors. Quotations of average annual total
return for a Portfolio will be expressed in terms of the average
annual compounded rate of return of a hypothetical investment in
the Portfolio over periods of one, five and ten years (up to the
life of the Portfolio), calculated pursuant to the following
formula: P (1 + T)n = ERV (where P = a hypothetical initial
payment of $1,000, T = the average annual total return, n =
number of years, and ERV = the ending redeemable value of a
hypothetical $1,000 payment made at the beginning of the period).
All total return figures reflect the deduction of a proportional
share of Portfolio expenses on an annual basis and assume that
all dividends and other distributions are reinvested when paid.
36
<PAGE>
The International Securities Portfolio's return as of June 30,
1994 was as follows:
<TABLE>
<CAPTION>
Average
Cumulative Annual
Total Return Total Return
<S> <C> <C>
One Year (1.13)% (1.13)%
Life of Fund(dagger) +4.61% +3.10%
</TABLE>
(dagger)Fund's inception January 7, 1993.
The Fund's performance may fluctuate daily depending upon
such factors as the average maturity of its securities, changes
in investments, changes in interest rates and variations in
operating expenses. Therefore, current performance does not
provide a basis for determining future performance. The fact
that the Fund's performance will fluctuate and that shareholders'
principal is not guaranteed or insured should be considered in
comparing the Fund's performance with the performance on fixed-
income investments. In comparing the performance of the Fund to
other investment vehicles, consideration should also be given to
the investment policies of each, including the types of
investments owned, lengths of maturities of the portfolio, the
method used to compute the performance and whether there are any
special charges that may reduce the yield.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT
State Street Bank and Trust Company, P.O. Box 1790, Boston,
Massachusetts 02105, serves as custodian of the Fund's assets.
Boston Financial Data Services, Inc., P.O. Box 8000, Boston, MA
02266-8000, serves as transfer and dividend-disbursing agent and
administrator of various shareholder services. Shareholders who
request an historical transcript of their accounts will be
charged a fee based upon the number of years researched. The
Fund reserves the right, upon 60 days' written notice, to make
other charges to investors to cover administrative costs.
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP, 7 St. Paul Street, Baltimore, Maryland
21202, has been selected by the Board of Directors to serve as
the Fund's independent accountants.
LEGAL COUNSEL
Munger, Tolles & Olson, 355 South Grand Avenue, Los Angeles,
California 90071, serves as legal counsel to the Fund.
FINANCIAL STATEMENTS
The Statement of Assets and Liabilities as of June 30, 1994
for the Corporate Securities Portfolio, and Mortgage Securities
Portfolio, and the Report of Independent Accountants related
thereto, are shown on the following pages. As of June 30, 1994,
37
<PAGE>
neither the Corporate Securities Portfolio nor the Mortgage
Securities Portfolio had commenced operations (i.e. first begun
to invest its assets in accordance with its investment
objectives). Accordingly, no financial statements other than
such Statement of Assets and Liabilities have been prepared.
The International Portfolio's Portfolio of Investments as of
June 30, 1994, the Statement of Assets and Liabilities as of June
30, 1994, the Statement of Operations for the year ended June 30,
1994, the Statement of Changes in Net Assets for the year ended
June 30, 1994 and the period January 7, 1993 (Commencement of
Operations) to June 30, 1993; and the Financial Highlights for
the same periods, the Notes to Financial Statements and the
related Report of the Independent Accountants, all of which are
included in the International Portfolio's report for the year
ended June 30, 1994, are hereby incorporated by reference in this
Statement of Additional Information.
38
<PAGE>
WESTERN ASSET TRUST, INC.
STATEMENTS OF ASSETS AND LIABILITIES
JUNE 30, 1994
<TABLE>
<CAPTION> Corporate Mortgage
Securities Securities
Portfolio Portfolio
<S> <C> <C>
Assets
Cash $ 1,000 $ 1,000
Deferred organization and initial offering
costs 16,000 16,000
Total assets 17,000 17,000
Liabilities
Accrued organization expenses and initial
offering costs 16,000 16,000
Total liabilities 16,000 16,000
Net Assets-Offering and redemption price of
$100.00 per share with 10 shares each
outstanding of the Corporate Securities
and Mortgage Securities Portfolios (5,000,000,000
shares par value $.001 per share authorized) $ 1,000 $ 1,000
</TABLE>
NOTES TO STATEMENTS OF ASSETS AND LIABILITIES<PAGE>
A. Western Asset Trust, Inc. ("Corporation") was organized on May 16, 1990.
The Corporate Securities Portfolio and Mortgage Securities Portfolio
("Portfolios") constitute two of the nine portfolios established under the
Corporation at June 30, 1994. The Portfolios have had no operations other than
those matters related to their organization and registration as an investment
company under the Investment Company Act of 1940 and the sale of their shares.
Western Asset Management Company ("Western Asset"), a wholly owned subsidiary
of Legg Mason, Inc. (a financial services holding company), has provided the
initial capital for the Portfolios by purchasing 10 shares each of the
Corporate Securities Portfolio and Mortgage Securities Portfolio at $100.00
per share. Such shares were acquired for investment and can be disposed of only
by redemption. Legg Mason Wood Walker, Incorporated, a wholly owned subsidiary
of Legg Mason, Inc. and a member of the New York Stock Exchange, acts as
distributor of the Portfolios' shares.
B. Deferred organization and initial offering costs represent expenses
incurred in connection with the Portfolios' organiztion and will be amortized
on a straight line basis over five years commencing on the effective date of
each Portfolio's initial sale of shares to the public. The Portfolios have
agreed to reimburse Western Asset for organization expenses advanced by Western
Asset. The advances are repayable on demand but must be fully repaid within
five years from the commencement of operations. The proceeds realized by
Western Asset upon redemption during the amortization period of any of the
shares constituting initial capital will be reduced by a proportionate amount
of unamortized deferred organization expenses which the number of initial
shares redeemed bears to the number of initial shares then outstanding.
39
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
of Western Asset Trust, Inc.
In our opinion, the accompanying statements of assets and liabilities present
fairly, in all material respects, the financial position of Western Asset
Trust Corporate Securities Portfolio and Mortgage Securities Portfolio (two
of the nine portfolios comprising Western Asset Trust, Inc.) at June 30, 1994,
in conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Trust's management; our responsibility
is to express an opinion on these financial statements based on our audits.
We conducted our audits of these financial statements in accordance with
generally accepted auditing standards which require that we plan and perform
the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for the
opinion expressed above.
/s/ Price Waterhouse LLP
PRICE WATERHOUSE LLP
Baltimore, Maryland
October 28, 1994
40
<PAGE>
APPENDIX A
RATINGS OF SECURITIES
Description of Moody's Investors Service, Inc. ("Moody's")
corporate bond ratings:
Aaa-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 exceptionally stable margin and principal
is secure. While the various protective elements are likely to
change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
Aa-Bonds 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.
A-Bonds which are rated A possess many favorable investment
attributes and are to be considered upper-medium grade
obligations. Factors giving security to principal and interest
are considered adequate but elements may be present which suggest
a susceptibility to impairment sometime in the future.
Baa-Bonds which are rated Baa are considered medium-grade
obligations, i.e., they are neither highly protected nor poorly
secured. Interest payments and principal security appear
adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as
well.
Ba-Bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered 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.
B- Bonds which are rated B generally lack characteristics of
the desirable investment. Assurance of interest and principal
payments or maintenance of other terms of the contract over any
long period of time may be small.
DESCRIPTION OF STANDARD & POOR'S RATINGS GROUP CORPORATE BOND RATINGS:
AAA-This is the highest rating assigned by Standard & Poor's
to an obligation and indicates an extremely strong capacity to
pay principal and interest.
A-1
<PAGE>
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 adequate 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, B, CCC, CC-Bonds rated BB, B, CCC and CC are regarded,
on balance, as predominately speculative with respect to the
issuer's capacity to pay interest and repay principal in
accordance with the terms of the obligation. BB indicates the
lowest degree of speculation and CC the highest degree of
speculation. While such bonds will likely have some quality and
protective characteristics, these are outweighed by large
uncertainties or major risk exposure to adverse conditions.
DESCRIPTION OF MOODY'S PREFERRED STOCK RATINGS:
aaa-An issue which is rated "aaa" is considered to be a top-
quality preferred stock. This rating indicates good asset
protection and the least risk of dividend impairment within the
universe of preferred stock.
aa-An issue which is rated "aa" is considered a high-grade
preferred stock. This rating indicates that there is a
reasonable assurance that earnings and asset protection will
remain relatively well maintained in the foreseeable future.
a-An issue which is rated "a" is considered to be an upper-
medium grade preferred stock. While risks are judged to be
somewhat greater than in the "aaa" and "aa" classification,
earnings and asset protection are, nevertheless, expected to be
maintained at adequate levels.
baa-An issue which is rated "baa" is considered to be a
medium-grade preferred stock, neither highly protected nor poorly
secured. Earnings and asset protection appear adequate at
present but may be questionable over any great length of time.
ba-An issue which is rated "ba" is considered to have
speculative elements and its future cannot be considered well
assured. Earnings and asset protection may be very moderate and
not well safeguarded during adverse periods. Uncertainty of
position characterizes preferred stocks in this class.
A-2
<PAGE>
DESCRIPTION OF MOODY'S SHORT-TERM DEBT RATINGS
Prime-1. Issuers (or supporting institutions) rated Prime-1
(P-1) have a superior capacity for repayment of short-term
promissory obligations. P-1 repayment capacity will normally be
evidenced by many of the following characteristics: leading
market positions in well-established industries; high rates of
return on funds employed; conservative capitalization structure
with moderate reliance on debt and ample asset protection; broad
margins in earnings coverage of fixed financial charges and high
internal cash generation; well-established access to a range of
financial markets and assured sources of alternate liquidity.
Prime-2. Issuers (or supporting institutions) rated Prime-2
(P-2) have a strong capacity for repayment of short-term
promissory obligations. This will normally be evidenced by many
of the characteristics cited above, but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more
subject to variation. Capitalization characteristics, while
still appropriate, may be more affected by external conditions.
Ample alternate liquidity is maintained.
DESCRIPTION OF STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A. Issues assigned this highest rating are regarded as
having the greatest capacity for timely payment. Issues in this
category are delineated with the numbers 1, 2, and 3 to indicate
the relative degree of safety.
A-1. This designation indicates that the degree of safety
regarding timely payment is either overwhelming or very strong.
Those issues determined to possess overwhelming safety
characteristics are denoted with a plus (+) sign designation.
A-2. Capacity for timely payment on issues with this
designation is strong. However, the relative degree of safety is
not as high as for the issues designated "A-1".
A-3<PAGE>
<PAGE>
WESTERN ASSET TRUST, INC.
CORPORATE SECURITIES PORTFOLIO
MORTGAGE SECURITIES PORTFOLIO
INTERNATIONAL SECURITIES PORTFOLIO
SUPPLEMENT TO PROSPECTUS DATED DECEMBER 31, 1994
The following information is inserted in the section captioned "Fee
Waivers" on page 5 of the Prospectus:
"Western Asset has also voluntarily undertaken to waive fees and/or
reimburse the International Portfolio to the extent that Portfolio's
expenses (exclusive of taxes, interest, brokerage and other transaction
expenses and any extraordinary expenses) exceed during any month an
annual rate of 0.85% of average daily net assets for such month. These
waiver and reimbursement agreements expired on December 31, 1994, but
were extended by Western Asset to June 30, 1995."
The following information is inserted in the section captioned
"Management and Other Expenses" on page 29 of the Prospectus:
"Western Asset has voluntarily agreed to waive its fees or reimburse
each of the Domestic Portfolios to the extent the Portfolio's expenses
(exclusive of taxes, interest, brokerage and other transaction expenses
and any extraordinary expenses) exceed during any month an annual
percentage rate equal to 0.25% of the Portfolio's average daily net
assets, and Western Asset has voluntarily agreed to waive its fees or
reimburse the International Portfolio to the extent that Portfolio's
expenses (exclusive of taxes, interest, brokerage and other transaction
expenses and any extraordinary expenses) exceed during any month an
annual percentage rate equal to 0.85% of that Portfolio's average daily
net assets. These waiver and reimbursement agreements expired December
31, 1994, but were extended by Western Asset until June 30, 1995."
February 9, 1995<PAGE>
<PAGE>
WESTERN ASSET TRUST, INC.
CORPORATE SECURITIES PORTFOLIO
MORTGAGE SECURITIES PORTFOLIO
INTERNATIONAL SECURITIES PORTFOLIO
SUPPLEMENT TO STATEMENT OF ADDITIONAL INFORMATION DATED DECEMBER 31, 1994
The following information is inserted in the section captioned "Expense
Limitations" on page 28 of the Statement of Additional Information:
"Western Asset has agreed to waive its fees or reimburse each of the
Corporate and Mortgage Portfolios to the extent a Portfolio's expenses
(exclusive of taxes, interest, brokerage and other transaction expenses
and any extraordinary expenses) exceed during any month an annual
percentage rate equal to 0.25% of the Portfolio's average daily net
assets. Western Asset has agreed to waive its fees or reimburse the
International Portfolio to the extent the Portfolio's expenses
(exclusive of taxes, interest, brokerage and other transaction expenses
and any extraordinary expenses) exceed during any month an annual
percentage rate equal to 0.85% of the Portfolio's average daily net
assets. These voluntary expense limitations expired December 31, 1994,
but were extended by Western Asset until June 30, 1995."
February 9, 1995<PAGE>
<PAGE>
WESTERN ASSET TRUST, INC.
CORPORATE SECURITIES PORTFOLIO
MORTGAGE SECURITIES PORTFOLIO
INTERNATIONAL SECURITIES PORTFOLIO
SUPPLEMENT TO STATEMENT OF ADDITIONAL INFORMATION DATED DECEMBER 31, 1994
The following information is inserted in the section captioned "Expense
Limitations" on page 28 of the Statement of Additional Information:
"Western Asset has agreed to waive its fees or reimburse the
International Portfolio to the extent the Portfolio's expenses
(exclusive of taxes, interest, brokerage and other transaction expenses
and any extraordinary expenses) exceed during any month an annual
percentage rate equal to 0.85% of the Portfolio's average daily net
assets. These voluntary expense limitations expired June 30, 1995, but
were extended by Western Asset until December 31, 1995."
June 30, 1995<PAGE>
<PAGE>
WESTERN ASSET TRUST, INC.
CORPORATE SECURITIES PORTFOLIO
MORTGAGE SECURITIES PORTFOLIO
INTERNATIONAL SECURITIES PORTFOLIO
SUPPLEMENT TO PROSPECTUS DATED DECEMBER 31, 1994
The following information is inserted in the section captioned "Fee Waivers"
on page 5 of the Prospectus:
"Western Asset has also voluntarily undertaken to waive fees and/or
reimburse the International Portfolio to the extent that Portfolio's
expenses (exclusive of taxes, interest, brokerage and other transaction
expenses and any extraordinary expenses) exceed during any month an
annual rate of 0.85% of average daily net assets for such month. These
waiver and reimbursement agreements expired on June 30, 1995, but were
extended by Western Asset to December 31, 1995."
The following information is inserted in the section captioned "Management
and Other Expenses" on page 29 of the Prospectus:
"Western Asset has voluntarily agreed to waive its fees or reimburse
each of the Domestic Portfolios to the extent the Portfolio's expenses
(exclusive of taxes, interest, brokerage and other transaction expenses
and any extraordinary expenses) exceed during any month an annual
percentage rate equal to 0.25% of the Portfolio's average daily net
assets, and Western Asset has voluntarily agreed to waive its fees or
reimburse the International Portfolio to the extent that Portfolio's
expenses (exclusive of taxes, interest, brokerage and other transaction
expenses and any extraordinary expenses) exceed during any month an
annual percentage rate equal to 0.85% of that Portfolio's average daily
net assets. These waiver and reimbursement agreements expired June 30,
1995, but were extended by Western Asset until December 31, 1995."
June 30, 1995<PAGE>
