<PAGE>
MAINSTAY INSTITUTIONAL FUNDS INC.
51 MADISON AVENUE
NEW YORK, NEW YORK 10010
STATEMENT OF ADDITIONAL INFORMATION
DATE: NOVEMBER 21, 1997
SUPPLEMENTED ON DECEMBER 11, 1997
MainStay Institutional Funds Inc. (the "Company") is an open-end
management investment company currently consisting of eleven separate investment
portfolios: EAFE Index Fund, Growth Equity Fund, Indexed Equity Fund,
International Equity Fund, Multi-Asset Fund, Value Equity Fund, Bond Fund,
Indexed Bond Fund, International Bond Fund, Money Market Fund, and Short-Term
Bond Fund (individually or collectively referred to as a "Fund" or the "Funds").
This Statement of Additional Information supplements the information
contained in the Company's Institutional Class and Institutional Service Class
Prospectuses dated November 21, 1997 (collectively, the "Prospectus"), and
should be read in conjunction with the Prospectus. The Prospectus is available
without charge by writing to MainStay Institutional Funds Inc., P.O. Box 461,
Parsippany, New Jersey 07054-0461, or by calling 1-800-695-2126. This Statement
of Additional Information, although not in itself a prospectus, is incorporated
in its entirety by reference in and is made a part of each Class' Prospectuses.
No dealer, salesman or any other person has been authorized to give any
information or to make any representations, other than those contained in this
Statement of Additional Information or in the related Prospectuses, in
connection with the offer contained herein, and, if given or made, such other
information or representations must not be relied upon as having been authorized
by the Funds or the Distributor. This Statement of Additional Information and
the related Prospectuses do not constitute an offer by the Company or by the
Distributor to sell or a solicitation of any offer to buy any of the securities
offered hereby in any jurisdiction to any person to whom it is unlawful to make
such offer in such jurisdiction.
<PAGE>
TABLE OF CONTENTS
ADDITIONAL INVESTMENT POLICIES OF THE MONEY MARKET FUND.............. 1
INVESTMENT OBJECTIVES AND POLICIES................................... 3
Arbitrage...................................................... 3
Borrowing...................................................... 4
Commercial Paper............................................... 4
Repurchase Agreements.......................................... 4
Government Securities.......................................... 5
Lending of Portfolio Securities................................ 6
Municipal Bonds................................................ 7
Banking Industry and Savings and Loan Industry
Obligations.................................................... 7
Floating and Variable Rate Securities.......................... 8
Foreign Securities............................................. 8
American Depositary Receipts ("ADRs").......................... 10
When-Issued and Firm or Standby Commitment Agreements.......... 10
Mortgage-Related and Other Asset-Backed Securities............. 11
Brady Bonds.................................................... 18
Loan Participation Interests................................... 19
Options on Securities.......................................... 21
Options on Foreign Currencies.................................. 25
Futures Transactions........................................... 27
Swap Agreements................................................ 36
Forward Foreign Currency Contracts............................. 39
Foreign Index-Linked Instruments............................... 43
Warrants....................................................... 43
Short Sales Against the Box.................................... 44
High Yield/High Risk Securities................................ 44
Zero Coupon Bonds.............................................. 45
INVESTMENT RESTRICTIONS.............................................. 46
MANAGEMENT OF THE COMPANY............................................ 48
Directors and Officers......................................... 48
Compensation Table............................................. 51
Management Agreement........................................... 52
Sub-Advisory Agreements........................................ 53
Distributor.................................................... 55
Service Fees................................................... 56
PURCHASES AND REDEMPTIONS............................................ 57
PORTFOLIO TRANSACTIONS AND BROKERAGE................................. 57
NET ASSET VALUE...................................................... 61
TAX INFORMATION...................................................... 64
PERFORMANCE INFORMATION.............................................. 73
- i -
<PAGE>
OTHER INFORMATION.................................................... 77
Capitalization................................................. 77
Effective Maturity............................................. 77
Beneficial Ownership of the Funds.............................. 77
Code of Ethics................................................. 80
Independent Accountants........................................ 80
Legal Counsel.................................................. 80
Financial Statements........................................... 80
Registration Statement......................................... 81
- ii -
<PAGE>
ADDITIONAL INVESTMENT POLICIES OF THE MONEY MARKET FUND
Each Fund has a separate investment objective or objectives which it
pursues through separate investment policies, as described in the Prospectus.
The following discussion elaborates on the presentation of the Money Market
Fund's investment policies contained in the Prospectus.
The Fund may invest its assets in U.S. dollar-denominated securities of
U.S. or foreign issuers and in securities of foreign branches of U.S. banks,
such as negotiable certificates of deposit (Eurodollars). Since the portfolio of
the Fund may contain such securities, an investment therein involves investment
risks that are different in some respects from an investment in a fund which
invests only in debt obligations of U.S. domestic issuers. Such risks may
include future political and economic developments, the possible imposition of
foreign withholding taxes on interest income payable on the securities held in
the portfolio, possible seizure or nationalization of foreign deposits, the
possible establishment of exchange controls or the adoption of other foreign
governmental restrictions which might adversely affect the payment of the
principal of and interest on securities in the portfolio.
All of the assets of the Fund generally will be invested in obligations
which mature in 397 days or less and substantially all of these investments will
be held to maturity; however, securities collateralizing repurchase agreements
may have maturities in excess of 397 days. The Fund will, to the extent
feasible, make portfolio investments primarily in anticipation of or in response
to changing economic and money market conditions and trends. The dollar-weighted
average maturity of the Fund's portfolio may not exceed 90 days. Consistent with
the provisions of a rule of the Securities and Exchange Commission ("SEC"), the
Fund invests only in U.S. dollar-denominated money market instruments that
present minimal credit risk and, with respect to 95% of its total assets,
measured at the time of investment, that are of the highest quality. The
Sub-Adviser shall determine whether a security presents minimal credit risk
under procedures adopted by the Company's Board of Directors. A money market
instrument will be considered to be of the highest quality (1) if rated in the
highest rating category (i.e., Aaa or Prime-1 by Moody's, AAA or A-1 by S&P's)
by (i) any two nationally recognized statistical rating organizations ("NRSROs")
or, (ii) if rated by only one NRSRO, by that NRSRO; (2) if issued by an issuer
that has short-term debt obligations of comparable maturity, priority, and
security, and that are rated in the highest rating category by (i) any two
NRSROs or, (ii) if rated by only one NRSRO, by that NRSRO; or (3) an unrated
security that is of comparable quality to a security in the highest rating
category as determined by the Sub-Adviser. With respect to 5% of its total
assets, measured at the time of investment, the Fund may also invest in money
market instruments that are in the second-highest rating category for short-term
debt obligations (i.e., rated Aa or Prime-2 by Moody's or AA or A-2 by S&P).
<PAGE>
The Fund may not invest more than 5% of its total assets, measured at the
time of investment, in securities of any one issuer that are of the highest
quality, except that the Fund may exceed this 5% limitation with respect to 25%
of its total assets for up to three business days after the purchase of a
security of any one issuer and except that this limitation shall not apply to
U.S. government securities or securities subject to certain puts. The Fund may
not invest more than the greater of 1% of its total assets or one million
dollars, measured at the time of investment, in securities of any one issuer
that are in the second-highest rating category, except that this limitation
shall not apply to U.S. government securities or securities subject to certain
puts. In the event that an instrument acquired by the Fund is downgraded or
otherwise ceases to be of the quality that is eligible for the Fund, the
Sub-Adviser, under procedures approved by the Board (or the Board itself if the
Sub-Adviser becomes aware an unrated security is downgraded below high quality
and the Sub-Adviser does not dispose of the security within five business days)
shall promptly reassess whether such security presents minimal credit risk and
determine whether or not to retain the instrument.
Pursuant to the rule, the Fund uses the amortized cost method of valuing
its investments, which facilitates the maintenance of the Fund's per share net
asset value at $1.00. The amortized cost method, which is normally used to value
all of the Fund's portfolio securities, involves initially valuing a security at
its cost and thereafter amortizing to maturity any discount or premium,
regardless of the impact of fluctuating interest rates on the market value of
the instrument.
The Directors have also established procedures designed to stabilize, to
the extent reasonably possible, the Fund's price per share as computed for the
purpose of sales and redemptions at $1.00. Such procedures include review of the
Fund's portfolio by the Directors, at such intervals as they deem appropriate,
to determine whether the Fund's net asset value calculated by using available
market quotations or market equivalents (the determination of value by reference
to interest rate levels, quotations of comparable securities and other factors)
deviates from $1.00 per share based on amortized cost.
The extent of deviation between the Fund's net asset value based upon
available market quotations or market equivalents and $1.00 per share based on
amortized cost will be periodically examined by the Directors. If such deviation
exceeds 1/2 of 1%, the Directors will promptly consider what action, if any,
will be initiated. In the event the Directors determine that a deviation exists
which may result in material dilution or other unfair results to investors or
existing shareholders, they will take such corrective action as they regard to
be necessary and appropriate,
- 2 -
<PAGE>
including the sale of portfolio instruments prior to maturity to realize capital
gains or losses or to shorten average portfolio maturity; withholding part or
all of dividends or payment of distributions from capital or capital gains;
redemptions of shares in kind; or establishing a net asset value per share by
using available market quotations or equivalents. In addition, in order to
stabilize the net asset value per share at $1.00, the Directors have the
authority (1) to reduce or increase the number of shares outstanding on a pro
rata basis, and (2) to offset each shareholder's pro rata portion of the
deviation between the net asset value per share and $1.00 from the shareholder's
accrued dividend account or from future dividends.
The Fund may hold cash for the purpose of stabilizing its net asset value
per share. Holdings of cash, on which no return is earned, would tend to lower
the yield on the Fund's shares.
The Fund may also, consistent with the provisions of the rule, invest in
securities with a face maturity of more than 397 days, provided that the
security is a variable or floating rate security that meets the guidelines of
Rule 2a-7 with respect to maturity.
INVESTMENT OBJECTIVES AND POLICIES
The Prospectus discusses the investment objectives of the Funds and the
policies to be employed to achieve those objectives. This section contains
supplemental information concerning certain of the securities and other
instruments in which the Funds may invest, the investment policies and portfolio
strategies the Funds may utilize, and certain risks involved with those
investments, policies and strategies.
ARBITRAGE
Each Fund may sell in one market a security which it owns and
simultaneously purchase the same security in another market, or it may buy a
security in one market and simultaneously sell it in another market, in order to
take advantage of differences in the price of the security in the different
markets. The Funds do not actively engage in arbitrage. Such transactions may be
entered into only with respect to debt securities and will occur only in a
dealer's market where the buying and selling dealers involved confirm their
prices to the Fund at the time of the transaction, thus eliminating any risk to
the assets of a Fund. Such transactions, which involve costs to a Fund, may be
limited by the requirements imposed on each Fund to qualify as a "regulated
investment company" under the Internal Revenue Code of 1986, as amended (the
"Code"). Each Fund has undertaken to a state securities commission that it will
not engage in any arbitrage
- 3 -
<PAGE>
transactions, if as a result thereof, the aggregate amount invested in such
transactions would exceed 5% of the Fund's net assets.
BORROWING
A Fund may borrow from a bank up to a limit of 15% of its total assets,
but only for temporary or emergency purposes. This borrowing may be unsecured.
The Investment Company Act of 1940, as amended (the "1940 Act") requires a Fund
to maintain continuous asset coverage (that is, total assets including
borrowings, less liabilities exclusive of borrowings) of 300% of the amount
borrowed. If the 300% asset coverage should decline as a result of market
fluctuations or other reasons, a Fund may be required to sell some of its
portfolio holdings within three days 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 and could cause the Fund to be unable
to meet certain requirements for qualification as a regulated investment company
for Federal tax purposes. To avoid the potential leveraging effects of a Fund's
borrowings, a Fund will repay any money borrowed in excess of 5% of its total
assets prior to purchasing additional securities. Borrowing may exaggerate the
effect on a Fund's net asset value of any increase or decrease in the market
value of the Fund's portfolio securities. Money borrowed will be subject to
interest costs which may or may not be recovered by appreciation of the
securities purchased. A Fund 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
cost of borrowing over the stated interest rate.
COMMERCIAL PAPER
Each Fund may invest in commercial paper. Each Fund will invest in
commercial paper only if rated at the time of investment Prime-1 by Moody's or
A-1 by S&P, or, if not rated by Moody's or S&P, if the Fund's Sub-Adviser
determines that the commercial paper is of comparable quality. Commercial paper
represents short-term unsecured promissory notes issued by banks or bank holding
companies, corporations and finance companies. (See "Appendix A Description of
Securities Ratings" in the Prospectus.)
REPURCHASE AGREEMENTS
The Funds may enter into domestic or foreign repurchase agreements with
certain sellers deemed to be creditworthy pursuant to guidelines adopted by the
Directors. A repurchase agreement, which provides a means for a Fund to earn
income on uninvested cash for periods as short as overnight, is an arrangement
under which the purchaser (i.e., the Fund) purchases securities (the
- 4 -
<PAGE>
"Obligation") and the seller agrees, at the time of sale, to repurchase the
Obligation at a specified time and price. Repurchase agreements with foreign
banks may be available with respect to government securities of the particular
foreign jurisdiction. The custody of the Obligation will be maintained by the
Fund's Custodian. The repurchase price may be higher than the purchase price,
the difference being income to the Fund, or the purchase and repurchase prices
may be the same, with interest at a stated rate due to the Fund together with
the repurchase price upon repurchase. In either case, the income to the Fund is
unrelated to the interest rate on the Obligation subject to the repurchase
agreement.
In the event of the commencement of bankruptcy or insolvency proceedings
with respect to the seller of the Obligation before repurchase of the Obligation
under a repurchase agreement, the Fund may encounter delays and incur costs
before being able to sell the security. Delays may involve loss of interest or
decline in price of the Obligation. The Sub-Advisers seek to minimize the risk
of loss from repurchase agreements by analyzing the creditworthiness of the
obligor, in this case the seller of the Obligation. Apart from the risk of
bankruptcy or insolvency proceedings, there is also the risk that the seller may
fail to repurchase the security. However, if the market value of the Obligation
subject to the repurchase agreement becomes less than the repurchase price
(including accrued interest), the Fund will direct the seller of the Obligation
to deliver additional securities so that the market value of all securities
subject to the repurchase agreement equals or exceeds the repurchase price. No
Fund will invest more than 10% of its net assets (taken at current market value)
(15% in the case of the International Equity and International Bond Funds) in
repurchase agreements maturing in more than seven days.
GOVERNMENT SECURITIES
Government securities are obligations of, or guaranteed by, the U.S.
government or its agencies or instrumentalities. Some U.S. government
securities, such as Treasury bills, notes and bonds, are supported by the full
faith and credit of the United States; others, such as those of the Federal Home
Loan Bank, are supported by the right of the issuer to borrow from the Treasury;
others, such as those of the Federal National Mortgage Association, are
supported by the discretionary authority of the U.S. government to purchase the
agency's obligations; and still others, such as those of the Student Loan
Marketing Association, are supported only by the credit of the instrumentality.
- 5 -
<PAGE>
STANDARD & POOR'S 500 COMPOSITE STOCK PRICE INDEX
The Indexed Equity Fund and the Multi-Asset Fund are managed in part to
replicate the Standard & Poor's 500 Composite Stock Price Index (the "S&P 500").
Because of the market-value weighing, the 20 largest companies in the S&P 500
currently account for approximately 28% of the Index. As of December 31, 1996,
the five largest weightings in the S&P 500 as a percentage of net assets were:
General Electric Company (2.9%); Coca Cola Co. (2.3%); Exxon Corporation (2.2%);
Intel Corporation (1.9%) and Microsoft Corporation (1.7%).
LENDING OF PORTFOLIO SECURITIES
In accordance with guidelines adopted by the Board of Directors, each Fund
may seek to increase its income by lending portfolio securities. Under present
regulatory policies, such loans may be made to institutions, such as
broker-dealers, and would be required to be secured continuously by collateral
in cash or U.S. Government securities maintained on a current basis at an amount
at least equal to 100% of the current market value of the securities loaned. The
Fund would have the right to call a loan and obtain the securities loaned at any
time generally on less than five days' notice. For the duration of a loan, the
Fund would continue to receive the equivalent of the interest or dividends paid
by the issuer on the securities loaned and would also receive compensation from
the investment of the collateral. The Fund would not, however, have the right to
vote any securities having voting rights during the existence of the loan, but
the Fund would call the loan in anticipation of an important vote to be taken
among holders of the securities or of the giving or withholding of their consent
on a material matter affecting the investment. The Company, on behalf of certain
of the Funds, has entered into an agency agreement with Merrill Lynch Portfolio
Services, Inc. which acts as the Funds' agent in making loans of portfolio
securities and short-term money market investments of the cash collateral
received, subject to the supervision and control of the Funds' Sub- Advisers.
As with other extensions of credit there are risks of delay in recovery
of, or even loss of rights in, the collateral should the borrower of the
securities fail financially. However, the loans would be made only to firms
deemed by a Sub-Adviser to be creditworthy and approved by the Board, and when,
in the judgment of a Sub-Adviser, the consideration which can be earned
currently from securities loans of this type justifies the attendant risk. If a
Sub-Adviser determines to make securities loans, it is intended that the value
of the securities loaned would not exceed 33% of the value of the total assets
of the lending Fund. Under the guidelines adopted by the Board of Directors, a
Fund may not
- 6 -
<PAGE>
enter into a lending agreement with a counterparty which would cause the Fund to
have loans outstanding to that counterparty for securities having a value
greater than 5% of the Fund's total assets.
MUNICIPAL BONDS
Municipal bonds are debt obligations of state and local governments,
agencies and authorities, which are issued to obtain funds for various public
purposes. Two principal classifications of municipal bonds are "general
obligation" and "revenue" bonds. General obligation bonds are secured by the
issuer's pledge of its full faith, credit and taxing power for the payment of
principal and interest. Revenue bonds are payable only from the revenues derived
from a particular facility or class of facilities, or, in some cases, from the
proceeds of a special excise or specific revenue source. Industrial development
bonds or private activity bonds are issued by or on behalf of public authorities
to obtain funds for privately operated facilities and are, in most cases,
revenue bonds which do not generally carry the pledge of the full faith and
credit of the issuer of such bonds, but depend for payment on the ability of the
industrial user to meet its obligations (or any property pledged as security).
BANKING INDUSTRY AND SAVINGS AND LOAN INDUSTRY OBLIGATIONS
Certificates of deposit are receipts from a bank or savings and loan
association ("S&L"), for funds deposited for a specified period of time at a
specified rate of return. Time deposits in banks or S&Ls are generally similar
to certificates of deposit, but are uncertificated. Bankers' acceptances are
time drafts drawn on commercial banks by borrowers, usually in connection with
international commercial transactions. Each Fund may not invest in time deposits
maturing in more than seven days which are subject to withdrawal penalties. Each
Fund will limit it investment in time deposits for which there is a penalty for
early withdrawal to 10% of its net assets.
Each Fund will not invest in any obligation of a domestic or foreign bank
unless (i) the bank has capital, surplus, and individual profits (as of the date
of the most recently published financial statements) in excess of $100 million,
or the equivalent in other currencies, and (ii) in the case of a U.S. bank, its
deposits are insured by the Federal Deposit Insurance Corporation. These
limitations do not prohibit investments in the securities issued by foreign
branches of U.S. banks, provided such U.S. banks meet the foregoing
requirements.
- 7 -
<PAGE>
FLOATING AND VARIABLE RATE SECURITIES
Floating and variable rate securities provide for a 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 an interest
rate adjustment index as provided in the respective obligations. The adjustment
intervals may be regular, and range from daily up to annually, or may be event
based, such as based on a change in the prime rate.
The interest rate on a floating rate debt instrument ("floater") is a
variable rate which is tied to another interest rate, such as a money-market
index or Treasury bill rate. The interest rate on a floater resets periodically,
typically every six months. While, because of the interest rate reset feature,
floaters provide a Fund with a certain degree of protection against rises in
interest rates, a Fund will participate in any declines in interest rates as
well.
The interest rate on a leveraged inverse floating rate debt instrument
("inverse floater") resets in the opposite direction from the market rate of
interest to which the inverse floater is indexed. An inverse floater may be
considered to be leveraged to the extent that its interest rate varies by a
magnitude that exceeds the magnitude of the change in the index rate of
interest. The higher degree of leverage inherent in inverse floaters is
associated with greater volatility in their market values. Accordingly, the
duration of an inverse floater may exceed its stated final maturity. Certain
inverse floaters may be determined to be illiquid securities for purposes of a
Fund's limitation on investments in such securities.
FOREIGN SECURITIES
The EAFE Index Fund, International Bond Fund and International Equity Fund
will, and the Bond Fund, Growth Equity Fund, Multi-Asset Fund, Short-Term Bond
Fund and Value Equity Fund may invest in securities of foreign issuers. The
Money Market Fund may purchase U.S. dollar-denominated securities of foreign
issuers. The Indexed Equity Fund and Indexed Bond Fund will invest in foreign
securities to the extent such securities are included in the securities that
comprise the Standard & Poor's 500 Composite Stock Price Index and the Salomon
Brothers Broad Investment Grade Bond Index, respectively. The International Bond
Fund and International Equity Fund may invest, without limit, subject to the
other investment policies applicable to the Fund, in U.S. dollar-denominated and
non-dollar denominated foreign debt securities and in certificates of deposit
issued by foreign banks and foreign branches of United States banks, to any
extent deemed appropriate by MacKay-Shields. Securities acquired by the
- 8 -
<PAGE>
International Bond Fund may be denominated in multinational currency units such
as the European Currency Unit ("ECU"). Securities of issuers within a given
country may be denominated in the currency of another country.
Foreign investing involves the possibility of expropriation,
nationalization or confiscatory taxation, foreign taxation of income earned in
the foreign nation (including withholding taxes on interest and dividends) or
other foreign taxes imposed with respect to investments in the foreign nation,
foreign exchange controls (which may include suspension of the ability to
transfer currency from a given country), default in foreign government
securities, political or social instability or diplomatic developments which
could affect investments in securities of issuers in those nations. In addition,
in many countries there is less publicly available information about issuers
than is available in reports about companies in the United States. Foreign
companies are not generally subject to uniform accounting and auditing and
financial reporting standards, and auditing practices and requirements may not
be comparable to those applicable to U.S. companies. In many foreign countries,
there is less government supervision and regulation of business and industry
practices, stock exchanges, brokers and listed companies than in the United
States. Foreign securities transactions may be subject to higher brokerage and
custodial costs than domestic securities transactions. In addition, the foreign
securities markets of many of the countries in which the Funds may invest may
also be smaller, less liquid and subject to greater price volatility than those
in the United States.
The Growth Equity Fund, Indexed Bond Fund, International Bond Fund,
International Equity Fund, Multi-Asset Fund and Value Equity Fund may invest in
emerging market countries, which presents risks in greater degree than, and in
addition to, those presented by investment in foreign issuers in general. A
number of emerging market countries restrict, to varying degrees, foreign
investment in stocks. Repatriation of investment income, capital and the
proceeds of sales by foreign investors may require governmental registration
and/or approval in some emerging market countries. A number of the currencies of
developing countries have experienced significant declines against the U.S.
dollar in recent years and devaluation may occur subsequent to investments in
these currencies by the Funds. Inflation and rapid fluctuations in inflation
rates have had and may continue to have negative effects on the economies and
securities markets of certain emerging market countries.
Many of the emerging securities markets are relatively small, have low
trading volumes, suffer periods of relative illiquidity, and are characterized
by significant price volatility. There is a risk in emerging market countries
that a future economic or
- 9 -
<PAGE>
political crisis could lead to price controls, forced mergers of companies,
expropriation or confiscatory taxation, seizure, nationalization or creation of
government monopolies, any of which may have a detrimental effect on the Funds'
investments.
To different degrees, the Bond Fund, Indexed Bond Fund, International Bond
Fund, International Equity Fund and Short-Term Bond Fund are permitted to invest
in debt securities or obligations of foreign governments, agencies, and
supranational organizations ("Sovereign Debt"). Investments in Sovereign Debt
can involve greater risks than investing in U.S. Government Securities. The
issuer of the debt or the governmental authorities that control the repayment of
the debt may be unable or unwilling to repay principal or interest when due in
accordance with the terms of such debt, and a Fund may have limited legal
recourse in the event of default.
The occurrence of political, social or diplomatic changes in one or more
of the countries issuing Sovereign Debt could adversely affect a Fund'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 the investment advisers intend to manage the Funds'
portfolios in a manner that will minimize the exposure to such risks, there can
be no assurance that adverse political changes will not cause a Fund to suffer a
loss of interest or principal on any of its holdings.
AMERICAN DEPOSITARY RECEIPTS ("ADRS")
ADRs (sponsored or unsponsored) are receipts typically issued by a U.S.
bank or trust company evidencing ownership of the underlying foreign securities.
Most ADRs are traded on a U.S. stock exchange. Issuers of unsponsored ADRs are
not contractually obligated to disclose material information in the U.S. and,
therefore, there may not be a correlation between such information and the
market value of the unsponsored ADR. European Depositary Receipts and
International Depositary Receipts are receipts typically issued by a European
bank or trust company evidencing ownership of the underlying foreign securities.
Global Depositary Receipts are receipts issued by either a U.S. or non-U.S.
banking institution evidencing ownership of the underlying foreign securities.
WHEN-ISSUED AND FIRM OR STANDBY COMMITMENT AGREEMENTS
Each Fund, as specified for the Fund in the Prospectus, may from time to
time purchase securities on a "when-issued" or "firm commitment" or "standby
commitment" basis. Debt securities are often issued in this manner. The price of
such securities, which may be expressed in yield terms, is fixed at the time a
commitment
- 10 -
<PAGE>
to purchase is made, but delivery of and payment for the when-issued, or firm or
standby commitment securities take place at a later date. Normally, the
settlement date occurs within one month of the purchase. During the period
between purchase and settlement, no payment is made by the Fund and no interest
accrues to the Fund. To the extent that assets of a Fund are held in cash
pending the settlement of a purchase of securities, that Fund would earn no
income; however, it is the Company's intention that each Fund will be fully
invested to the extent practicable and subject to the policies stated herein.
Although when-issued, or firm or standby commitment securities may be sold prior
to the settlement date, the Company intends to purchase such securities with the
purpose of actually acquiring them unless a sale appears desirable for
investment reasons.
At the time the Company makes the commitment on behalf of a Fund to
purchase a security on a when-issued, or firm or standby commitment basis, it
will record the transaction and reflect the amount due and the value of the
security in determining the Fund's net asset value. The market value of the
when-issued, or firm or standby commitment securities may be more or less than
the purchase price payable at the settlement date. The Directors do not believe
that a Fund's net asset value or income will be exposed to additional risk by
the purchase of securities on a when-issued or firm commitment basis. Each Fund
will establish a segregated account in which it will maintain liquid assets at
least equal in value to any commitments to purchase securities on a when-issued,
firm, or standby commitment basis. Such segregated securities either will mature
or, if necessary, be sold on or before the settlement date.
MORTGAGE-RELATED AND OTHER ASSET-BACKED SECURITIES
The value of some mortgage-related or asset-backed securities in which the
Funds invest may be particularly sensitive to changes in prevailing interest
rates, and, like the other investments of the Funds, the ability of a Fund to
successfully utilize these instruments may depend in part upon the ability of an
investment adviser to forecast interest rates and other economic factors
correctly. While principal and interest payments on some mortgage-related
securities may be guaranteed by the U.S. government, government agencies or
other guarantors, the market value of such securities is not guaranteed.
A Fund will invest only in mortgage-related (or other asset- backed)
securities either (i) issued by U.S. government-sponsored corporations
(currently GNMA, FHLMC and FNMA), or (ii) privately issued securities rated Baa
or better by Moody's or BBB by S&P or, if not rated, of comparable investment
quality as determined by the Fund's investment adviser. In addition, if any such
security is
- 11 -
<PAGE>
determined to be illiquid, a Fund will limit its investments in these and other
illiquid instruments to not more than 10% of its net assets (15% in the case of
the International Bond Fund and International Equity Fund).
Mortgage Pass-Through Securities. Mortgage pass-through securities
--------------------------------
which are securities interests in pools of mortgage-related securities, differ
from other forms of debt securities, which normally provide for periodic payment
of interest in fixed amounts with principal payments at maturity or specified
call dates. Instead, these securities provide a monthly payment which consists
of both interest and principal payments. 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 are caused by repayments of principal
resulting from the sale of the underlying residential property, refinancing or
foreclosure, net of fees or costs which may be incurred. Some mortgage-related
securities (such as securities issued by the Government National Mortgage
Association) are described as "modified pass-through." These securities entitle
the holder to receive all interest and principal payments owed on the mortgage
pool, net of certain fees, at the scheduled payment dates regardless of whether
or not the mortgagor actually makes the payment.
The principal governmental guarantor of mortgage-related securities is the
Government National Mortgage Association ("GNMA"). GNMA is a wholly owned U.S.
Government corporation within the Department of Housing and Urban Development.
GNMA is authorized to guarantee, with the full faith and credit of the U.S.
Government, the timely payment of principal and interest on securities issued by
institutions approved by GNMA (such as S&Ls, commercial banks and mortgage
bankers) and backed by pools of Federal Housing Administration-insured or
Veterans Administration-guaranteed mortgages.
Government-related guarantors (i.e., not backed by the full faith and
----
credit of the U.S. Government) include the Federal National Mortgage Association
("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC"). FNMA is a
government-sponsored corporation owned entirely by private stockholders. It is
subject to general regulation by the Secretary of Housing and Urban Development.
FNMA purchases conventional (i.e., not insured or guaranteed by any government
----
agency) residential mortgages from a list of approved seller/servicers which
include state and federally chartered savings and loan associations, mutual
savings banks, commercial banks, credit unions and mortgage bankers.
Pass-through securities issued by FNMA are guaranteed as to timely payment of
principal and interest by FNMA but are not backed by the full faith and credit
of the U.S. Government.
- 12 -
<PAGE>
FHLMC is a corporate instrumentality of the U.S. Government and was
created by Congress in 1970 for the purpose of increasing the availability of
mortgage credit for residential housing. Its stock is owned by the twelve
Federal Home Loan Banks. FHLMC issues Participation Certificates ("Pcs") which
represent interests in conventional mortgages from FHLMC's national portfolio.
FHLMC guarantees the timely payment of interest and ultimate collection of
principal, but Pcs are not backed by the full faith and credit of the U.S.
Government.
Commercial banks, savings and loan institutions, private mortgage
insurance companies, mortgage bankers and other secondary market issuers also
create pass-through pools of conventional residential mortgage loans. Such
issuers may, in addition, be the originators and/or servicers of the underlying
mortgage loans as well as the guarantors of the mortgage-related securities.
Pools created by such non-governmental issuers generally offer a higher rate of
interest than government and government-related pools because there are no
direct or indirect government or agency guarantees of payments in the former
pools. However, timely payment of interest and principal of these pools may be
supported by various forms of insurance or guarantees, including individual
loan, title, pool and hazard insurance and letters of credit. The insurance and
guarantees are issued by governmental entities, private insurers and the
mortgage poolers. Such insurance and guarantees and the creditworthiness of the
issuers thereof will be considered in determining whether a mortgage-related
security meets a Fund's investment quality standards. There can be no assurance
that the private insurers or guarantors can meet their obligations under the
insurance policies or guarantee arrangements. Although the market for such
securities is becoming increasingly liquid, securities issued by certain private
organizations may not be readily marketable. Early repayment of principal on
mortgage pass-through securities (arising from prepayments of principal due to
sale of the underlying property, refinancing, or foreclosure, net of fees and
costs which may be incurred) may expose a Fund to a lower rate of return upon
reinvestment of principal. Also, if a security subject to repayment has been
purchased at a premium, in the event of prepayment the value of the premium
would be lost. No Fund will purchase mortgage-related securities or any other
assets which in the opinion of the Fund's investment adviser are illiquid if, as
a result, more than 10% of the value of the Fund's net assets will be illiquid
(15% in the case of the International Bond or International Equity Funds).
Collateralized Mortgage Obligations ("CMOs"). A CMO is a hybrid between a
--------------------------------------------
mortgage-backed bond and a mortgage pass-through security. Similar to a bond,
interest and prepaid principal is paid, in most cases, semiannually. CMOs may be
collateralized by whole mortgage loans, but are more typically collateralized by
- 13 -
<PAGE>
portfolios of mortgage pass-through securities guaranteed by GNMA, FHLMC, or
FNMA, and their income streams.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral. CMOs provide for a modified form of call
protection through a de facto breakdown of the underlying pool of mortgages
--------
according to how quickly the loans are repaid. Monthly payment of principal
received from the pool of underlying mortgages, including prepayments, is first
returned to investors holding the shortest maturity class. Investors holding the
longer maturity classes receive principal only after the first class has been
retired. An investor is partially guarded against a sooner than desired return
of principal because of the sequential payments.
In a typical CMO transaction, a corporation ("issuer") issues multiple
series (e.g., A, B, C, Z) of CMO bonds ("Bonds"). Proceeds of the Bond offering
----
are used to purchase mortgages or mortgage pass-through certificates
("Collateral"). The Collateral is pledged to a third-party trustee as security
for the Bonds. Principal and interest payments from the Collateral are used to
pay principal on the Bonds in the order A, B, C, Z. The Series A, B, and C Bonds
all bear current interest. Interest on the Series Z Bond is accrued and added to
principal and a like amount is paid as principal on the Series A, B, or C Bond
currently being paid off. When the Series A, B, and C Bonds are paid in full,
interest and principal on the Series Z Bond begins to be paid currently. With
some CMOs, the issuer serves as a conduit to allow loan originators (primarily
builders or savings and loan associations) to borrow against their loan
portfolios.
FHLMC Collateralized Mortgage Obligations. FHLMC CMOs are debt obligations
-----------------------------------------
of FHLMC issued in multiple classes having different maturity dates which are
secured by the pledge of a pool of conventional mortgage loans purchased by
FHLMC. Unlike FHLMC Pcs, payments of principal and interest on the CMOs are made
semiannually, as opposed to monthly. The amount of principal payable on each
semiannual payment date is determined in accordance with FHLMC's mandatory
sinking fund schedule, which, in turn, is equal to approximately 100% of Federal
Housing Administration ("FHA") prepayment experience applied to the mortgage
collateral pool. All sinking fund payments in the CMOs are allocated to the
retirement of the individual classes of bonds in the order of their stated
maturities. Payment of principal on the mortgage loans in the collateral pool in
excess of the amount of FHLMC's minimum sinking fund obligation for any payment
date are paid to the holders of the CMOs as additional sinking fund payments.
Because of the "pass-through" nature of all principal payments received on the
collateral pool in excess of FHLMC's minimum sinking fund
- 14 -
<PAGE>
requirement, the rate at which principal of the CMOs is actually repaid is
likely to be such that each class of bonds will be retired in advance of its
scheduled maturity date.
If collection of principal (including prepayments) on the mortgage loans
during any semiannual payment period is not sufficient to meet FHLMC's minimum
sinking fund obligation on the next sinking fund payment date, FHLMC agrees to
make up the deficiency from its general funds.
Criteria for the mortgage loans in the pool backing the CMOs are identical
to those of FHLMC Pcs. FHLMC has the right to substitute collateral in the event
of delinquencies and/or defaults.
Other Mortgage-Related Securities. The Funds' Sub-Advisers expect that
---------------------------------
governmental, government-related or private entities may create mortgage loan
pools and other mortgage-related securities offering mortgage pass-through and
mortgage-collateralized investments in addition to those described above. The
mortgages underlying these securities may include alternative mortgage
instruments, that is, mortgage instruments whose principal or interest payments
may vary or whose terms to maturity may differ from customary long-term fixed
rate mortgages. As new types of mortgage-related securities are developed and
offered to investors, a Fund's Sub-Adviser will, consistent with the
Fund's investment objectives, policies and quality standards, consider making
investments in such new types of mortgage-related securities.
CMO Residuals. CMO residuals are derivative mortgage securities issued by
-------------
agencies or instrumentalities of the U.S. Government or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
homebuilders, mortgage banks, commercial banks, investment banks and special
purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs
is applied first to make required payments of principal and interest on the CMOs
and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess cash
flow remaining after making the foregoing payments. Each payment of such excess
cash flow to a holder of the related CMO residual represents income and/or a
return of capital. The amount of residual cash flow resulting from a CMO will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of CMO, prevailing interest rates, the amount of
administrative expenses and the prepayment experience on the mortgage assets. In
particular, the yield to maturity on CMO
- 15 -
<PAGE>
residuals is extremely sensitive to prepayments on the related underlying
mortgage assets, in the same manner as an interest-only ("IO") class of stripped
mortgage-backed securities. See "Stripped Mortgage-Backed Securities." In
addition, if a series of a CMO includes a class that bears interest at an
adjustable rate, the yield to maturity on the related CMO residual will also be
extremely sensitive to changes in the level of the index upon which interest
rate adjustments are based. As described below with respect to stripped
mortgage-backed securities, in certain circumstances a portfolio may fail to
recoup fully its initial investment in a CMO residual.
CMO residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The CMO
residual market has only very recently developed and CMO residuals currently may
not have the liquidity of other more established securities trading in other
markets. Transactions in CMO residuals are generally completed only after
careful review of the characteristics of the securities in question. In
addition, CMO residuals may or, pursuant to an exemption therefrom, may not have
been registered under the Securities Act of 1933, as amended. CMO residuals,
whether or not registered under such Act, may be subject to certain restrictions
on transferability, and may be deemed "illiquid" and subject to a portfolio's
limitations on investment in illiquid securities. Each of the Funds limits its
investment in CMO residuals to less than 5% of its net assets.
Stripped Mortgage-Backed Securities. Stripped mortgage-backed securities
-----------------------------------
("SMBS") are derivative multi-class mortgage securities. SMBS may be issued by
agencies or instrumentalities of the U.S. Government, or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
mortgage banks, commercial banks, investment banks and special purpose entities
of the foregoing.
SMBS are usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. A common type of SMBS will have one class receiving some of the interest
and most of the principal from the mortgage assets, while the other class will
receive most of the interest and the remainder of the principal. In the most
extreme case, one class will receive all of the interest (the IO class), while
the other class will receive all of the principal (the principal-only or "PO"
class). The yield to maturity on an IO class is extremely sensitive to the rate
of principal payments (including prepayments) on the related underlying mortgage
assets, and a rapid rate of principal payments may have a material adverse
effect on a Fund's yield to maturity from these securities. If the underlying
mortgage assets experience greater than anticipated
- 16 -
<PAGE>
prepayments of principal, a Fund may fail to fully recoup its initial investment
in these securities even if the security is in one of the highest rating
categories.
Although SMBS are purchased and sold by institutional investors through
several investment banking firms acting as brokers or dealers, these securities
were only recently developed. As a result, established trading markets have not
yet developed and, accordingly, these securities may be deemed "illiquid" and
subject to a Fund's limitations on investment in illiquid securities.
Risks Associated with Mortgage-Backed Securities. Like other fixed income
------------------------------------------------
securities, when interest rates rise the value of a mortgage-related security
generally will decline; however, when interest rates are declining, the value of
mortgage-related securities with prepayment features may not increase as much as
other fixed income securities. The value of some mortgage-backed securities in
which the Funds may invest may be particularly sensitive to changes in
prevailing interest rates, and, like the other investments of the Funds, the
ability of a Fund to successfully utilize these instruments may depend in part
upon the ability of a Sub-Adviser to forecast interest rates and other economic
factors correctly. If a Sub-Adviser incorrectly forecasts such factors and has
taken a position in mortgage-backed securities that is or becomes contrary to
prevailing market trends, the Funds could be exposed to the risk of a loss.
Investment in mortgage-backed securities poses several risks, including
prepayment, market, and credit risk. Prepayment risk reflects the chance that
borrowers may prepay their mortgages faster than expected, thereby affecting the
investment's average life and perhaps its yield. Whether or not a mortgage loan
is prepaid is almost entirely controlled by the borrower. Borrowers are most
likely to exercise their prepayment options at a time when it is least
advantageous to investors, generally prepaying mortgages as interest rates fall,
and slowing payments as interest rates rise. Besides the effect of prevailing
interest rates, the rate of prepayment and refinancing of mortgages may also be
affected by home value appreciation, ease of the refinancing process and local
economic conditions.
Market risk reflects the chance that the price of the security may
fluctuate over time. The price of mortgage-backed securities may be particularly
sensitive to prevailing interest rates, the length of time the security is
expected to be outstanding, and the liquidity of the issue. In a period of
unstable interest rates, there may be decreased demand for certain types of
mortgage-backed securities, and a Fund invested in such securities wishing to
sell
- 17 -
<PAGE>
them may find it difficult to find a buyer, which may in turn decrease the price
at which they may be sold.
Credit risk reflects the chance that a Fund may not receive all or part of
its principal because the issuer or credit enhancer has defaulted on its
obligations. Obligations issued by U.S. Government-related entities are
guaranteed as to the payment of principal and interest, but are not backed by
the full faith and credit of the U.S. Government. The performance of private
label mortgage-backed securities, issued by private institutions, is based on
the financial health of those institutions.
Other Asset-Backed Securities. The Funds' investment advisers expect that
-----------------------------
other asset-backed securities (unrelated to mortgage loans) will be offered to
investors in the future. Several types of asset-backed securities have already
been offered to investors, including Certificates for Automobile Receivablessm
("CARSsm"). CARSsm represent undivided fractional interests in a trust ("trust")
whose assets consist of a pool of motor vehicle retail installment sales
contracts and security interests in the vehicles securing the contracts.
Payments of principal and interest on CARSsm are passed-through monthly to
certificate holders, and are guaranteed up to certain amounts and for a certain
time period by a letter of credit issued by a financial institution unaffiliated
with the trustee or originator of the trust. An investor's return on CARSsm may
be affected by early prepayment of principal on the underlying vehicle sales
contracts. If the letter of credit is exhausted, the trust may be prevented from
realizing the full amount due on a sales contract because of state law
requirements and restrictions relating to foreclosure sales of vehicles and the
obtaining of deficiency judgments following such sales or because of
depreciation, damage or loss of a vehicle, the application of Federal and state
bankruptcy and insolvency laws, or other factors. As a result, certificate
holders may experience delays in payments or losses if the letter of credit is
exhausted.
Consistent with a Fund's investment objective and policies, a Fund's
Sub-Adviser also may invest in other types of assetbacked securities. Certain
asset-backed securities may present the same types of risks that may be
associated with mortgage-backed securities.
BRADY BONDS
The International Bond Fund may invest a portion of its assets in Brady
Bonds, which are securities created through the exchange of existing commercial
bank loans to sovereign entities for new obligations in connection with debt
restructurings. Brady Bonds are not considered U.S. Government securities.
- 18 -
<PAGE>
Brady Bonds may be collateralized or uncollateralized and are issued in
various currencies (primarily the U.S. dollar). U.S. dollar-denominated,
collateralized Brady Bonds, which may be fixed rate par bonds or floating rate
discount bonds, are generally collateralized in full as to principal by U.S.
Treasury zero coupon bonds having the same maturity as the Brady Bonds. Interest
payments on these Brady Bonds generally are collateralized on a one-year or
longer rolling-forward basis by cash or securities in an amount that, in the
case of fixed rate bonds, is equal to at least one year of interest payments or,
in the case of floating rate bonds, initially is equal to at least one year's
interest payments based on the applicable interest rate at that time and is
adjusted at regular intervals thereafter. Certain Brady Bonds are entitled to
"value recovery payments" in certain circumstances, which in effect constitute
supplemental interest payments but generally are not collateralized. Brady Bonds
are often viewed as having three or four valuation components: (i) the
collateralized repayment of principal at final maturity; (ii) the collateralized
interest payments; (iii) the uncollateralized interest payments; and (iv) any
uncollateralized repayment of principal at maturity (these uncollateralized
amounts constitute the "residual risk").
Brady Bonds involve various risk factors, including the history of
defaults with respect to commercial bank loans by public and private entities of
countries issuing Brady Bonds, investments in Brady Bonds are to be viewed as
speculative. There can be no assurance that Brady Bonds in which the Fund may
invest will not be subject to restructuring arrangements or to requests for new
credit, which may cause the Fund to suffer a loss of interest or principal on
any of its holdings.
LOAN PARTICIPATION INTERESTS
A Fund's investment in loan participation interests may take the form of
participation interests in, assignments or novations of a corporate loan
("Participation Interests"). The Participation Interests may be acquired from an
agent bank, co-lenders or other holders of Participation Interests
("Participants"). In a novation, a Fund would assume all of the rights of the
lender in a corporate loan, including the right to receive payments of principal
and interest and other amounts directly from the borrower and to enforce its
rights as a lender directly against the borrower. As an alternative, a Fund may
purchase an assignment of all or a portion of a lender's interest in a corporate
loan, in which case, the Fund may be required generally to rely on the assigning
lender to demand payment and enforce its rights against the borrower, but would
otherwise be entitled to all of such lender's rights in the corporate loan. A
Fund also may purchase a Participation Interest in a portion of the rights of a
lender in a corporate loan. In such a case, the Fund will be entitled to
- 19 -
<PAGE>
receive payments of principal, interest and fees, if any, but generally will not
be entitled to enforce its rights directly against the agent bank or the
borrower; rather the Fund must rely on the lending institution for that purpose.
A Fund will not act as an agent bank, a guarantor or sole negotiator or a
structure with respect to a corporate loan.
In a typical corporate loan involving the sale of Participation Interests,
the agent bank administers the terms of the corporate loan agreement and is
responsible for the collection of principal and interest and fee payments to the
credit of all lenders which are parties to the corporate loan agreement. The
agent bank in such cases will be qualified under the 1940 Act to serve as a
custodian for a registered investment company such as the Company. A Fund
generally will rely on the agent bank or an intermediate Participant to collect
its portion of the payments on the corporate loan. The agent bank monitors the
value of the collateral and, if the value of the collateral declines, may take
certain action, including accelerating the corporate loan, giving the borrower
an opportunity to provide additional collateral or seeking other protection for
the benefit of the Participants in the corporate loan, depending on the terms of
the corporate loan agreement. Furthermore, unless under the terms of a
participation agreement a Fund has direct recourse against the borrower (which
is unlikely), the Fund will rely on the agent bank to use appropriate creditor
remedies against the borrower. The agent bank also is responsible for monitoring
compliance with covenants contained in the corporate loan agreement and for
notifying holders of corporate loans of any failures of compliance. Typically,
under corporate loan agreements, the agent bank is given broad discretion in
enforcing the corporate loan agreement, and is obligated to use only the same
care it would use in the management of its own property. For these services, the
borrower compensates the agent bank. Such compensation may include special fees
paid on structuring and funding the corporate loan and other fees paid on a
continuing basis.
A financial institution's employment as an agent bank may be terminated in
the event that it fails to observe the requisite standard of care or becomes
insolvent, or has a receiver, conservator, or similar official appointed for it
by the appropriate bank regulatory authority or becomes a debtor in a bankruptcy
proceeding. A successor agent bank generally will be appointed to replace the
terminated bank, and assets held by the agent bank under the corporate loan
agreement should remain available to holders of corporate loans. If, however,
assets held by the agent bank for the benefit of a Fund were determined by an
appropriate regulatory authority or court to be subject to the claims of the
agent bank's general or secured creditors, the Fund might incur certain costs
and delays in realizing payment on a
- 20 -
<PAGE>
corporate loan, or suffer a loss of principal and/or interest. In situations
involving intermediate Participants similar risks may arise.
When a Fund acts as co-lender in connection with a Participation Interest
or when a Fund acquires a Participation Interest the terms of which provide that
the Fund will be in privity of contract with the corporate borrower, the Fund
will have direct recourse against the borrower in the event the borrower fails
to pay scheduled principal and interest. In all other cases, the Fund will look
to the agent bank to enforce appropriate credit remedies against the borrower.
In acquiring Participation Interests a Fund will conduct analysis and evaluation
of the financial condition of each such co-lender and participant to ensure that
the Participation Interest meets the Fund's qualitative standards. There is a
risk that there may not be a readily available market for Participation
Interests and, in some cases, this could result in a Fund disposing of such
securities at a substantial discount from face value or holding such security
until maturity. When a Fund is required to rely upon a lending institution to
pay the Fund principal, interest, and other amounts received by the lending
institution for the loan participation, the Fund will treat both the borrower
and the lending institution as an "issuer" of the loan participation for
purposes of certain investment restrictions pertaining to the diversification
and concentration of the Fund's portfolio. The Funds consider Participation
Interests not subject to puts to be illiquid.
OPTIONS ON SECURITIES
Writing Call Options. Each Fund, as specified for that Fund in the
--------------------
Prospectus, may sell ("write") covered call options on its portfolio securities
in an attempt to enhance investment performance. A call option sold by a Fund is
a short-term contract, having a duration of nine months or less, which gives the
purchaser of the option the right to buy, and the writer of the option--in
return for a premium received--the obligation to sell, the underlying security
at the exercise price upon the exercise of the option at any time prior to the
expiration date, regardless of the market price of the security during the
option period. A call option on a stock or bond index gives the purchaser of the
option, in return for the premium paid, the right to receive from the seller
cash equal to the difference between the closing price of the index and the
exercise price of the option. A call option may be covered by, among other
things, the writer's owning the underlying security throughout the option
period, or by holding, on a share-for-share basis, a call on the same security
as the call written, where the exercise price of the call held is equal to or
less than the price of the call written, or greater than the exercise price of a
call written if the difference is maintained by
- 21 -
<PAGE>
the Fund in liquid assets in a segregated account with its custodian.
A Fund will write covered call options both to reduce the risks associated
with certain of its investments and to increase total investment return through
the receipt of premiums. In return for the premium income, the Fund will give up
the opportunity to profit from an increase in the market price of the underlying
security above the exercise price so long as its obligations under the contract
continue, except insofar as the premium represents a profit. Moreover, in
writing the call option, the Fund will retain the risk of loss should the price
of the security decline, which loss the premium is intended to offset in whole
or in part. A Fund, in writing "American Style" call options, must assume that
the call may be exercised at any time prior to the expiration of its obligations
as a writer, and that in such circumstances the net proceeds realized from the
sale of the underlying securities pursuant to the call may be substantially
below the prevailing market price. In contrast, "European Style" options may
only be exercised on the expiration date of the option. Covered call options and
the securities underlying such options will be listed on national securities
exchanges, except for certain transactions in options on debt securities and
foreign securities.
A Fund may protect itself from further losses due to a decline in value of
the underlying security or from the loss of ability to profit from appreciation
by buying an identical option, in which case the purchase cost may offset the
premium. In order to do this, the Fund makes a "closing purchase
transaction"--the purchase of a call option on the same security with the same
exercise price and expiration date as the covered call option which it has
previously written on any particular security. The Fund will realize a gain or
loss from a closing purchase transaction if the amount paid to purchase a call
option in a closing transaction is less or more than the amount received from
the sale of the covered call option. Also, because increases in the market price
of a call option will generally reflect increases in the market price of the
underlying security, any loss resulting from the closing out of a call option is
likely to be offset in whole or in part by unrealized appreciation of the
underlying security owned by the Fund. When a security is to be sold from the
Fund's portfolio, the Fund will first effect a closing purchase transaction so
as to close out any existing covered call option on that security.
A closing purchase transaction may be made only on a national or foreign
securities exchange (an "Exchange") which provides a secondary market for an
option with the same exercise price and expiration date. There is no assurance
that a liquid secondary market on an Exchange or otherwise will exist for any
particular option, or at any particular time, and for some options no
- 22 -
<PAGE>
secondary market on an Exchange or otherwise may exist. If a Fund is unable to
effect a closing purchase transaction involving an exchange-traded option, the
Fund will not sell the underlying security until the option expires or the Fund
delivers the underlying security upon exercise. Over-the-counter options differ
from exchange-traded options in that they 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. Therefore, a closing purchase
transaction for an over-the-counter option may in many cases only be made with
the other party to the option.
Each Fund pays brokerage commissions and dealer spreads in connection with
writing covered call options and effecting closing purchase transactions, as
well as for purchases and sales of underlying securities. The writing of covered
call options could result in significant increases in a Fund's portfolio
turnover rate, especially during periods when market prices of the underlying
securities appreciate. Subject to the limitation that all call and put option
writing transactions be covered, the International Bond Fund and International
Equity Fund may, to the extent determined appropriate by the Sub-Adviser, engage
without limitation in the writing of options on their portfolio securities.
Writing Put Options. Each Fund, as specified for the Fund in the
-------------------
Prospectus, may also write covered put options. A put option is a short-term
contract which gives the purchaser of the put option, in return for a premium,
the right to sell the underlying security to the seller of the option at a
specified price during the term of the option. A put option written by the Fund
is "covered" if the Fund maintains liquid assets with a value equal to the
exercise price in a segregated account with its custodian. A put option is also
"covered" if the Fund holds on a share-for-share basis a put on the same
security as the put written, where the exercise price of the put held is equal
to or greater than the exercise price of the put written, or less than the
exercise price of the put written if the difference is maintained by the Fund in
liquid assets in a segregated account with its custodian.
The premium which the Funds receive from writing a put option will
reflect, among other things, the current market price of the underlying
security, the relationship of the exercise price to such market price, the
historical price volatility of the underlying security, the option period,
supply and demand and interest rates.
The Funds may effect a closing purchase transaction to realize a profit on
an outstanding put option or to prevent an outstanding put option from being
exercised. If a Fund is able to enter into a closing purchase transaction, the
Fund will realize a profit or loss from such transaction if the cost of such
transaction is less
- 23 -
<PAGE>
or more than the premium received from the writing of the option. After writing
a put option, the Fund may incur a loss equal to the difference between the
exercise price of the option and the sum of the market value of the underlying
security plus the premium received from the sale of the option.
In addition, the Funds, as specified for the Fund in the Prospectus, may
also write straddles (combinations of covered puts and calls on the same
underlying security). The extent to which the Funds may write covered call
options and enter into so-called "straddle" transactions involving put or call
options may be limited by the requirements of the Internal Revenue Code for
qualification as a regulated investment company and the Company's intention that
each Fund qualify as such.
Purchasing Options. Each Fund, as specified for the Fund in the
------------------
Prospectus, may purchase put or call options which are traded on an Exchange or
in the over-the-counter market. Options traded in the over-the-counter market
may not be as actively traded as those listed on an Exchange. Accordingly, it
may be more difficult to value such options and to be assured that they can be
closed out at any time. The Funds will engage in such transactions only with
firms of sufficient creditworthiness so as to minimize these risks.
The Funds may purchase put options on securities to protect their holdings
in an underlying or related security against a substantial decline in market
value. Securities are considered related if their price movements generally
correlate with one another. The purchase of put options on securities held in
the portfolio or related to such securities will enable a Fund to preserve, at
least partially, unrealized gains occurring prior to the purchase of the option
on a portfolio security without actually selling the security. In addition, the
Fund will continue to receive interest or dividend income on the security.
The Funds may also purchase call options on securities the Funds intend to
purchase to protect against substantial increases in prices of such securities
pending their ability to invest in an orderly manner in such securities. In
order to terminate an option position, the Funds may sell put or call options
identical to those previously purchased, which could result in a net gain or
loss depending on whether the amount received on the sale is more or less than
the premium and other transaction costs paid on the put or call option when it
was purchased.
Special Risks Associated With Options On Securities. There can be no
---------------------------------------------------
assurance that viable markets will develop or continue in the United States or
abroad for options on securities. If a put or call option purchased by a Fund is
not sold when it has remaining value, and if the market price of the underlying
security, in the
- 24 -
<PAGE>
case of a put, remains equal to or greater than the exercise price, or, in the
case of a call, remains less than or equal to the exercise price, the Fund will
not be able to exercise profitably the option and will lose its entire
investment in the option. Also, the price of a put or call option purchased to
hedge against price movements in a related security may move more or less than
the price of the related security.
OPTIONS ON FOREIGN CURRENCIES
Each Fund, as specified for the Fund in the Prospectus, may purchase and
write options on foreign currencies for hedging purposes in a manner similar to
that of the Fund's transactions in currency futures contracts or forward
contracts. A Fund may purchase and write put and call options on foreign
currencies for the purpose of protecting against declines in the dollar value of
foreign portfolio securities and against increases in the U.S. dollar cost of
foreign securities to be acquired. A fund may also use foreign currency options
to protect against potential losses in positions denominated in one foreign
currency against another foreign currency in which the Fund's assets are or may
be invested. For example, a decline in the dollar value of a foreign currency in
which portfolio securities are denominated will reduce the dollar value of such
securities, even if their value in the foreign currency remains constant. In
order to protect against such diminutions in the value of portfolio securities,
a Fund may purchase put options on the foreign currency. If the value of the
currency does decline, that Fund will have the right to sell such currency for a
fixed amount of dollars which exceeds the market value of such currency,
resulting in a gain that may offset, in whole or in part, the negative effect of
currency depreciation on the value of the Fund's securities denominated in that
currency.
Conversely, if a rise in the dollar value of a currency in which
securities to be acquired are denominated is projected, thereby increasing the
cost of such securities, a Fund may purchase call options on such currency. If
the value of such currency does increase, the purchase of such call options
would enable the Fund to purchase currency for a fixed amount of dollars which
is less than the market value of such currency, resulting in a gain that may
offset, at least partially, the effect of any currency-related increase in the
price of securities the Fund intends to acquire. As in the case of other types
of options transactions, however, the benefit a Fund derives from purchasing
foreign currency options will be reduced by the amount of the premium and
related transaction costs. In addition, if currency exchange rates do not move
in the direction or to the extent anticipated, a Fund could sustain losses on
transactions in foreign currency options which would deprive it of a portion or
all of the benefits of advantageous changes in such rates.
- 25 -
<PAGE>
A Fund may also write options on foreign currencies for hedging purposes.
For example, if a Fund anticipates a decline in the dollar value of foreign
currency-denominated securities due to declining exchange rates, it could,
instead of purchasing a put option, write a call option on the relevant
currency. If the expected decline occurs, the option will most likely not be
exercised, and the diminution in value of portfolio securities will be offset by
the amount of the premium received by the Fund.
Similarly, instead of purchasing a call option to hedge against an
anticipated increase in the dollar cost of securities to be acquired, a Fund
could write a put option on the relevant currency. If rates move in the manner
projected, the put option will expire unexercised and allow the Fund to offset
such increased cost up to the amount of the premium. As in the case of other
types of options transactions, however, the writing of a foreign currency option
will constitute only a partial hedge up to the amount of the premium, and only
if rates move in the expected direction. If unanticipated exchange rate
fluctuations occur, the option may be exercised and a Fund would be required to
purchase or sell the underlying currency at a loss which may not be fully offset
by the amount of the premium. As a result of writing options on foreign
currencies, a Fund also may be required to forego all or a portion of the
benefits which might otherwise have been obtained from favorable movements in
currency exchange rates.
A call option written on foreign currency by a Fund is "covered" if that
Fund owns the underlying foreign currency subject to the call or securities
denominated in that currency or has an absolute and immediate right to acquire
that foreign currency without additional cash consideration (or for additional
cash consideration held in a segregated account by its custodian) upon
conversion or exchange of other foreign currency held in its portfolio. A call
option is also covered if a Fund holds a call on the same foreign currency for
the same principal amount as the call written where the exercise price of the
call held (a) is equal to or less than the exercise price of the call written or
(b) is greater than the exercise price of the call written if the amount of the
difference is maintained by a Fund in liquid assets in a segregated account with
its custodian.
Options on foreign currencies to be written or purchased by a Fund will be
traded on U.S. and foreign exchanges or over-the-counter. Exchange-traded
options generally settle in cash, whereas options traded over-the-counter may
settle in cash or result in delivery of the underlying currency upon exercise of
the option. As with other kinds of option transactions, however, the writing of
an option on foreign currency will constitute only a partial hedge up to the
amount of the premium received and a Fund could be required to purchase or sell
foreign currencies at disadvantageous
- 26 -
<PAGE>
exchange rates, thereby incurring losses. The purchase of an option on foreign
currency may constitute an effective hedge against exchange rate fluctuations,
although, in the event of rate movements adverse to a Fund's position, a Fund
may forfeit the entire amount of the premium plus related transaction costs.
FUTURES TRANSACTIONS
Each Fund, as specified for the Fund in the Prospectus, may purchase and
sell futures contracts on securities, interest rates, foreign currency and on
indexes of securities, to hedge against anticipated changes in interest rates
and other economic factors that might otherwise have an adverse effect upon the
value of a Fund's portfolio securities. An interest rate or stock index futures
contract is an agreement to take or make delivery of an amount of cash based on
the difference between the value of the index at the beginning and at the end of
the contract period. A futures contract on a foreign currency is an agreement to
buy or sell a specified amount of a currency for a set price on a future date.
The Funds, as specified in the Prospectus, may also enter into such futures
contracts in order to lengthen or shorten the average maturity or duration of
the Fund's portfolio. For example, a Fund may purchase futures contracts as a
substitute for the purchase of longer-term debt securities to lengthen the
average duration of a Fund's portfolio of fixed-income securities. A Fund may
purchase and sell stock index futures to hedge its securities portfolio with
regard to market (systematic) risk (involving the market's assessment of overall
economic prospects), as distinguished from stock-specific risk (involving the
market's evaluation of the merits of the issuer of a particular security).
The Funds, as specified for the Fund in the Prospectus, may also purchase
and sell other futures when deemed appropriate, in order to hedge the equity or
non-equity portions of their portfolios. In addition, each Fund, as specified
for the Fund in the Prospectus, may enter into contracts for the future delivery
of foreign currencies to hedge against changes in currency exchange rates. Each
of the Funds, as specified for the Fund in the Prospectus, may also purchase and
write put and call options on futures contracts of the type into which such Fund
is authorized to enter and may engage in related closing transactions. In the
United States, all such futures on securities, debt index futures, stock index
futures, foreign currency futures and related options will be traded on
exchanges that are regulated by the Commodity Futures Trading Commission
("CFTC"). Subject to compliance with applicable CFTC rules, the Funds also may
enter into futures contracts traded on foreign futures exchanges as long as
trading on the aforesaid foreign futures exchanges does not subject a Fund to
risks that are materially greater than the risks associated with trading on U.S.
exchanges.
- 27 -
<PAGE>
A futures contract is an agreement to buy or sell a security or currency
(or to deliver a final cash settlement price in the case of a contract relating
to an index or otherwise not calling for physical delivery at the end of trading
in the contracts), for a set price in a future month. In the United States,
futures contracts are traded on boards of trade which have been designated
"contract markets" by the CFTC. Futures contracts trade on these markets through
an "open outcry" auction on the exchange floor. Currently, there are futures
contracts based on a variety of instruments, indexes and currencies.
When a purchase or sale of a futures contract is made by a Fund, the Fund
is required to deposit with its custodian (or broker, if legally permitted) a
specified amount of liquid assets ("initial margin") as a partial guarantee of
its performance under the contract. 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 Fund upon termination of the contract assuming all contractual
obligations have been satisfied. Each Fund expects to earn interest income on
its initial margin deposits. A futures contract held by a Fund is valued daily
at the official settlement price of the exchange on which it is traded. Each
day, as the value of the security, currency or index fluctuates, the Fund 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 Fund but is instead a
settlement between the Fund and the broker of the amount one would owe the other
if the futures contract expired. In computing daily net asset value, each Fund
will mark to market its open futures positions.
A Fund 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 Fund.
Positions taken in the futures markets are not normally held until
delivery or final cash settlement is required, but are instead liquidated
through offsetting transactions which may result in a gain or a loss. While
futures positions taken by a Fund will usually be liquidated in this manner, the
Fund may instead make or take delivery of underlying securities or currencies
whenever it appears economically advantageous to the Fund to do so. A clearing
organization associated with the exchange on which futures are traded assumes
responsibility for closing-out transactions and
- 28 -
<PAGE>
guarantees that as between the clearing members of an exchange, the sale and
purchase obligations will be performed with regard to all positions that remain
open at the termination of the contract.
Futures on Debt Securities. A futures contract on a debt security is a
--------------------------
binding contractual commitment which, if held to maturity, will result in an
obligation to make or accept delivery, during a particular future month, of
securities having a standardized face value and rate of return. By purchasing
futures on debt securities--assuming a "long" position--a Fund will legally
obligate itself to accept the future delivery of the underlying security and pay
the agreed-upon price. By selling futures on debt securities--assuming a "short"
position--it will legally obligate itself to make the future delivery of the
security against payment of the agreed-upon price. Open futures positions on
debt securities will be valued at the most recent settlement price, unless such
price does not appear to the Directors to reflect the fair value of the
contract, in which case the positions will be valued by or under the direction
of the Directors.
Hedging by use of futures on debt securities seeks to establish more
certainly than would otherwise be possible the effective rate of return on
portfolio securities. A Fund may, for example, take a "short" position in the
futures market by selling contracts for the future delivery of debt securities
held by the Fund (or securities having characteristics similar to those held by
the Fund) in order to hedge against an anticipated rise in interest rates that
would adversely affect the value of the Fund's portfolio securities. When
hedging of this character is successful, any depreciation in the value of
portfolio securities will be substantially offset by appreciation in the value
of the futures position.
On other occasions, a Fund may take a "long" position by purchasing
futures on debt securities. This would be done, for example, when the Fund
intends to purchase particular securities and it has the necessary cash, but
expects the rate of return available in the securities markets at that time to
be less favorable than rates currently available in the futures markets. If the
anticipated rise in the price of the securities should occur (with its
concomitant reduction in yield), the increased cost to the Fund of purchasing
the securities will be offset, at least to some extent, by the rise in the value
of the futures position taken in anticipation of the subsequent securities
purchase. A Fund may also purchase futures contracts as a substitute for the
purchase of longer-term securities to lengthen the average duration of the
Fund's portfolio.
The Fund could accomplish similar results by selling securities with long
maturities and investing in securities with
- 29 -
<PAGE>
short maturities when interest rates are expected to increase or by buying
securities with long maturities and selling securities with short maturities
when interest rates are expected to decline. However, by using futures contracts
as a risk management technique, given the greater liquidity in the futures
market than in the cash market, it may be possible to accomplish the same result
more easily and more quickly.
Securities Index Futures. A securities index futures contract does not
------------------------
require the physical delivery of securities, but merely provides for profits and
losses resulting from changes in the market value of the contract to be credited
or debited at the close of each trading day to the respective accounts of the
parties to the contract. On the contract's expiration date a final cash
settlement occurs and the futures positions are simply closed out. Changes in
the market value of a particular stock index futures contract reflect changes in
the specified index of equity securities on which the contract is based. A stock
index is designed to reflect overall price trends in the market for equity
securities.
Stock index futures may be used to hedge a Fund's securities portfolio
with regard to market (systematic) risk, as distinguished from stock-specific
risk. Similarly, the Funds, as specified for the Fund in the Prospectus, may
enter into futures on debt securities indexes to the extent they have debt
securities in their portfolios. By establishing an appropriate "short" position
in securities index futures, a Fund may seek to protect the value of its
portfolio against an overall decline in the market for securities.
Alternatively, in anticipation of a generally rising market, a Fund can seek to
avoid losing the benefit of apparently low current prices by establishing a
"long" position in securities index futures and later liquidating that position
as particular securities are in fact acquired. To the extent that these hedging
strategies are successful, the Fund will be affected to a lesser degree by
adverse overall market price movements, unrelated to the merits of specific
portfolio securities, than would otherwise be the case. A Fund, as specified for
the Fund in the Prospectus, may also purchase futures on debt securities or
indexes as a substitute for the purchase of longer-term debt securities to
lengthen the average duration of the Fund's debt portfolio.
Currency Futures. A sale of a currency futures contract creates an
-----------------
obligation by a Fund, as seller, to deliver the amount of currency called for in
the contract at a specified future time for a specified price. A purchase of a
currency futures contract creates an obligation by a Fund, as purchaser, to take
delivery of an amount of currency at a specified future time at a specified
price. A Fund, as specified for the Fund in the Prospectus, may sell a currency
futures contract if a Sub-Adviser anticipates that
- 30 -
<PAGE>
exchange rates for a particular currency will fall, as a hedge against a decline
in the value of the Fund's securities denominated in such currency. If a
Sub-Adviser anticipates that exchange rates will rise, the Fund may purchase a
currency futures contract to protect against an increase in the price of
securities denominated in a particular currency the Fund intends to purchase.
Although the terms of currency futures contracts specify actual delivery or
receipt, in most instances the contracts are closed out before the settlement
date without the making or taking of delivery of the currency. Closing out of a
currency futures contract is effected by entering into an offsetting purchase or
sale transaction. To offset a currency futures contract sold by a Fund, the Fund
purchases a currency futures contract for the same aggregate amount of currency
and delivery date. If the price in the sale exceeds the price in the offsetting
purchase, the Fund is immediately paid the difference. Similarly, to close out a
currency futures contract purchased by the Fund, the Fund sells a currency
futures contract. If the offsetting sale price exceeds the purchase price, the
Fund realizes a gain, and if the offsetting sale price is less than the purchase
price, the Fund realizes a loss.
A risk in employing currency futures contracts to protect against the
price volatility of portfolio securities denominated in a particular currency is
that changes in currency exchange rates or in the value of the futures position
may correlate imperfectly with changes in the cash prices of a Fund's
securities. The degree of correlation may be distorted by the fact that the
currency futures market may be dominated by short-term traders seeking to profit
from changes in exchange rates. This would reduce the value of such contracts
for hedging purposes over a short-term period. Such distortions are generally
minor and would diminish as the contract approached maturity. Another risk is
that a Sub-Adviser could be incorrect in its expectation as to the direction or
extent of various exchange rate movements or the time span within which the
movements take place.
Options on Futures. For bona fide hedging and other appropriate risk
------------------
management purposes, the Funds, as specified for the Fund in the Prospectus,
also may purchase and write call and put options on futures contracts which are
traded on exchanges that are licensed and regulated by the CFTC for the purpose
of options trading, or, subject to applicable CFTC rules, on foreign exchanges.
A "call" option on a futures contract gives the purchaser the right, in return
for the premium paid, to purchase a futures contract (assume a "long" position)
at a specified exercise price at any time before the option expires. A "put"
option gives the purchaser the right, in return for the premium paid, to sell a
futures contract (assume a "short" position), for a specified exercise price at
any time before the option expires.
- 31 -
<PAGE>
Upon the exercise of a "call," the writer of the option is obligated to
sell the futures contract (to deliver a "long" position to the option holder) at
the option exercise price, which will presumably be lower than the current
market price of the contract in the futures market. Upon exercise of a "put,"
the writer of the option is obligated to purchase the futures contract (deliver
a "short" position to the option holder) at the option exercise price, which
will presumably be higher than the current market price of the contract in the
futures market. When an entity exercises an option and assumes a long futures
position, in the case of a "call," or a short futures position, in the case of a
"put," its gain will be credited to its futures margin account, while the loss
suffered by the writer of the option will be debited to its account. However, as
with the trading of futures, most participants in the options markets do not
seek to realize their gains or losses by exercise of their option rights.
Instead, the writer or holder of an option will usually realize a gain or loss
by buying or selling an offsetting option at a market price that will reflect an
increase or a decrease from the premium originally paid.
Options on futures contracts can be used by a Fund to hedge substantially
the same risks and for the same duration and risk management purposes as might
be addressed or served by the direct purchase or sale of the underlying futures
contracts. If the Fund purchases an option on a futures contract, it may obtain
benefits similar to those that would result if it held the futures position
itself.
The purchase of put options on futures contracts is a means of hedging a
Fund's portfolio against the risk of rising interest rates, declining securities
prices or declining exchange rates for a particular currency. The purchase of a
call option on a futures contract represents a means of hedging against a market
advance affecting securities prices or currency exchange rates when the Fund is
not fully invested or of lengthening the average maturity or duration of a
Fund's portfolio. Depending on the pricing of the option compared to either the
futures contract upon which it is based or upon the price of the underlying
securities or currencies, it may or may not be less risky than ownership of the
futures contract or underlying securities or currencies.
In contrast to a futures transaction, in which only transaction costs are
involved, benefits received in an option transaction will be reduced by the
amount of the premium paid as well as by transaction costs. In the event of an
adverse market movement, however, the Fund will not be subject to a risk of loss
on the option transaction beyond the price of the premium it paid plus its
transaction costs, and may consequently benefit from a favorable movement in the
value of its portfolio securities or the
- 32 -
<PAGE>
currencies in which such securities are denominated that would have been more
completely offset if the hedge had been effected through the use of futures.
If a Fund writes options on futures contracts, the Fund will receive a
premium but will assume a risk of adverse movement in the price of the
underlying futures contract comparable to that involved in holding a futures
position. If the option is not exercised, the Fund will realize a gain in the
amount of the premium, which may partially offset unfavorable changes in the
value of securities held by or to be acquired for the Fund. If the option is
exercised, the Fund will incur a loss in the option transaction, which will be
reduced by the amount of the premium it has received, but which may partially
offset favorable changes in the value of its portfolio securities or the
currencies in which such securities are denominated.
The writing of a call option on a futures contract constitutes a partial
hedge against declining prices of the underlying securities or the currencies in
which such securities are denominated. If the futures price at expiration is
below the exercise price, the Fund will retain the full amount of the option
premium, which provides a partial hedge against any decline that may have
occurred in the Fund's holdings of securities or the currencies in which such
securities are denominated.
The writing of a put option on a futures contract is analogous to the
purchase of a futures contract. For example, if the Fund writes a put option on
a futures contract on debt securities related to securities that the Fund
expects to acquire and the market price of such securities increases, the net
cost to a Fund of the debt securities acquired by it will be reduced by the
amount of the option premium received. Of course, if market prices have
declined, the Fund's purchase price upon exercise may be greater than the price
at which the debt securities might be purchased in the securities market.
While the holder or writer of an option on a futures contract may normally
terminate its position by selling or purchasing an offsetting option of the same
series, a Fund's ability to establish and close out options positions at fairly
established prices will be subject to the maintenance of a liquid market. The
Funds will not purchase or write options on futures contracts unless the market
for such options has sufficient liquidity such that the risks associated with
such options transactions are not at unacceptable levels.
Limitations on Purchase and Sale of Futures Contracts and Options on
--------------------------------------------------------------------
Futures Contracts. A Fund will only enter into futures contracts or related
- -----------------
options which are standardized and traded on
- 33 -
<PAGE>
a U.S. or foreign exchange or board of trade, or similar entity, or quoted on an
automated quotation system. In general, the Funds will engage in transactions in
futures contracts and related options only for bona fide hedging and other
appropriate risk management purposes, and not for speculation. The Funds will
not enter into futures contracts for which the aggregate contract amounts exceed
100% of the Fund's net assets. In addition, with respect to positions in futures
and related options that do not constitute bona fide hedging positions, a Fund
will not enter into a futures contract or futures option contract if,
immediately thereafter, the aggregate initial margin deposits relating to such
positions plus premiums paid by it for open futures option positions, less the
amount by which any such options are "in-the-money," would exceed 5% of the
Fund'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.
When purchasing a futures contract, a Fund will maintain with its
custodian (and mark-to-market on a daily basis) liquid assets that, when added
to the amounts deposited with a futures commission merchant as margin, are equal
to the market value of the futures contract. Alternatively, the Fund may "cover"
its position by purchasing a put option on the same futures contract with a
strike price as high or higher than the price of the contract held by the Fund.
When selling a futures contract, a Fund will maintain with its custodian
(and mark-to-market on a daily basis) liquid assets that, when added to the
amount deposited with a futures commission merchant as margin, are equal to the
market value of the instruments underlying the contract. Alternatively, the Fund
may "cover" its position by owning the instruments underlying the contract (or,
in the case of an index futures contract, a portfolio with a volatility
substantially similar to that of the index on which the futures contract is
based), or by holding a call option permitting the Fund to purchase the same
futures contract at a price no higher than the price of the contract written by
the Fund (or at a higher price if the difference is maintained in liquid assets
with the Fund's custodian).
When selling a call option on a futures contract, a Fund will maintain
with its custodian (and mark-to-market on a daily basis) liquid assets that,
when added to the amounts deposited with a futures commission merchant as
margin, equal the total market value of the futures contract underlying the call
option. Alternatively, the Fund may cover its position by entering into a long
position in the same futures contract at a price no higher than the strike price
of the call option, by owning the instruments underlying the
- 34 -
<PAGE>
futures contract, or by holding a separate call option permitting the Fund to
purchase the same futures contract at a price not higher than the strike price
of the call option sold by the Fund.
When selling a put option on a futures contract, a Fund will maintain with
its custodian (and mark-to-market on a daily basis) liquid assets that equal the
purchase price of the futures contract, less any margin on deposit.
Alternatively, the Fund may cover the position either by entering into a short
position in the same futures contract, or by owning a separate put option
permitting it to sell the same futures contract so long as the strike price of
the purchased put option is the same or higher than the strike price of the put
option sold by the Fund.
The requirements for qualification as a regulated investment company also
may limit the extent to which a Fund may enter into futures or futures options.
See "Tax Information."
Risks Associated with Futures and Futures Options. There are several risks
-------------------------------------------------
associated with the use of futures contracts and futures options as hedging
techniques. There can be no assurance that hedging strategies using futures will
be successful. A purchase or sale of a futures contract may result in losses in
excess of the amount invested in the futures contract, which in some cases may
be unlimited. There can be no guarantee that there will be a correlation between
price movements in the hedging vehicle and in the Fund's securities being
hedged. An incorrect correlation could result in a loss on both the hedged
securities or currencies and the hedging vehicle so that the portfolio return
might have been better had hedging not be attempted. In addition, there are
significant differences between the securities and futures markets that could
result in an imperfect correlation between the markets, causing a given hedge
not to achieve its objectives. The degree of imperfection of correlation depends
on circumstances such as variations in speculative market demand for futures and
futures options on securities, including technical influences in futures trading
and futures options, and differences between the financial instruments being
hedged and the instruments underlying the standard contracts available for
trading in such respects as interest rate levels, maturities, and
creditworthiness of issuers. A decision as to whether, when and how to hedge
involves the exercise of skill and judgment, and even a well-conceived hedge may
be unsuccessful to some degree because of market behavior or unexpected interest
rate trends.
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
- 35 -
<PAGE>
session. Once the daily limit has been reached in a futures contract subject to
the limit, no more trades may be made on that day at a price beyond that limit.
The daily limit governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may work to prevent
the liquidation of unfavorable positions. For example, futures prices have
occasionally moved to the daily limit for several consecutive trading days with
little or no trading, thereby preventing prompt liquidation of positions and
subjecting some holders of futures contracts to substantial losses.
There can be no assurance that a liquid market will exist at a time when a
Fund seeks to close out a futures or a futures option position, and that Fund
would remain obligated to meet margin requirements until the position is closed.
In addition, many of the contracts discussed above are relatively new
instruments without a significant trading history. As a result, there can be no
assurance that an active secondary market will develop or continue to exist.
Lack of a liquid market for any reason may prevent the Fund from liquidating an
unfavorable position and the Fund would remain obligated to meet margin
requirements until the position is closed.
Additional Risks of Options on Securities, Futures Contracts, Options on
------------------------------------------------------------------------
Futures Contracts, and Forward Currency Exchange Contracts and Options Thereon.
- ------------------------------------------------------------------------------
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
prices of, foreign securities. The value of such positions also could be
adversely affected by (i) other complex foreign political, legal and economic
factors, (ii) lesser availability than in the United States of data on which to
make trading decisions, (iii) delays in a Fund's ability to act upon economic
events occurring in foreign markets during non-business hours in the United
States, (iv) the imposition of different exercise and settlement terms and
procedures and margin requirements than in the United States, and (v) lesser
trading volume.
SWAP AGREEMENTS
The International Bond Fund, International Equity Fund and Multi-Asset
Fund may enter into interest rate, index and currency exchange rate swap
agreements for purposes of attempting to obtain a particular desired return at a
lower cost to the Fund than if the Fund had invested directly in an instrument
that yielded that desired return or for other portfolio management purposes. The
- 36 -
<PAGE>
EAFE Index Fund may enter into index and currency exchange rate swap agreements,
the Indexed Bond Fund may invest up to 10% of its total assets in interest rate
and index swap agreements and the Indexed Equity Fund may enter into index swap
agreements. Swap agreements are two party contracts entered into primarily by
institutional investors for periods ranging from a few weeks to more than one
year. In a standard "swap" transaction, two parties agree to exchange the
returns (or differentials in rates of return) earned or realized on particular
predetermined investments or instruments. The gross returns to be exchanged or
"swapped" between the parties are calculated with respect to a "notional
amount," i.e., the return on or increase in value of a particular dollar amount
----
invested at a particular interest rate, in a particular foreign currency, or in
a "basket" of securities representing a particular index. The "notional amount"
of the swap agreement is only a fictive basis on which to calculate the
obligations that the parties to a swap agreement have agreed to exchange. Most
swap agreements entered into by the Funds would calculate the obligations of the
parties to the agreement on a "net" basis. Consequently, a Fund's obligations
(or rights) under a swap agreement will generally be equal only to the net
amount to be paid or received under the agreement based on the relative values
of the positions held by each party to the agreement (the "net amount"). A
Fund's obligations under a swap agreement will be accrued daily (offset against
any amounts owing to the Fund) and any accrued but unpaid net amounts owed to a
swap counterparty will be covered by the maintenance of a segregated account
consisting of liquid assets to avoid any potential leveraging of the Fund's
portfolio. The International Bond Fund and International Equity Fund will not
enter into a swap agreement with any single party if the net amount owed or to
be received under existing contracts with that party would exceed 5% of the
Fund's assets. The EAFE Index Fund, Indexed Bond Fund, Indexed Equity Fund and
Multi-Asset Fund may enter into swap agreements only to the extent that
obligations under such agreements represent not more than 10% of the Fund's
total assets.
Commonly used swap agreements include interest rate caps, under which, in
return for a premium, one party agrees to make payments to the other to the
extent that interest rates exceed a specified rate, or "cap"; interest rate
floors, under which, in return for a premium, one party agrees to make payments
to the other to the extent that interest rates fall below a specified level, or
"floor"; and interest rate collars, under which a party sells a cap and
purchases a floor or vice versa in an attempt to protect itself against interest
rate movements exceeding given minimum or maximum levels.
Whether a Fund's use of swap agreements will be successful in furthering
its investment objective will depend on the Sub-
- 37 -
<PAGE>
Adviser's ability to correctly predict whether certain types of investments are
likely to produce greater returns than other investments. Because they are two
party contracts and because they may have terms of greater than seven days, swap
agreements may be considered to be illiquid. Moreover, a Fund bears the risk of
loss of the amount expected to be received under a swap agreement in the event
of the default or bankruptcy of a swap agreement counterparty. The Sub-Adviser
will cause a Fund to enter into swap agreements only with counterparties that
would be eligible for consideration as repurchase agreement counterparties under
the Fund's repurchase agreement guidelines. Certain restrictions imposed on the
Funds by the Internal Revenue Code may limit the Funds' ability to use swap
agreements. The swaps market is a relatively new market and is largely
unregulated. It is possible that developments in the swaps market, including
potential government regulation, could adversely affect a Fund's ability to
terminate existing swap agreements or to realize amounts to be received under
such agreements.
Certain swap agreements are exempt from most provisions of the Commodity
Exchange Act ("CEA") and, therefore, are not regulated as futures or commodity
option transactions under the CEA, pursuant to regulations approved by the
Commodity Futures Trading Commission ("CFTC") effective February 22, 1993. To
qualify for this exemption, a swap agreement must be entered into by "eligible
participants," which includes the following, provided the participants' total
assets exceed established levels: a bank or trust company, savings association
or credit union, insurance company, investment company subject to regulation
under the Investment Company Act of 1940, commodity pool, corporation,
partnership, proprietorship, organization, trust or other entity, employee
benefit plan, governmental entity, broker-dealer, futures commission merchant,
natural person, or regulated foreign person. To be eligible, natural persons and
most other entities must have total assets exceeding $10 million; commodity
pools and employee benefit plans must have assets exceeding $5 million. In
addition, an eligible swap transaction must meet three conditions. First, the
swap agreement may not be part of a fungible class of agreements that are
standardized as to their material economic terms. Second, the creditworthiness
of parties with actual or potential obligations under the swap agreement must be
a material consideration in entering into or determining the terms of the swap
agreement, including pricing, cost or credit enhancement terms. Third, swap
agreements may not be entered into and traded on or through a multilateral
transaction execution facility.
This exemption is not exclusive, and participants may continue to rely on
existing exclusions for swaps, such as the Policy Statement issued in July 1989
which recognized a safe harbor for swap transactions from regulation as futures
or commodity option
- 38 -
<PAGE>
transactions under the CEA or its regulations. The Policy Statement applies to
swap transactions settled in cash that (1) have individually tailored terms, (2)
lack exchange style offset and the use of a clearing organization or margin
system, (3) are undertaken in conjunction with a line of business, and (4) are
not marketed to the public.
FORWARD FOREIGN CURRENCY CONTRACTS
A forward foreign currency contract (a "forward contract") is an
obligation to purchase or sell a specific currency for an agreed price at a
future date (usually less than a year), which is individually negotiated and
privately traded by currency traders and their customers. A forward contract
generally has no deposit requirement, and no commissions are charged at any
stage for trades. Although foreign exchange dealers do not charge a fee for
commissions, they do realize a profit based on the difference between the price
at which they are buying and selling various currencies. Although these
contracts are intended to minimize the risk of loss due to a decline in the
value of the hedged currencies, at the same time, they tend to limit any
potential gain which might result should the value of such currencies increase.
While a Fund may enter into forward contracts to reduce currency exchange
risks, changes in currency exchange rates may result in poorer overall
performance for the Fund than if it had not engaged in such transactions.
Moreover, there may be an imperfect correlation between a Fund's portfolio
holdings of securities denominated in a particular currency and forward
contracts entered into by the Fund. Such imperfect correlation may prevent the
Fund from achieving the intended hedge or expose the Fund to the risk of
currency exchange loss.
A Fund will not enter into forward contracts or maintain a net exposure to
such contracts where the consummation of the contracts would obligate the Fund
to deliver an amount of currency in excess of the value of the Fund's portfolio
securities or other assets denominated in that currency.
A Fund will hold liquid assets in a segregated account with its custodian
in an amount equal (on a daily marked-to-market basis) to the amount of the
commitments under these contracts. At the maturity of a forward contract, a Fund
may either accept or make delivery of the currency specified in the contract, or
prior to maturity, enter into a closing purchase transaction involving the
purchase or sale of an offsetting contract. Closing purchase transactions with
respect to forward contracts are usually effected with the currency trader who
is a party to the original forward contract. A Fund will only enter into such a
forward contract if it is expected that there will be a liquid market in which
to close
- 39 -
<PAGE>
out the contract. However, there can be no assurance that a liquid market will
exist in which to close a forward contract, in which case the Fund may suffer a
loss.
Normally, consideration of the prospect for currency parities will be
incorporated in a longer term investment decision made with regard to overall
diversification strategies. However, each Sub- Adviser believes that it is
important to have the flexibility to enter into such forward contracts when it
determines that the best interest of a Fund will be served. For example, when a
Fund enters into a contract for the purchase or sale of a security denominated
in a foreign currency, it may desire to "lock in" the U.S. dollar price of the
security. By entering into a forward contract for the purchase or sale, for a
fixed amount of U.S. dollars, of the amount of foreign currency involved in the
underlying security transaction, a Fund will be able to insulate itself from a
possible loss resulting from a change in the relationship between the U.S.
dollar and the subject foreign currency during the period between the date on
which the security is purchased or sold and the date on which payment is made or
received, although a Fund would also forego any gain it might have realized had
rates moved in the opposite direction. This technique is sometimes referred to
as a "settlement" hedge or "transaction" hedge.
When a Sub-Adviser believes that the currency of a particular foreign
country may suffer a substantial decline against the U.S. dollar, it may enter
into a forward contract to sell, for a fixed amount of dollars, the amount of
foreign currency approximating the value of some or all of a Fund's portfolio
securities denominated in such foreign currency. Such a hedge (sometimes
referred to as a "position hedge") will tend to offset both positive and
negative currency fluctuations, but will not offset changes in security values
caused by other factors. The Fund also may hedge the same position by using
another currency (or a basket of currencies) expected to perform in a manner
substantially similar to the hedged currency ("proxy" hedge). The precise
matching of the forward contract amounts and the value of the securities
involved will not generally be possible since 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. With respect to positions that
constitute "transaction" or "position" hedges (including "proxy" hedges), a Fund
will not enter into forward contracts to sell currency or maintain a net
exposure to such contracts if the consummation of such contracts would obligate
the Fund 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 the
related currency, in the case of a "proxy" hedge).
- 40 -
<PAGE>
Finally, a Fund may enter into forward contracts to shift its investment
exposure from one currency into another currency that is expected to perform
inversely with respect to the hedged currency relative to the U.S. dollar. This
type of strategy, sometimes known as a "cross-currency" hedge, will tend to
reduce or eliminate exposure to the currency that is sold, and increase exposure
to the currency that is purchased, much as if the Fund had sold a security
denominated in one currency and purchased an equivalent security denominated in
another. "Cross-currency" hedges protect against losses resulting from a decline
in the hedged currency, but will cause the Fund to assume the risk of
fluctuations in the value of the currency it purchases.
At the consummation of the forward contract, a Fund may either make
delivery of the foreign currency or terminate its contractual obligation to
deliver the foreign currency by purchasing an offsetting contract obligating it
to purchase at the same maturity date the same amount of such foreign currency.
If a Fund chooses to make delivery of the foreign currency, it may be required
to obtain such currency for delivery through the sale of portfolio securities
denominated in such currency or through conversion of other assets of the Fund
into such currency. If a Fund engages in an offsetting transaction, the Fund
will realize a gain or a loss to the extent that there has been a change in
forward contract prices. Closing purchase transactions with respect to forward
contracts are usually effected with the currency trader who is a party to the
original forward contract.
A Fund's dealing in forward contracts will be limited to the transactions
described above. Of course, a Fund is not required to enter into such
transactions with regard to its foreign currency-denominated securities and will
not do so unless deemed appropriate by a Sub-Adviser. A Fund generally will not
enter into a forward contract with a term of greater than one year.
In cases of transactions which constitute "transaction" or "settlement"
hedges or "position" hedges (including "proxy" hedges) or "cross-currency"
hedges that involve the purchase and sale of two different foreign currencies
directly through the same forward foreign currency contact, a Fund may deem its
forward currency hedge position to be covered by underlying Fund portfolio
securities or may establish a Segregated Account with its Custodian in an amount
equal to the value of the Fund's total assets committed to the consummation of
the subject hedge. The Segregated Account will consist of liquid assets. In the
case of "anticipatory" hedges and "cross-currency" hedges that involve the
purchase and sale of two different foreign currencies indirectly through
separate forward currency contracts, the Fund will establish a Segregated
Account with its Custodian as described above. In the event a Fund establishes a
Segregated Account, the
- 41 -
<PAGE>
Fund will mark-to-market the value of the assets in the Segregated Account. If
the value of the assets placed in the Segregated Account declines, additional
liquid assets will be placed in the account by the Fund on a daily basis so that
the value of the account will equal the amount of the Fund's commitments with
respect to such contracts.
It should be realized that this method of protecting the value of a Fund's
portfolio securities against a decline in the value of a currency does not
eliminate fluctuations in the underlying prices of the securities. It simply
establishes a rate of exchange which can be achieved at some future point in
time. It also reduces any potential gain which may have otherwise occurred had
the currency value increased above the settlement price of the contract.
The Sub-Advisers believe that active currency management can enhance
portfolio returns through opportunities arising from interest rate differentials
between securities denominated in different currencies and/or changes in value
between currencies. Moreover, the Sub-Advisers believe active currency
management can be employed as an overall portfolio risk management tool. For
example, in their view, foreign currency management can provide overall
portfolio risk diversification when combined with a portfolio of foreign
securities and the market risks by currency strategies which may not involve the
currency in which the foreign security is denominated.
Forward contracts are intended to minimize the risk of loss to a Fund from
adverse changes in the relationship between the U.S. dollar and foreign
currencies. Such contracts do not eliminate fluctuations in the underlying
prices of securities held by the Funds. Although such contracts tend to minimize
the risk of loss due to a decline in the value of a currency that has been sold
forward, and the risk of loss due to an increase in the value of a currency that
has been purchased forward, at the same time they tend to limit any potential
gain that might be realized should the value of such currency increase.
The Funds cannot assure that their use of forward contracts will always be
successful. Successful use of forward contracts depends on the Sub-Adviser's
skill in analyzing and predicting relative currency values. Forward contracts
alter a Fund's exposure to currency exchange rate activity and could result in
losses to the Fund if currencies do not perform as the Sub-Adviser anticipates.
A Fund may also incur significant costs when converting assets from one currency
to another.
A Fund's foreign currency transactions may be limited by the requirements
of Subchapter M of the Code for qualification as a regulated investment company.
- 42 -
<PAGE>
FOREIGN INDEX-LINKED INSTRUMENTS
As part of its investment program, and to maintain greater flexibility,
the EAFE Index Fund, International Equity Fund, Multi- Asset Fund and
International Bond Fund may invest in instruments which have the investment
characteristics of particular securities, securities indexes, futures contracts
or currencies. Such instruments may take a variety of forms, such as debt
instruments with interest or principal payments determined by reference to the
value of a currency or commodity at a future point in time. For example, a Fund
may, subject to compliance with its respective limitations applicable to its
investment in debt securities, invest in instruments issued by the U.S. or a
foreign government or by private issuers that return principal and/or pay
interest to investors in amounts which are linked to the level of a particular
foreign index ("foreign index-linked instruments"). A foreign index may be based
upon the exchange rate of a particular currency or currencies or the
differential between two currencies, or the level of interest rates in a
particular country or countries or the differential in interest rates between
particular countries. In the case of foreign index-linked instruments linking
the interest components to a foreign index, the amount of interest payable will
adjust periodically in response to changes in the level of the foreign index
during the term of the foreign index-linked instrument. The risks of such
investments would reflect the risks of investing in the index or other
instrument, the performance of which determines the return for the instrument.
Tax considerations may limit the Funds' ability to invest in foreign
index-linked instruments.
WARRANTS
With the exception of the International Bond Fund and International Equity
Fund, a Fund's investments in warrants (not including those that have been
acquired in units or attached to other securities) will be limited to no more
than 5% of its net assets measured at the time of the acquisition. Included
within that amount, but not to exceed 2% of the Fund's net assets, may be
warrants not listed on the New York or American Stock Exchanges. The
International Bond Fund and International Equity Fund may not invest more than
5% of the Fund's net assets, nor exceed 2% of assets if a warrant's underlying
securities are not traded on a principal domestic or foreign exchange.
The holder of a warrant has the right to purchase a given number of shares
of a particular issuer at a specified price until expiration of the warrant.
Such investments can provide a greater potential for profit or loss than an
equivalent investment in the underlying security. Prices of warrants do not
necessarily move in tandem with the prices of the underlying securities, and are
- 43 -
<PAGE>
speculative investments. Warrants pay no dividends and confer no rights other
than a purchase option. If a warrant is not exercised by the date of its
expiration, the Fund will lose its entire investment in such warrant.
SHORT SALES AGAINST THE BOX
A short sale is a transaction in which a Fund sells through a broker a
security it does not own in anticipation of a decline in market price. A short
sale "against the box" is a short sale in which, at the time of the short sale,
a Fund owns or has the right to obtain securities equivalent in kind and amount.
Each of the Funds will only enter into short sales against the box. A Fund may
enter into a short sale against the box among other reasons, to hedge against a
possible market decline in the value of a security owned or to defer recognition
of a gain or loss for federal income tax purposes on the security owned by the
Fund. If the value of a security sold short against the box increases, the Fund
would suffer a loss when it purchases or delivers to the selling broker the
security sold short. The proceeds of the short sale are retained by the broker
pursuant to applicable margin rules. In addition, the Fund may segregate assets,
equal in value to 50% of the value of the short sale, in a special account with
the Fund's custodian. The segregated assets are pledged to the broker pursuant
to applicable margin rules. If a broker, with which the Fund has open short
sales, were to become bankrupt, a Fund could experience losses or delays in
recovering gains on short sales. The Funds will only enter into short sales
against the box with brokers they believe are creditworthy. Short sales against
the box will be limited to no more than 25% of a Fund's total assets.
HIGH YIELD/HIGH RISK SECURITIES
Analysis of the creditworthiness of issuers of high yield/high risk bonds
may be more complex than for issuers of higher quality debt securities, and the
ability of the Fund to achieve its investment objective may, to the extent of
its investment in high yield/high risk bonds, be more dependent upon such
creditworthiness analysis than would be the case if the Fund were investing in
higher quality bonds.
High yield/high risk bonds may be more susceptible to real or perceived
adverse economic and competitive industry conditions than higher grade bonds.
The prices of high yield/high risk bonds have been found to be less sensitive to
interest rate changes than more highly rated investments, but more sensitive to
adverse economic downturns or individual corporate developments. If the issuer
of high yield/high risk bonds defaults, the Fund may incur additional expenses
to seek recovery. In the case of high yield/high risk bonds structured as zero
coupon or payment-in-kind securities, the
- 44 -
<PAGE>
market prices of such securities are affected to a greater extent by interest
rate changes and, therefore, tend to be more volatile than securities which pay
interest periodically and in cash.
The secondary market on which high yield/high risk bonds are traded may be
less liquid than the market for higher grade bonds. Less liquidity in the
secondary trading market could adversely affect the price at which the Fund
could sell a high yield/high risk bond, and could adversely affect and cause
large fluctuations in the daily net asset value of the Fund's shares. A
projection of an economic downturn or of a period of rising interest rates, for
example, could cause a decline in high yield/high risk bond prices because the
advent of a recession could lessen the ability of a highly leveraged company to
make principal and interest payments on its debt securities. Adverse publicity
and investor perceptions, whether or not based on fundamental analysis, may
decrease the values and liquidity of high yield/high risk bonds, especially in a
thinly traded market.
Legislation designed to limit the use of high yield/high risk bonds in
corporate transactions may have a material adverse effect on the International
Bond Fund's net asset value and investment practices. In addition, there may be
special tax considerations associated with investing in high yield/high risk
bonds structured as zero coupon or payment-in-kind securities. Interest on these
securities is recorded annually as income even though no cash interest is
received until the security's maturity or payment date. As a result, the amounts
which have accrued each year are required to be distributed to shareholders and,
such amounts will be taxable to shareholders. Therefore, the Fund may have to
sell some of its assets to distribute cash to shareholders. These actions are
likely to reduce the Fund's assets and may thereby increase its expense ratios
and decrease its rate of return.
The use of credit ratings as the sole method for evaluating high
yield/high risk bonds also involves certain risks. For example, credit ratings
evaluate the safety of principal and interest payments, not the market value
risk of high yield/high risk bonds. Also, credit rating agencies may fail to
change credit ratings on a timely basis to reflect subsequent events.
ZERO COUPON BONDS
Zero coupon bonds are debt obligations issued without any requirement for
the periodic payment of interest. Zero coupon bonds are issued at a significant
discount from the face value. The discount approximates the total amount of
interest the bonds would accrue and compound over the period until maturity at a
rate of interest reflecting the market rate at the time of issuance. Cash to pay
dividends representing unpaid, accrued interest may be
- 45 -
<PAGE>
obtained from sales proceeds of portfolio securities and Fund shares and from
loan proceeds. Because interest on zero coupon obligations is not paid to the
Fund on a current basis but is in effect compounded, the value of the securities
of this type is subject to greater fluctuations in response to changing interest
rates than the value of debt obligations which distribute income regularly. Zero
coupon bonds tend to be subject to greater market risk than interest paying
securities of similar maturities. The discount represents income a portion of
which a Fund must accrue and distribute every year even though the Fund receives
no payment on the investment in that year.
INVESTMENT RESTRICTIONS
The Funds' investment objectives, and investment restrictions set forth in
the Prospectus under "Investment Restrictions," and below, are fundamental
policies of each Fund; i.e., they may not be changed with respect to a Fund
without a majority vote of the outstanding shares of that Fund. Except for those
investment policies of a Fund specifically identified as fundamental in the
Prospectus and this Statement of Additional Information, all other investment
policies and practices described may be changed by the Board of Directors
without the approval of shareholders.
Unless otherwise indicated, all of the percentage limitations below, and
in the fundamental investment restrictions recited in the Prospectus, apply to
each Fund on an individual basis, and apply only at the time a transaction is
entered into. Accordingly, if a percentage restriction is adhered to at the time
of investment, a later increase or decrease in the percentage which results from
a relative change in values or from a change in a Fund's net assets will not be
considered a violation.
In addition to the fundamental restrictions set forth in the Prospectus,
each Fund has adopted a fundamental restriction that it may not:
(1) purchase or sell real estate (although it may purchase securities
secured by real estate or interests therein, or securities issued by companies
which invest in real estate, or interests therein);
(2) purchase or sell commodities or commodities contracts, except that,
subject to restrictions described in the Prospectus and in this Statement of
Additional Information, (i) a Fund may enter into futures contracts on
securities, currencies or on indexes of such securities or currencies, or any
other financial instruments and options on such futures contracts; (ii) a Fund
may enter into spot or forward foreign currency contracts and foreign currency
options; or
- 46 -
<PAGE>
(3) act as an underwriter of securities of other issuers, except to the
extent that in connection with the disposition of portfolio securities, it may
be deemed to be an underwriter under the Federal securities laws.
ADDITIONAL RESTRICTIONS
Each Fund has adopted the following additional restrictions which are not
fundamental and which may be changed without shareholder approval, to the extent
permitted by applicable law, regulation or regulatory policy.
Unless otherwise indicated, all percentage limitations apply to each Fund
on an individual basis, and apply only at the time a transaction is entered
into. Accordingly, if a percentage restriction is adhered to at the time of
investment, a later increase or decrease in the percentage which results from a
relative change in values or from a change in a Fund's net assets will not be
considered a violation.
Under these restrictions, a Fund may not:
(1) (except for the International Bond Fund and International Equity Fund)
purchase puts, calls, straddles, spreads and any combination thereof if, as a
result, the value of its aggregate investment in such classes of securities
would exceed 5% of its total assets;
(2) purchase securities that may not be sold without first being
registered under the Securities Act of 1933, as amended ("restricted
securities") other than Rule 144A securities determined to be liquid pursuant to
guidelines adopted by the Company's Board of Directors; enter into repurchase
agreements having a duration of more than seven days; purchase loan
participation interests that are not subject to puts; purchase instruments
lacking readily available market quotations ("illiquid instruments"); or
purchase or sell over-the-counter options, if as a result of the purchase or
sale, the Fund's aggregate holdings of restricted securities, repurchase
agreements having a duration of more than seven days, loan participation
interests that are not subject to puts, illiquid instruments, and
over-the-counter options purchased by the Fund and the assets used as cover for
over-the-counter options written by the Fund exceed 10% of the Fund's net assets
(15% of net assets in the case of the International Bond Fund and International
Equity Fund);
(3) invest in other companies for the purpose of exercising control;
- 47 -
<PAGE>
(4) purchase the securities of other investment companies, except to the
extent permitted by the 1940 Act or in connection with a merger, consolidation,
acquisition or reorganization;
(5) a Fund may not purchase securities on margin, except that the Fund may
obtain such short-term credits as are necessary for the clearance of
transactions, and provided that margin payments in connection with futures
contracts and options on futures contracts shall not constitute the purchase of
securities on margin;
(6) a Fund may not sell securities short, except for covered short sales
or unless it owns or has the right to obtain securities equivalent in kind and
amount to the securities sold short, and provided that transactions in options,
futures and forward contracts are deemed not to constitute short sales of
securities.
MANAGEMENT OF THE COMPANY
DIRECTORS AND OFFICERS
The Directors and Officers of the Company, their addresses, ages and their
principal occupations during the past five years are as follows (unless
otherwise indicated, the address of all persons below is 51 Madison Avenue, New
York, NY 10010):
<TABLE>
<CAPTION>
Name Position(s) with Principal Occupation(s)
Address and Age the Company During Past 5 Years
- --------------- ---------------- -----------------------
<S> <C> <C>
Stephen C. Roussin, 34 Director and Chairperson President, Chief Executive Officer and Trustee,
of the Board of Directors* The MainStay Funds, 1997-present; Senior Vice
President, New York Life Insurance Company 1997
to present; Senior Vice President, Smith Barney,
1994 to 1997; and Division Sales Manager,
Prudential Securities, 1989 to 1994.
</TABLE>
- 48 -
<PAGE>
<TABLE>
<CAPTION>
Name Position(s) with Principal Occupation(s)
Address and Age the Company During Past 5 Years
- --------------- ---------------- --------------------
<S> <C> <C>
Patrick G. Boyle, 43 Director* Senior Vice President, Pension Department, New York Life Insurance Company,
1991 to present; Vice President, Pension Department, New York Life Insurance
Company, 1988-1991; Pension Vice President, Pension Department, New York Life
Insurance Company, 1986-1988; Assistant Vice President, Pension Department,
New York Life Insurance Company, 1985-1986; Director, NYLIFE Distributors
Inc., 1993 to 1996; Chairman, Monitor Capital Advisors, Inc., 1996 to
present, and Director, 1991 to present; Director, New York Life Benefit
Services, Inc., 1994 to present; Director, New York Life International
Investment Inc., 1995 to present; Director, New York Life Trust Company, 1995
to present; Director, NYL Capital Management Limited, 1994 to present;
Member, American Council of Life Insurance Pension Committee, 1992 to
present.
Lawrence Glacken, 69 Director Retired, 1987 to present; Vice President,
353 Canterbury Drive Investment Banking, The First Boston Corporation, 1964-1987.
Ramsey, NJ 07446
Robert P. Mulhearn, 50 Director Private Investor, 1987 to present; Managing
60 Twin Brooks Road Director, Morgan Stanley, 1979-1987.
Saddle River, NJ 07458
Susan B. Kerley, 45 Director President, Global Research Associates, 1990 to present; Manager,
P.O. 9572 Special Investments, Rockefeller & Co., 1988-1990; Director of Research,
New Haven, CT 06535 Rogers, Casey and Barksdale, 1983-1988; Director, Landmark Funds, 1991 to
present.
Linda M. Livornese, 45 President Vice President, Pension Department, New York Life Insurance Company, 1990 to
present; Pension Vice President, Pension Department, New York Life Insurance
Company, 1988-1990; Assistant Vice President, Pension Department, New York
Life Insurance Company, 1986-1988; Vice President, NYLIFE Distributors Inc.,
1993 to present; Vice President, NYLIFE Securities Inc., 1992 to present.
</TABLE>
- 49 -
<PAGE>
<TABLE>
<CAPTION>
Name Position(s) with Principal Occupation(s)
Address and Age the Company During Past 5 Years
- --------------- ---------------- -------------------
<S> <C> <C>
Jefferson C. Boyce, 40 Senior Vice President Senior Vice President, New York Life Insurance Company,
1994 to present; Senior Vice President, The MainStay Funds,
1995 to present; Director, Monitor Capital Advisors, Inc.,
1991 to present and Senior Vice President, 1996 to present;
Director, MSC Holding, Inc., 1992 to present and Secretary,
1994 to present; Director, Eagle Strategies Corp., 1993 to
present; Director, NYLIFE Equity, Inc., 1993 to present;
President and Chief Executive Officer, NYLIFE Distributors
Inc., 1996 to present and Director, 1993 to present;
Director, NYLIFE Inc., 1993 to present; Director, NYLIFE
Structured Asset Management Company Ltd., 1993 to present;
Director, CNP Realty Investments, Inc., 1994 to present;
Director New York Life Benefit Services, Inc., 1994 to
present; Director, NYLIFE Depositary Corporation, 1994 to
present; Director, NYLIFE Realty Inc., 1994 to present;
Director, NYLIFE SFD Holding Inc. (formerly NAFCO, Inc.),
1994 to present; Director, President and Chief Executive
Officer, NYLIFE Securities Inc., 1996 to present; Chairman
and Director, MainStay Shareholder Services Inc., 1997 to
present; Chief Administrative Officer, Pension, Mutual
Funds, Structured Finance, Corporate Quality, Human
Resources and Employees' Health Departments, New York Life
Insurance Company, 1992 to 1994; Vice President, Pension
Department, New York Life Insurance Company, 1989 to 1992.
Robert S. Fenster, 47 Vice President Vice President, Pension Department, New York Life Insurance
Company, 1988 to present; Director New York Life Trust
Company, 1995 to present.
Richard W. Zuccaro, 47 Tax Vice President Vice President, New York Life Insurance Company, 1995 to
present; Vice President-- Tax, New York Life Insurance
Company, 1986 to 1995; Tax Vice President, NYLIFE
Securities Inc., 1987 to present; Tax Vice President,
NYLIFE SFD Holding Inc., 1990 to present; Tax Vice
President, NYLIFE Depositary Inc., 1990 to present; Tax
Vice President, NYLIFE Inc., 1990 to present; Tax Vice
President, NYLIFE Insurance Company of Arizona, 1990 to
present; Tax Vice President, NYLIFE Realty Inc., 1991 to
present; Tax Vice President, NYLICO Inc., 1991 to present;
Tax Vice President, New York Life Fund Inc., 1991 to
present; Tax Vice President, New York Life International
Investment, Inc., 1991 to present; Tax Vice President
NYLIFE Funding Inc., 1991 to present; Tax Vice President,
NYLCO, 1991 to present; Tax Vice President, NYLIFE Equity
Inc., 1991 to present; Tax Vice President, MainStay VP
Series Fund, Inc., 1991 to present; Tax Vice President, CNP
Realty Investments, Inc., 1991 to present; Tax Vice
President, New York Life Worldwide Holding, Inc., 1992 to
present; Tax Vice President, NYLIFE Structured Asset
Management Company Ltd., 1992 to present; Tax Vice
President, The MainStay Funds, 1991 to present; Tax Vice
President, Eagle Strategies Corp. (registered investment
adviser), 1993 to present; Tax Vice President, NYLIFE
Distributors Inc., 1993 to present; Vice President &
Assistant Controller, New York Life Insurance and Annuity
Corp., 1995 to present, and Assistant Controller, 1991 to
1995; Vice President, NYLCare Health Plans, Inc., 1995
</TABLE>
- 50 -
<PAGE>
<TABLE>
<CAPTION>
Name Position(s) with Principal Occupation(s)
Address and Age the Company During Past 5 Years
- --------------- ---------------- -------------------
<S> <C> <C> to present; Vice President - Tax, New York Life and
Health Insurance Co., 1996 to present; Tax Vice
President, New York Life Trust Company, 1996 to
present; Tax Vice President, Monitor Capital Advisors,
Inc., 1996 to present; Tax Vice President, NYLINK
Insurance Agency Incorporated, 1996 to present; Tax
Vice President, MainStay Shareholder Services Inc.,
1997 to present.
Anthony W. Polis, 53 Treasurer (Principal Financial and Vice President, New York Life Insurance Company, 1988
Accounting Officer) to present; Director, Vice President and Chief
Financial Officer, NYLIFE Securities Inc., 1988 to
present; Vice President and Chief Financial Officer,
NYLIFE Distributors Inc., 1993 to present; Vice
President and Chief Financial Officer, Eagle Strategies
Corp., 1993 to present; Vice President and Chief
Financial Officer, MainStay Shareholder Services Inc.,
1997 to present; Vice President and Chief Financial
Officer, The MainStay Funds, 1990 to present;
Treasurer, MainStay VP Series Fund, Inc., 1993 to
present; Assistant Treasurer, MainStay VP Series Fund,
Inc., 1992 to 1993; Vice President and Treasurer,
Eclipse Financial Asset Trust, 1992 to present; Vice
President, Drexel Burnham Lambert Incorporated, DBL
Tax-Free Fund Inc., DBL Cash Fund Inc., The Drexel
Burnham Fund, Drexel Series Trust, Fenimore
International Fund Inc., BT Investment Trust and BT Tax
Free Investment Trust, 1983 to 1988; Assistant
Treasurer, Drexel Bond-Debenture Trading Fund, 1983-
1988.
Sara L. Badler, 37 Secretary Assistant General Counsel, New York Life Insurance
Company, 1996 to present; Associate Counsel, New York
Life Insurance Company, 1994 to 1996; Secretary,
MainStay VP Series Fund, Inc., 1997 to present;
Assistant Secretary, the MainStay Funds, 1994 to
present; Assistant Secretary, Eclipse Financial Asset
Trust, 1994 to present; Teacher, New York City Board of
Education, 1993 to 1994; and Vice President and
Associate Counsel and Consulting Attorney; Oppenhyeimer
Management Corporation, 1987 to 1993
</TABLE>
* Messrs. Boyle and Roussin are Directors who are "interested persons" of
the Company as that term is defined in the 1940 Act.
COMPENSATION TABLE
The following table sets forth information regarding compensation received
by the Directors of the Company for the year ended December 31, 1996.
- 51 -
<PAGE>
Aggregate Compensation
Name and Position from Company/1/
Lawrence Glacken $ 30,000
Director
Robert P. Mulhearn $ 30,000
Director
Susan B. Kerley $ 30,000
Director
/1/ Directors, other than those affiliated with New York Life
Insurance Company, MainStay Management, Inc., MacKay-Shields
Financial Corporation, Monitor Capital Advisors, Inc. or
NYLIFE Distributors Inc. are paid an annual fee of $24,000 and
$1,000 for each Board of Directors meeting and Committee
meeting attended plus reimbursement for travel and
out-of-pocket expenses.
MANAGEMENT AGREEMENT
Pursuant to the Management Agreement for the Funds dated November 21,
1997, MainStay Management, Inc. (the "Manager"), subject to the supervision of
the Directors of the Company and in conformity with the stated policies of the
Funds, administers the Funds' business affairs and investment advisory
responsibilities.
The Directors, including the Independent Directors, approved the
Management Agreement at an in-person meeting held on September 9, 1997. On
November 17, 1997, the shareholders of each of the Funds approved the Management
Agreement. The Management Agreement will remain in effect for two years
following its effective date, and will continue in effect thereafter only if
such continuance is specifically approved at least annually by the Directors or
by a vote of a majority of the outstanding voting securities of each of the
Funds (as defined in the 1940 Act and the rules thereunder) and, in either case
by a majority of the Directors who are not "interested persons" of the Company
or of the Manager (as the term is defined in the 1940 Act).
The Manager has authorized any of its directors, officers and employees
who have been elected or appointed as Directors of the Company to serve in the
capacities in which the have been elected or appointed.
The Management Agreement provides that the Manager shall not be liable to
a Fund for any error or judgment by the Manager or for any loss sustained by a
Fund except in the case of the Manager's
- 52 -
<PAGE>
willful misfeasance, bad faith, gross negligence or reckless disregard of duty.
The Management Agreement also provides that it shall terminate automatically if
assigned and that it may be terminated without penalty by either party upon no
more than 60 days' nor less than 30 days' written notice.
In connection with its administration of the business affairs of each of
the Funds, and except as indicated in the Prospectus under the heading "Manager
and Sub-Advisers," the Manager bears the following expenses:
(a) the salaries and expenses of all personnel of the Company and the
Manager, except the fees and expenses of the Directors not affiliated with the
Manager or the Sub-Adviser;
(b) the fees to be paid to the Sub-Advisers pursuant to the Sub-Advisory
Agreements; and
(c) all expenses incurred by the Manager in connection with administering
the ordinary course of the Funds' business, other than those assumed by the
Company.
For its services, each Fund pays the Manager a monthly fee.
(See page 48 of the Prospectus, "Manager and Sub-Advisers.")
SUB-ADVISORY AGREEMENTS
Pursuant to the Sub-Advisory Agreements between the Manager and
MacKay-Shields Financial Corporation ("MacKay-Shields"), between the Manager and
Monitor Capital Advisors, Inc. ("Monitor") and between the Manager and New York
Life Insurance Company ("New York Life") on behalf of each Fund (each a
"Sub-Adviser" and collectively the "Sub-Advisers"), MacKay-Shields, Monitor and
New York Life, subject to the supervision of the Directors of the Company and
the Manager in conformity with the stated policies of each of the Funds and the
Company, manage the Funds' portfolios, including the purchase, retention,
disposition and loan of securities.
The Directors, including the Independent Directors, approved the
Sub-Advisory Agreements at an in-person meeting held September 9, 1997. On
November 17, the shareholders of each of the Funds approved the Sub-Advisory
Agreements with MacKay-Shields, Monitor and New York Life. The Sub-Advisory
Agreements will remain in effect for two years following its effective date, and
will continue in effect thereafter only if such continuance is specifically
approved at least annually by the Directors or by a vote of a majority of the
outstanding voting securities of each of the Funds (as defined in the 1940 Act
and the rules thereunder) and, in either case by a majority of the Directors who
are not
- 53 -
<PAGE>
"interested persons" of the Company, the Manager, or any Sub- Adviser (as the
term is defined in the 1940 Act).
The Sub-Advisory Agreements provide that the Sub-Advisers shall not be
liable to a Fund for any error of judgment by a Sub- Adviser or for any loss
sustained by a Fund except in the case of the Sub-Adviser's willful misfeasance,
bad faith, gross negligence or reckless disregard of duty. The Sub-Advisory
Agreements also provide that they shall terminate automatically if assigned and
that they may be terminated without penalty by either party upon no more than 60
days' nor less than 30 days' written notice.
In previous years, prior to a change in management structure, each Fund
paid an advisory fee directly to New York Life, MacKay- Shields or Monitor. For
the fiscal years ended December 31, 1996, 1995 and 1994, the amount of the
advisory fee paid by each Fund to New York Life, MacKay-Shields or Monitor was
as follows:
Year Ended Year Ended Year Ended
Fund 12/31/96 12/31/95 12/31/94
- ---- -------- -------- --------
EAFE Index Fund $ 124,284 $ 115,497 $ 106,887
Growth Equity Fund 1,186,388 879,351 676,347
Indexed Equity Fund 502,686 295,487 238,454
International Equity Fund 395,717 290,777 N/A
Multi-Asset Fund 461,408 372,064 374,026
Value Equity Fund 1,768,836 1,275,060 890,814
Bond Fund 355,167 378,811 427,182
Indexed Bond Fund 123,798 168,137 167,785
International Bond Fund 141,296 121,813 N/A
Money Market Fund 100,230 59,918 63,676
Short-Term Bond Fund 98,265 79,193 156,983
In previous years, prior to a change in management structure, each Fund
paid an administrative fee directly to New York Life as administrator. For the
fiscal years ended December 31, 1996, 1995 and 1994, the amount of the
administration fee paid by each Fund to New York Life was as follows:
Year Ended Year Ended Year Ended
Fund 12/31/96 12/31/95 12/31/94
- ---- -------- -------- --------
EAFE Index Fund $ 662,846 $ 615,986 $ 570,064
Growth Equity Fund 2,847,330 2,110,442 1,623,233
Indexed Equity Fund 2,010,753 1,181,947 953,814
International Equity Fund 565,311 415,395 N/A
Multi-Asset Fund 1,538,025 1,240,213 1,246,753
Value Equity Fund 4,245,206 3,060,145 2,137,952
Bond Fund 976,711 1,041,729 1,174,749
Indexed Bond Fund 495,190 672,553 671,140
International Bond Fund 235,493 203,021 N/A
Money Market Fund 400,921 239,673 254,704
Short-Term Bond Fund 294,794 237,578 470,949
Also prior to the above-referenced change in management structure and in
connection with the voluntary expense limitation, New York Life, as
administrator, assumed the following expenses for
- 54 -
<PAGE>
the Funds for the fiscal years ended December 31, 1996, 1995 and
1994.
Year Ended Year Ended Year Ended
Fund 12/31/96 12/31/95 12/31/94
- ---- -------- -------- --------
EAFE Index Fund $238,764 $ 165,321(1) $ N/A(2)
Growth Equity Fund N/A(2) N/A(2) N/A(2)
Indexed Equity Fund 753,575(3) 272,396 194,838
International Equity Fund 82,203 60,652 N/A
Multi-Asset Fund 164,519(4) 167,833 130,798
Value Equity Fund N/A(2) N/A(2) N/A(2)
Bond Fund 188,561 198,399 148,020
Indexed Bond Fund 189,996 225,553 177,755
International Bond Fund 61,961 31,528 N/A
Money Market Fund 170,221 136,576 116,556
Short-Term Bond Fund 122,335 114,433 121,241
1 Fund expense limitation resumed April 1, 1995.
2 Fund had no expense limitation during period.
3 New York Life assumed $676,954, Monitor assumed $76,621.
4 Fund expense limitation expired December 31, 1996.
As of November 21, 1997, the Manager has limited certain Funds' expenses
as discussed in the Prospectus. As long as temporary expense limitations
continue, they may lower the Funds' expenses and increase their respective
yields. After December 31, 1997, (December 31, 1998 for the Indexed Equity Fund)
the voluntary expense limitations may be terminated or revised at any time, at
which time the Funds' expenses may increase and their respective yields may be
reduced, depending on the total assets of each of the Funds.
DISTRIBUTOR
NYLIFE Distributors Inc. serves as the Company's distributor and principal
underwriter (the "Distributor") pursuant to a Distribution Agreement, dated
January 1, 1994. Prior to that time, NYLIFE Securities Inc. ("NYLIFE
Securities") an affiliated company, had acted as principal underwriter. NYLIFE
Securities sells shares of the Funds pursuant to a dealer agreement with the
Distributor. The Distributor is not obligated to sell any specific amount of the
Company's shares, and receives no compensation from the Company pursuant to the
Distribution Agreement. The Company anticipates making a continuous offering of
its shares, although it reserves the right to suspend or terminate such offering
at any time. The Distribution 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 Company or the Distributor, on
March 4, 1997. After an initial two-year period, the Distribution Agreement is
subject to annual approval by the Board of Directors. The Distribution Agreement
is terminable with respect to a Fund at any time, without payment of a penalty,
by vote of a majority of the Company's Directors who are not
- 55 -
<PAGE>
"interested persons" (as defined in the 1940 Act) of the Company, upon 60 days'
written notice to the Distributor, by vote of a majority of the outstanding
voting securities of that Fund, upon 60 days' written notice to the Distributor,
or by the Distributor, upon 60 days' written notice to the Company. The
Distribution Agreement will terminate in the event of its assignment.
SERVICE FEES
The Company has adopted a Shareholder Services Plan with respect to the
Institutional Service Class of each Fund. Under the terms of the Plan, the
Company is permitted to pay, a fee out of the Institutional Service Class assets
of each Fund, in the amount of 0.25% on an annual basis of the average daily net
assets attributable to that class, to New York Life Insurance Company, its
affiliates or independent third party service providers, for providing services
in connection with the administration of plans or programs that use Fund shares
as their funding medium.
Under the terms of the Shareholder Services Plan, each Fund may pay to
service agents "service fees" as that term is defined in the rules of the
National Association of Securities Dealers for services provided to shareholders
of the Institutional Service Class of the Fund. These fees are for personal
services, including assistance in establishing and maintaining shareholder
accounts and assisting shareholders that have questions or other needs relating
to their accounts.
The Plan provides that it may not be amended to materially increase the
costs which holders of Institutional Service Class of a Fund may bear under the
Plan without the approval of a majority of both (i) the Directors of the Company
and (ii) those Directors who are not "interested persons" of the Company (as
defined in the 1940 Act) and who have no direct or indirect financial interest
in the operation of the Plan or any agreements related to it (the "Plan
Directors"), cast in person at a meeting called for the purpose of voting on the
Plan and any related amendments.
The Plan provides that it may not take effect until approved by vote of a
majority of both (i) the Directors of the Company and (ii) the Plan Directors.
The Plan was approved by the Directors, including the Plan Directors, at a
meeting held on September 13, 1994 and amended at a meeting held on March 4,
1997.
The Plan provides that it shall continue in effect so long as such
continuance is specifically approved at least annually by the Directors and the
Plan Directors. The Plan provides that New York Life shall provide to the
Directors, and the Board shall review at least quarterly, a written report of
the amounts expended in
- 56 -
<PAGE>
connection with the performance of service activities, and the purposes for
which such expenditures were made.
PURCHASES AND REDEMPTIONS
Purchases and redemptions are discussed in the Prospectus under the
headings "Tell Me The Key Facts -- Open an Account and Buy Shares", and "Know
How to Sell and Exchange Shares", and that information is incorporated herein by
reference.
Certain clients of the Company's Sub-Advisers may purchase shares of a
Fund with liquid assets with a value which is readily ascertainable (and not
established only by evaluation procedures) as evidenced by a listing on a bona
fide domestic or foreign exchange and which would be eligible for purchase by
the Fund (consistent with such Fund's investment policies and restrictions).
These transactions will be effected only if the Fund's Sub-Adviser intends to
retain the security in the Fund as an investment. Assets so purchased by a Fund
will be valued in generally the same manner as they would be valued for purposes
of pricing the Fund's shares, if such assets were included in the Fund's assets
at the time of the purchase. The Fund reserves the right to amend or terminate
this practice at any time.
The Company determines the net asset value per share of each Fund on each
day the New York Stock Exchange is open for trading.
The Company reserves the right to suspend or postpone redemptions during
any period when: (a) trading on the New York Stock Exchange is restricted, as
determined by the SEC, or that Exchange is closed for other than customary
weekend and holiday closings; (b) the SEC has by order permitted such
suspension; or (c) an emergency, as determined by the SEC, exists, making
disposal of portfolio securities or valuation of net assets of the Company not
reasonably practicable.
Certain of the Funds have entered into a committed line of credit with The
Bank of New York, as agent, and various other lenders, from whom a Fund may
borrow up to 5% of its net assets in order to honor redemptions. The credit
facility is expected to be utilized in periods when the Funds experience
unusually large redemption requests.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Purchases and sales of securities on a securities exchange are effected by
brokers, and the Funds pay a brokerage commission for this service. In
transactions on stock exchanges in the United States, these commissions are
negotiated, whereas on many foreign stock exchanges these commissions are fixed.
In the
- 57 -
<PAGE>
over-the-counter markets, securities (i.e., municipal bonds and other debt
securities) are generally traded on a "net" basis with dealers acting as
principal for their own accounts without a stated commission, although the price
of the security usually includes a profit to the dealer. Transactions in certain
over-the-counter securities also may be effected on an agency basis when the
total price paid (including commission) is equal to or better than the best
total prices available from other sources. In underwritten offerings, securities
are purchased at a fixed price which includes an amount of compensation to the
underwriter, generally referred to as the underwriter's concession or discount.
On occasion, certain money market instruments may be purchased directly from an
issuer, in which case no commissions or discounts are paid.
In effecting purchases and sales of portfolio securities for the account
of a Fund, the Fund's Sub-Adviser will seek the best execution of the Fund's
orders. The Sub-Adviser attempts to achieve this result by selecting
broker-dealers to execute portfolio transactions on behalf of the Fund and its
other clients on the basis of the broker-dealers' professional capability, the
value and quality of their brokerage services and the level of their brokerage
commissions.
NYLIFE Securities (the "Affiliated Broker") may act as broker for the
Funds. In order for the Affiliated Broker to effect any portfolio transactions
for the Funds, the commissions, fees or other remuneration received by the
Affiliated Broker must be reasonable and fair compared to the commissions, fees
or other remuneration paid to other brokers in connection with comparable
transactions involving similar securities being purchased or sold on an exchange
during a comparable period of time. This standard would allow the Affiliated
Broker to receive no more than the remuneration which would be expected to be
received by an unaffiliated broker in a commensurate arms-length transaction.
The Funds will not deal with the Affiliated Broker in any portfolio transaction
in which the Affiliated Broker acts as principal.
Some securities considered for investment by the Funds may also be
appropriate for other clients served by the Funds' Sub- Advisers. If a purchase
or sale of securities consistent with the investment policies of a Fund and one
or more of the clients served by the Fund's Sub-Adviser is considered at or
about the same time, transactions in such securities will, to the extent
practicable, be allocated among the Fund and clients in a manner deemed
equitable to the Fund and the clients by the Fund's Sub-Adviser. Although there
is no specified formula for allocating such transactions, the various allocation
methods used by a Fund's Sub-Adviser, and the results of such allocations, are
subject to periodic review by the Company's Directors.
- 58 -
<PAGE>
It has for many years been a common practice in the investment advisory
business for advisers (or sub-advisers) of investment companies and other
institutional investors to receive research services from broker-dealers which
execute portfolio transactions for the clients of such advisers. Consistent with
this practice, the Sub-Adviser for a Fund may receive research services from
many broker-dealers with which the Sub-Adviser places the Fund's portfolio
transactions. These services, which in some cases may also be purchased for
cash, include such matters as general economic and security market reviews,
industry and company reviews, evaluations of securities and recommendations as
to the purchase and sale of securities. Some of these services may be of value
to the Sub-Adviser in advising its various clients (including the Fund),
although not all of these services are necessarily useful and of value in
managing a Fund. The management fee paid by the Fund and the sub-advisory fee
paid by the Manager are not reduced because the Sub-Adviser and its affiliates
receive such services.
As permitted by Section 28(e) of the Securities Exchange Act of 1934, an
investment adviser (or sub-adviser) may cause a Fund to pay a broker-dealer
which provides "brokerage and research services" (as defined in that Act) to the
investment adviser (or sub-adviser) an amount of disclosed commission for
effecting a securities transaction for the Fund in excess of the commission
which another broker-dealer would have charged for effecting that transaction.
For the years ended December 31, 1996, 1995 and 1994 each of the following
Funds paid brokerage commissions as follows:
<TABLE>
<CAPTION>
Total Brokerage Total Brokerage Commissions
Commissions Paid Paid to Affiliated Persons
---------------- --------------------------
Year ended Year ended Year ended Year ended Year ended Year ended
12/31/96 12/31/95 12/31/94 12/31/96 12/31/95 12/31/94
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
EAFE Index Fund $ N/A $ 44,798 $ 79,676 0(0%)(1) 0(0%)(1) 0(0%)(1)
Growth Equity Fund 296,284 306,776 254,728 0(0%)(1) 0(0%)(1) 1,490(0%)(1)*
Indexed Equity Fund N/A25,484 45,597 0 (0%) 0(0%)(1) 0(0%)(1)
International Equity Fund 290,329 330,914 N/A 0(0%)(1) 0(0%)(1) N/A
Multi-Asset Fund N/A 12,451 87,112 0(0%)(1) 0(0%)(1) 0(0%)(1)
Value Equity Fund 1,042,205 945,310 588,653 0(0%)(1) 0(0%)(1) 720(0%)(1)*
Bond Fund 768 15,608 13,436 0(0%)(1) 0(0%)(1) 0(0%)(1)
Short-Term Bond Fund 106 523 1,939 0(0%)(1) 0(0%)(1) 0(0%)(1)
</TABLE>
- 59 -
<PAGE>
<TABLE>
<CAPTION>
Total Brokerage
Total Amount of Transaction Commissions Paid
Where Commissions Paid to Brokers that
Provided
Research
Year ended Year ended Year ended Year ended
12/31/96 12/31/95 12/31/96 12/31/94
-------------- -------------- --------------- -------------------
<S> <C> <C> <C> <C>
EAFE Index Fund..........$ N/A $ 10,362,714(0%)(2) $ 56,509,039(0%)(2) $ N/A
Growth Equity Fund....... 182,941,279 173,585,053(0%)(2) 134,977,896(2%)(2) 290,265
Indexed Equity Fund...... 70,163,300 20,707,836(0%)(2) 339,976,251(0%)(2) N/A
International Equity Fund N/A 79,632,317(0%)(2) N/A 290,329
Multi-Asset Fund......... N/A 9,523,672(0%)(2) 72,654,644(0%)(2) N/A
Value Equity Fund....... .656,491,378 490,519,118(0%)(2) 306,971,001(0%)(2)* 1,037,247
Bond Fund................ 17,690,332 200,756,257(0%)(2) 179,145,860(0%)(2) 768
Short Term Bond Fund..... 1,533,460 7,828,803(0%)(2) 25,030,765(0%)(2) 106
</TABLE>
(1) Percent of total commissions paid.
(2) Percent of total transactions involving the payment of commissions effected
through affiliated persons. * Less than one percent
The Indexed Bond Fund, International Bond Fund and Money Market Fund paid
no brokerage commissions during the years ended December 31, 1996, 1995 and
1994.
As of December 31, 1996, the following Funds held securities in issuers
with whose broker-dealer subsidiaries or affiliates of the Funds regularly
conduct business:
Fund Broker-Dealer Market Value
- ---- ------------- ------------
Growth Equity Fund American Express Credit Corp. $ 17,315,000(1)
Schwab (Charles) Corp. 12,960,000(2)
Indexed Equity Fund Alexander & Alexander Services, Inc. 86,892(2)
American Express Company 2,925,344(2)
Dean Witter Discover & Company 1,164,476(2)
Morgan (J.P.) & Co. Inc. 2,009,709(2)
Marsh & McLennan Companies, Inc. 838,032(2)
Merrill Lynch & Co., Inc. 1,462,354(2)
Morgan Stanley Group, Inc. 951,474(2)
Salomon Inc. 571,061(2)
Multi-Asset Fund Alexander & Alexander Services, Inc. 30,736(2)
American Express Company 1,045,193(2)
Dean Witter Discover & Company 418,104(2)
Morgan (J.P.) & Co. Inc. 731,895(2)
Marsh & McLennan Companies, Inc. 299,416(2)
Merrill Lynch & Co., Inc. 527,876(2)
Morgan Stanley Group, Inc. 338,237(2)
Salomon Inc. 198,679(2)
Bear Stearns Cos., Inc. (The) 489,375(3)
Morgan (J.P.) & Co. Inc. 545,625(3)
PaineWebber Group, Inc. 412,500(3)
Value Equity Fund American Express Credit Corp. 26,386,000(1)
Prudential Funding Corp. 19,940,000(1)
- 60 -
<PAGE>
Bond Fund American Express Credit Corp. 420,000(1)
Lehman Brothers Holdings, Inc. 2,061,660(3)
Merrill Lynch & Co., Inc. 1,889,794(3)
Morgan Stanley Group, Inc. 1,665,285(3)
PaineWebber Group, Inc. 1,961,826(3)
Salomon Inc. 1,643,265(3)
Indexed Bond Fund Donaldson, Lufkin & Jenrette
Securities Corp. 2,925,000(3)
Money Market Fund Dean Witter Discover & Company 4,984,512(1)
Morgan Stanley Group, Inc. 2,991,133(1)
Short-Term Bond Fund American Express Credit Corp. 1,420,000(1)
(1) Represents investment in commercial paper.
(2) Represents investment in common stock.
(3) Represents investment in corporate bond.
A Fund's portfolio turnover rate is calculated by dividing the lesser of
sales or purchases of portfolio securities by the average monthly value of the
Fund's portfolio securities. For purposes of this calculation, portfolio
securities will exclude purchases and sales of debt securities having a maturity
at the date of purchase of one year or less.
The turnover rate for a Fund will vary from year-to-year and depending on
market conditions, turnover could be greater in periods of unusual market
movement and volatility. A higher turnover rate generally would result in
greater brokerage commissions or other transactional expenses which must be
borne, directly or indirectly, by the Fund and, ultimately, by the Fund's
shareholders. High portfolio turnover may result in increased brokerage
commissions and in the realization of a substantial increase in net short-term
capital gains by the Fund which, when distributed to non-tax-exempt
shareholders, will be treated as dividends (ordinary income).
Moreover, certain requirements that must be satisfied in order for the
Fund to qualify as a regulated investment company for Federal income tax
purposes may limit the extent to which the Fund can sell securities held for
less than three months.
NET ASSET VALUE
The Company determines the net asset value per share of each class of each
Fund on each day the New York Stock Exchange is open for trading. Net asset
value per share is calculated as of the close of the first session of the New
York Stock Exchange (currently 4:00 p.m., New York City time) for each class of
shares of each Fund (except the Money Market Fund, which is determined at noon),
by dividing the current market value (amortized cost, in the
- 61 -
<PAGE>
case of the Money Market Fund) of the total assets attributable to a class, less
liabilities attributable to that class, by the total number of outstanding
shares of that class.
Portfolio securities of the Money Market Fund are valued at their
amortized cost, which does not take into account unrealized securities gains or
losses. This method involves initially valuing an instrument at its cost and
thereafter assuming a constant amortization to maturity of any premium paid or
discount received. While this method provides certainty in valuation, it may
result in periods during which value, as determined by amortized cost, is higher
or lower than the price the Fund would receive if it sold the instrument. During
such periods, the yield to an investor in a Fund may differ somewhat than that
obtained in a similar investment company which uses available market quotations
to value all of its portfolio securities.
Portfolio securities of each of the other Funds are valued (a) by
appraising common and preferred stocks which are traded on the New York Stock
Exchange at the last sale price of the first session on that day or, if no sale
occurs, the stock is valued at the mean between the closing bid price and asked
price; (b) by appraising other common and preferred stocks as nearly as possible
in the manner described in clause (a) if traded on any other exchange, including
the National Association of Securities Dealers National Market System and
foreign securities exchanges; (c) by appraising over-the-counter common and
preferred stocks quoted on the National Association of Securities Dealers NASDAQ
system (but not listed on the National Market System) at the bid price supplied
through such system; (d) by appraising over-the-counter common and preferred
stocks not quoted on the NASDAQ system and securities listed or traded on
certain foreign exchanges whose operations are similar to the U.S.
over-the-counter market at prices supplied by a pricing agent selected by a
Fund's Sub-Adviser if the prices are deemed to be representative of market
values at the close of the first session of the New York Stock Exchange; (e) by
appraising debt securities at prices supplied by a pricing agent or, determined
using pricing procedures selected by a Fund's Sub-Adviser, which prices reflect
broker/dealer-supplied valuations or electronic data processing techniques
and/or matrix pricing if those prices are deemed by a Fund's Sub-Adviser to be
representative of market values at the close of the first session of the New
York Stock Exchange; (f) by appraising options and futures contracts at the last
sale price on the market where any such option or futures contract is
principally traded, and (g) by appraising all other securities and other assets,
including over-the-counter common and preferred stocks not quoted on the NASDAQ
system, securities not listed or traded on foreign exchanges whose operations
are similar to the U.S. over-the-counter market and debt securities for which
prices are supplied by a pricing agent but are not deemed by a
- 62 -
<PAGE>
Fund's Sub-Adviser to be representative of market values, but excluding money
market instruments with a remaining maturity of sixty days or less and including
restricted securities and securities for which no market quotation is available,
at fair value in accordance with procedures approved by and determined in good
faith by the Directors, although the actual calculations may be done by others.
Money Market instruments held by the Funds with a remaining maturity of sixty
days or less are valued by the amortized cost method unless such method does not
represent fair value.
Portfolio securities traded on more than one U.S. national securities
exchange or foreign securities exchange are valued at the last sale price on the
business day as of which such value is being determined on the close of the
exchange representing the principal market for such securities. The value of all
assets and liabilities expressed in foreign currencies will be converted into
U.S. dollar values, using the W.M. Company exchange rates that have been adopted
as the standard for exchange rate valuations by major indices. If such
quotations are not available, the rate of exchange will be determined in
accordance with policies established by the Company's Directors. For financial
accounting purposes, the Company recognizes dividend income and other
distributions on the ex-dividend date, except certain dividends from foreign
securities are recognized as soon as the Company is informed on or after the
ex-dividend date.
Trading in securities on European and Far Eastern securities exchanges and
over-the-counter markets is normally completed well before the close of business
on each business day in New York (i.e., a day on which the New York Stock
Exchange is open for trading). In addition, European or Far Eastern securities
trading in a particular country or countries may not take place on all business
days in New York. Furthermore, trading takes place in Japanese markets on
certain Saturdays and in various foreign markets on days which are not business
days in New York and on which the Funds' net asset values are not calculated.
Such calculation does not take place contemporaneously with the determination of
the prices of the portfolio securities used in such calculation. Events
affecting the values of portfolio securities that occur between the time their
prices are determined and the close of the New York Stock Exchange will not be
reflected in the Fund's calculation of net asset values unless a Fund's Sub-
Adviser determines that the particular event may materially affect net asset
value, in which case an adjustment will be made.
To the extent that any newly organized fund or class of shares receives,
on or before December 31, any seed capital, the net asset value of such fund(s)
or class(es) will be calculated as of December 31.
- 63 -
<PAGE>
TAX INFORMATION
While it is anticipated that many shareholders of the Funds will be
tax-exempt institutions, the following discussion may be of general interest to
these shareholders as well as for those shareholders of the Funds who do not
have tax-exempt status. Although the discussion below refers in certain
instances to distributions and other transactions as being taxable to a
shareholder, tax-exempt shareholders will, of course, not be taxed to the extent
provided by applicable tax exemptions. The discussion herein relating to taxes
is presented for general informational purposes only. Since the tax laws are
complex and tax results can vary depending upon specific circumstances,
investors should consult tax advisers regarding investment in a Fund.
Each Fund intends to qualify annually and elect to be treated as a
regulated investment company under Subchapter M of the Internal Revenue Code of
1986, as amended (the "Code"). If a Fund so qualifies and elects, it generally
will not be subject to Federal income tax on its investment company taxable
income (which includes, among other items, dividends, interest, and the excess,
if any, of net short-term capital gains over net long-term capital losses) and
its net capital gains (net long-term capital gains in excess of net short-term
capital losses) that it distributes to its shareholders.
Each Fund intends to distribute, at least annually, to its shareholders
substantially all of its investment company taxable income and its net capital
gains. In determining amounts of capital gains to be distributed, any capital
loss carryovers from prior years will be applied against capital gains.
To qualify for treatment as a regulated investment company, a Fund
generally must, among other things: (a) derive in each taxable year at least 90%
of its gross income from dividends, interest, payments with respect to
securities loans, gains from the sale or other disposition of securities or
foreign currencies, and other income (including gains from certain options,
futures, and forward contracts) derived with respect to its business of
investing in securities or foreign currencies; (b) diversify its holdings so
that at the end of each quarter of the taxable year, (i) at least 50% of the
market value of a Fund's assets is represented by cash, cash items, U.S.
Government securities, the securities of other regulated investment companies
and other securities, with such other securities of any one issuer limited for
the purposes of this calculation to an amount not greater than 5% of the value
of the Fund's total assets and 10% of the outstanding voting securities of such
issuer, and (ii) not more than 25% of the value of its total assets is invested
in the
- 64 -
<PAGE>
securities of any one issuer (other than U.S. Government securities or the
securities of other regulated investment companies), or of two or more issuers
which the Fund controls and which are engaged in the same or similar trades or
businesses or related trades or businesses; and (c) distribute in each taxable
year at least 90% of the sum of its investment company taxable income and its
net tax-exempt interest income. If a Fund does not meet all of these Code
requirements, it will be taxed as an ordinary corporation and its distributions
(to the extent of available earnings and profits) will be taxed to shareholders
as ordinary income (except to the extent a shareholder is exempt from tax).
The Treasury Department is authorized to issue regulations to provide that
foreign currency gains that are not directly related to a Fund's principal
business of investing in securities (or options and futures with respect to
securities) may be excluded from the income which qualifies for purposes of the
90% gross income requirement described above. To date, however, no such
regulations have been issued.
Amounts not distributed on a timely basis in accordance with a calendar
year distribution requirement are subject to a nondeductible 4% excise tax. To
prevent imposition of the excise tax, a Fund must distribute for the calendar
year an amount equal to the sum of (1) at least 98% of its ordinary taxable
income (excluding any capital gains or losses) for the calendar year, (2) at
least 98% of the excess of its capital gains over capital losses (adjusted for
certain ordinary losses) for the one-year period ending October 31 of such year,
and (3) all ordinary taxable income and capital gain net income (adjusted for
certain ordinary losses) for previous years that were not distributed during
such years. A distribution will be treated as paid on December 31 of the
calendar year if it is declared by a Fund in October, November or December of
that year to shareholders on a record date in such a month and paid by the Fund
during January of the following calendar year. Such a distribution will be
includable in the gross income of shareholders in the calendar year in which it
is declared, rather than the calendar year in which it is received. To prevent
application of the excise tax, the Funds intend to make distributions in
accordance with the calendar year distribution requirement.
A Fund's deduction for interest expense may be restricted where the Fund
invests in obligations the interest on which is exempt in whole or in part from
Federal income tax.
Distributions of investment company taxable income generally are
characterized as ordinary income. If a Fund's income consists in whole or in
part of dividends paid by U.S. corporations, a portion of the dividends paid by
a Fund may be eligible for the
- 65 -
<PAGE>
corporate dividends-received deduction. The dividends-received deduction is
reduced to the extent shares of a Fund or the underlying company paying
dividends to a Fund are treated as debt-financed under the Code and is
eliminated if shares are deemed to have been held for less than 46 days. In
addition, dividends (including the deducted portion) are includable in the
corporate shareholder's alternative minimum taxable income. A portion of the
dividends paid by the Growth Equity Fund, Indexed Equity Fund, Multi-Asset Fund,
and Value Equity Fund, may qualify for the dividends-received deduction
available to corporations. The dividends paid by the other Funds are not
expected to so qualify. The alternative minimum tax and environmental tax
applicable to corporations may reduce the value of the dividends-received
deduction.
Distributions of net capital gains, if any, designated by a Fund as
capital gain dividends, are taxable to shareholders as long-term capital gain,
regardless of the length of time the Fund's shares have been held by a
shareholder and are not eligible for the dividends-received deduction. All
distributions are includable in the gross income of a shareholder whether
reinvested in additional shares or received in cash. Shareholders will be
notified annually as to the Federal tax status of distributions.
A Fund's distributions with respect to a given taxable year may exceed its
current and accumulated earnings and profits available for distribution. In that
event, distributions in excess of such earnings and profits would be
characterized as a return of capital to shareholders for Federal income tax
purposes, thus reducing each shareholder's cost basis in his Fund shares.
Distributions in excess of a shareholder's cost basis in his shares would be
treated as a gain realized from a sale of such shares.
Distributions by a Fund reduce the net asset value of the Fund's shares.
Should a distribution reduce the net asset value below a shareholder's cost
basis, such distribution, nevertheless, would be taxable to the shareholder as
ordinary income or capital gain as described above, even though, from an
investment standpoint, it may constitute a partial return of capital. In
particular, investors should be careful to consider the tax implications of
buying shares just prior to a distribution by a Fund. The price of shares
purchased at that time includes the amount of the forthcoming distribution.
Those purchasing just prior to a distribution will receive a distribution which
will nevertheless generally be taxable to them.
Upon the taxable disposition (including a sale or redemption) of shares of
a Fund, a shareholder may realize a gain or loss depending generally upon his
basis in his shares. Such gain or loss will be treated as capital gain or loss
if the shares are
- 66 -
<PAGE>
capital assets in the shareholder's hands and will be long-term or short-term,
generally depending upon the shareholder's holding period for the shares.
However, a loss realized by a shareholder on the disposition of shares of a Fund
with respect to which capital gain dividends have been paid will, to the extent
of such capital gain dividends, be treated as long-term capital loss if such
shares have been held by the shareholder for six months or less. Further, a loss
realized on a disposition will be disallowed to the extent the shares disposed
of are replaced (whether by reinvestment of distributions or otherwise) within a
period of 61 days beginning 30 days before and ending 30 days after the shares
are disposed of. In such a case, the basis of the shares acquired will be
adjusted to reflect the disallowed loss. Shareholders receiving distributions in
the form of additional shares will have a cost basis for Federal income tax
purposes in each share received equal to the net asset value of a share of a
Fund on the reinvestment date.
Under the Code, gains or losses attributable to fluctuations in foreign
currency exchange rates which occur between the time a Fund accrues income or
other receivables or accrues expenses or other liabilities denominated in a
foreign currency and the time a Fund actually collects such receivables or pays
such liabilities generally are treated as ordinary income or ordinary loss.
Similarly, on disposition of debt securities denominated in a foreign currency
and on disposition of certain financial contracts and options, gains or losses
attributable to fluctuations in the value of foreign currency between the date
of acquisition of the security or contract and the date of disposition also are
treated as ordinary gain or loss. These gains and losses, referred to under the
Code as "section 988" gains and losses, may increase or decrease the amount of a
Fund's investment company taxable income to be distributed to its shareholders
as ordinary income. For example, fluctuations in exchange rates may increase the
amount of income that a Fund must distribute in order to qualify for treatment
as a regulated investment company and to prevent application of an excise tax on
undistributed income. Alternatively, fluctuations in exchange rates may decrease
or eliminate income available for distribution. If section 988 losses exceed
other investment company taxable income during a taxable year, a Fund generally
would not be able to make ordinary dividend distributions, or distributions made
before the losses were realized would be recharacterized as return of capital to
shareholders for Federal income tax purposes, rather than as an ordinary
dividend, reducing each shareholder's basis in his Fund shares.
Foreign investing involves the possibility of confiscatory taxation,
foreign taxation of income earned in the foreign nation (including withholding
taxes on interest and dividends) or other
- 67 -
<PAGE>
foreign taxes imposed with respect to investments in the foreign nation.
Income received by a Fund from sources within a foreign country may be
subject to withholding and other income or similar taxes imposed by that
country. If more than 50% of the value of a Fund's total assets at the close of
its taxable year consists of securities of foreign corporations, the Fund will
be eligible and may elect to "pass-through" to the Fund's shareholders the
amount of foreign income and similar taxes paid by the Fund. Pursuant to the
Funds' current investment policies and practices, only the EAFE Index Fund and
the International Equity Fund are expected to invest in foreign securities
sufficient in amount to be eligible to permit this election to be made. Pursuant
to this election, a shareholder will be required to include in gross income (in
addition to taxable dividends actually received) his pro rata share of the
foreign income and similar taxes paid by a Fund, and will be entitled either to
claim a deduction (as an itemized deduction) for his pro rata share of such
foreign taxes in computing his taxable income or to use it as a foreign tax
credit against his U.S. Federal income taxes, subject to limitations. Foreign
taxes may not be deducted by a shareholder that is an individual in computing
the alternative minimum tax. Each shareholder will be notified within 60 days
after the close of a Fund's taxable year whether the foreign taxes paid by the
Fund will "pass-through" for that year and, if so, such notification will
designate (a) the shareholder's portion of the foreign taxes paid to each such
country and (b) the portion of the dividend which represents income derived from
sources within each such country.
Generally, a credit for foreign taxes is subject to the limitation that it
may not exceed the shareholder's U.S. tax attributable to his total foreign
source taxable income. For this purpose, if a Fund makes the election described
in the preceding paragraph, the source of a Fund's income flows through to its
shareholders. With respect to the Funds, gains from the sale of securities
generally will be treated as derived from U.S. sources and section 988 gains
generally will be treated as ordinary income derived from U.S. sources. The
limitation on the foreign tax credit is applied separately to foreign source
passive income (as defined for purposes of the foreign tax credit), including
foreign source passive income received from a Fund. In addition, the foreign tax
credit may offset only 90% of the alternative minimum tax imposed on
corporations and individuals. If a Fund is not eligible to make the election
described above, the foreign income and similar taxes it pays generally will
reduce investment company taxable income and distributions by a Fund will be
treated as United States source income.
- 68 -
<PAGE>
The foregoing is only a general description of the foreign tax credit
under current law. Because application of the credit depends on the particular
circumstances of each shareholder, shareholders are advised to consult their own
tax advisers.
A Fund may invest in shares of foreign corporations which may be
classified under the Code as passive foreign investment companies ("PFICs").
Pursuant to the Funds' current investment policies and practices, the EAFE Index
Fund, Growth Equity Fund, International Equity Fund, Multi-Asset Fund and Value
Equity Fund are expected to invest in shares of foreign corporations. In
general, a foreign corporation is classified as a PFIC for a taxable year if at
least one-half of its assets constitute investment-type assets or 75% or more of
its gross income is investment-type income. If a Fund receives a so-called
"excess distribution" with respect to PFIC stock, the Fund itself may be subject
to a tax on a portion of the excess distribution, whether or not the
corresponding income is distributed by the Fund to shareholders. In general,
under the PFIC rules, an excess distribution is treated as having been realized
ratably over the period during which a Fund held the PFIC shares. A Fund itself
will be subject to tax on the portion, if any, of an excess distribution that is
so allocated to prior Fund taxable years and an interest factor will be added to
the tax, as if the tax had been payable in such prior taxable years. Certain
distributions from a PFIC as well as gain from the sale of PFIC shares are
treated as excess distributions. Excess distributions are characterized as
ordinary income even though, absent application of the PFIC rules, certain
excess distributions might have been classified as capital gain.
A Fund may be eligible to elect alternative tax treatment with respect to
PFIC shares. Under an election that currently is available in some
circumstances, a Fund generally would be required to include in its gross income
its share of the earnings of a PFIC on a current basis, regardless of whether
distributions are received from the PFIC in a given year. If this election were
made, the special rules, discussed above, relating to the taxation of excess
distributions, would not apply. In addition, another election may be available
that would involve marking to market a Fund's PFIC shares at the end of each
taxable year (and on certain other dates prescribed in the Code), with the
result that unrealized gains would be treated as though they were realized. If
this election were made, tax at the Fund level under the PFIC rules would
generally be eliminated, but the Funds could, in limited circumstances, incur
nondeductible interest charges. Each Fund's intention to qualify annually as a
regulated investment company may limit its elections with respect to PFIC
shares.
- 69 -
<PAGE>
Because the application of the PFIC rules may affect, among other things,
the character of gains, the amount of gain or loss and the timing of the
recognition of income with respect to PFIC shares, as well as subject a Fund
itself to tax on certain income from PFIC shares, the amount that must be
distributed to shareholders, and which will be taxed to shareholders as ordinary
income or long-term capital gain, may be increased or decreased substantially as
compared to a fund that did not invest in PFIC shares.
A Fund may invest in municipal bonds or obligations issued or guaranteed
by a state, the interest on which may be exempt from Federal income tax. It is
expected that shareholders will be subject to tax on dividends distributed by a
Fund that are derived from tax-exempt interest income.
Some of the debt securities that may be acquired by a Fund may be treated
as debt securities that are originally issued at a discount. Original issue
discount can generally be defined as the difference between the price at which a
security was issued and its stated redemption price at maturity. Although no
cash income is actually received by the Funds, original issue discount on a
taxable debt security earned in a given year generally is treated for Federal
income tax purposes as interest and, therefore, such income would be subject to
the distribution requirements of the Code.
Some of the debt securities may be purchased by a Fund at a discount which
exceeds the original issue discount on such debt securities, if any. This
additional discount represents market discount for Federal income tax purposes.
The gain realized on the disposition of any debt security acquired after April
30, 1993 or any taxable debt security acquired prior to May 1, 1993 having
market discount will be treated as ordinary income to the extent it does not
exceed the accrued market discount on such debt security. Generally, market
discount accrues on a daily basis for each day the debt security is held by a
Fund at a constant rate over the time remaining to the debt security's maturity
or, at the election of a Fund, at a constant yield to maturity which takes into
account the semi-annual compounding of interest.
If a Fund holds zero coupons bonds in its portfolio it will recognize
income currently for Federal tax purposes in the amount of the unpaid, accrued
interest (determined under tax rules) and generally will be required to
distribute dividends representing such income to shareholders currently, even
through funds representing such income have not been received by the Fund.
Certain of the options, futures contracts, and forward contracts in which
the Funds may invest may be "section 1256
- 70 -
<PAGE>
contracts." With certain exceptions, gains or losses on section 1256 contracts
generally are considered 60% long-term and 40% short-term capital gains or
losses ("60/40"). Also, section 1256 contracts held by a Fund at the end of each
taxable year are "marked-to-market" with the result that unrealized gains or
losses are treated as though they were realized and the resulting gain or loss
generally is treated as 60/40 gain or loss. These contracts also may be
marked-to-market at other times during the year under rules prescribed pursuant
to the Code.
The transactions undertaken by the Funds involving options, futures and
forward contracts may result in "straddles" for Federal income tax purposes. The
straddle rules may affect the character of gains (or losses) realized by a Fund.
In addition, losses realized by a Fund on positions that are part of a straddle
may be deferred under the straddle rules, rather than being taken into account
in calculating the taxable income for the taxable year in which such losses are
realized. Because only a few regulations implementing the straddle rules have
been promulgated, the tax consequences to the Funds of transactions involving
options, futures and forward contracts are not entirely clear. These
transactions may increase the amount of short-term capital gain realized by a
Fund which is taxed as ordinary income when distributed to shareholders.
The Funds may make one or more of the elections available under the Code
which are applicable to straddles. If a Fund makes any of the elections, the
amount, character and timing of the recognition of gains or losses from the
affected straddle positions will be determined under rules that vary according
to the election(s) made. The rules applicable under certain of the elections may
operate to accelerate the recognition of gains or losses from the affected
straddle positions.
Because application of the straddle rules may affect the character of
gains or losses, defer losses and/or accelerate the recognition of gains or
losses from the affected straddle positions, the amount which must be
distributed to shareholders, and which will be taxed to shareholders as ordinary
income or long-term capital gain, may be increased or decreased substantially as
compared to a Fund that did not engage in such transactions.
Rules governing the tax aspects of swap agreements are in a developing
stage and are not entirely clear in certain respects. Accordingly, while the
Funds eligible to enter into swap agreements intend to account for such
transactions in a manner deemed to be appropriate, the Internal Revenue Service
("IRS") might not accept such treatment. If it did not, the status of a Fund as
a regulated investment company might be affected. It is possible that
developments in the swap market and the laws relating to swaps,
- 71 -
<PAGE>
including potential government regulation, could have tax consequences. The
Funds intend to monitor developments in this area.
Certain requirements that must be met under the Code in order for a Fund
to qualify as a regulated investment company may limit the extent to which a
Fund will be able to engage in transactions in options, futures, forward
contracts, and swaps.
If a Fund sells short "against the box," it may realize a capital gain or
loss upon the closing of the sale. Such gain or loss generally will be long- or
short-term depending upon the length of time the Fund held the security which it
sold short. In some circumstances, short sales may have the effect of reducing
an otherwise applicable holding period of a security in the portfolio. Were that
to occur, the affected security would again have to be held for the requisite
period before its disposition to avoid treating that security as having been
sold within the first three months of its holding period.
Each Fund is required to report to the IRS all distributions except in the
case of certain exempt shareholders. All such distribution and redemption
proceeds generally are subject to withholding of Federal income tax at a rate of
31% ("backup withholding") in the case of non-exempt shareholders if (1) the
shareholder fails to furnish the Fund with and to certify the shareholder's
correct taxpayer identification number, (2) the IRS notifies the Fund or
shareholder that the shareholder has failed to report properly certain interest
and dividend income to the IRS and to respond to notices to that effect, or (3)
when required to do so, the shareholder fails to certify that he is not subject
to backup withholding. If the withholding provisions are applicable, any such
distributions, whether reinvested in additional shares or taken in cash, will be
reduced by the amounts required to be withheld. Backup withholding is not an
additional tax and any amounts withheld may be credited against the
shareholder's U.S. Federal income tax liability. Investors may wish to consult
their tax advisers about the applicability of the backup withholding provisions.
The foregoing discussion relates only to Federal income tax law as
applicable to U.S. persons (i.e., U.S. citizens and residents and U.S. domestic
corporations, partnerships, trusts and estates). Distributions by the Funds also
may be subject to state and local taxes and their treatment under state and
local income tax laws may differ from the Federal income tax treatment.
Shareholders should consult their tax advisers with respect to particular
questions of Federal, state and local taxation. Shareholders who are not U.S.
persons should consult their tax advisers regarding U.S. and foreign tax
consequences of ownership
- 72 -
<PAGE>
of shares of the Funds including the likelihood that distributions to them would
be subject to withholding of U.S. tax at a rate of 30% (or at a lower rate under
a tax treaty).
PERFORMANCE INFORMATION
The Company may, from time to time, include the yield and effective yield
of its Money Market Fund, the yield of the other Funds or Classes, and the total
return of all Funds or Classes in advertisements, sales literature, or reports
to shareholders or prospective investors. Due to the deduction of the
shareholder service fee, performance of the Institutional Service Class of each
Fund will be lower than the performance of the Institutional Class of the Fund.
Each of the Funds began offering Institutional Service Class shares on
January 1, 1995. Thus, the performance figures for Institutional Service Class
shares prior to that date have been calculated based on the historical
performance of the Funds' Institutional Class shares from inception through
December 31, 1994.
Current yield for the Money Market Fund will be based on the change in the
value of a hypothetical investment (exclusive of capital charges) over a
particular seven-day period, less a pro rata share of Fund expenses accrued over
--- ----
that period (the "base period"), and stated as a percentage of the investment at
the start of the base period (the "base period return"). The base period return
is then annualized by multiplying by 366/7, with the resulting yield figure
carried to at least the nearest hundredth of one percent. "Effective yield" for
the Money Market Fund assumes that all dividends received during an annual
period have been reinvested. Calculation of "effective yield" begins with the
same "base period return" used in the calculation of yield, which is then
annualized to reflect weekly compounding pursuant to the following formula:
Effective Yield = [(Base Period Return + 1)366/7] - 1
The current and effective seven-day average yields as of June 30, 1997 for
the Money Market Fund were 5.33% and 5.47%, respectively, for the Institutional
Class, and were 5.08% and 5.21%, respectively, for the Institutional Service
Class. Had certain expenses not been assumed by New York Life, the Fund's
administrator at that time, these yields would have been 5.26% and 5.40%,
respectively, for the Institutional Class, and 5.01% and 5.14%, respectively,
for the Institutional Service Class.
Quotations of yield for the other Funds will be based on all investment
income per share earned during a particular 30-day
- 73 -
<PAGE>
period (including dividends and interest), less expenses accrued during the
period ("net investment income"), and are computed by dividing net investment
income by the maximum offering price per share on the last day of the period,
according to the following formula:
2[(a - b + 1)to the 6th power - 1]
-----
cd
where a = dividends and interest earned during the
period,
b = expenses accrued for the period (net of
reimbursements),
c = the average daily number of shares outstanding during
the period that were entitled to receive dividends, and
d = the maximum offering price per share on the
last day of the period.
For the 30-day period ended June 30, 1997, the yield for the Short-Term
Bond Fund was 6.11% for the Institutional Class, and was 5.87% for the
Institutional Service Class.
Quotations of average annual total return for a Fund will be expressed in
terms of the average annual compounded rate of return of a hypothetical
investment in the Fund or Class over certain periods that will include a period
of one year (or, if less, up to the life of the Fund), calculated pursuant to
the following formula: P(1 + T)n = ERV (where P = a hypothetical initial payment
of $1,000, T = the total return for the period, n = the number of periods, and
ERV = the ending redeemable value of a hypothetical $1,000 payment made at the
beginning of the period). Quotations of total return may also be shown for other
periods. All total return figures reflect the deduction of a proportional share
of Fund or Class expenses on an annual basis, and assume that all dividends and
distributions are reinvested when paid. Quotations of total return may also be
shown for other periods.
The average annual total return of the following Funds for the one-year
and five-year periods ended June 30, 1997 and the period from inception to June
30, 1997 were as follows:
Five Years Average Annual
Year Ended Ended Total Return
Fund 6/30/97 6/30/97 Since Inception
---- ------- ------- ---------------
EAFE Index Fund
Institutional Class (1)........ 12.51% 11.70% 8.65%
Institutional Service Class(2). 12.29% 11.56% 8.55%
Growth Equity Fund
Institutional Class (1)........ 24.07% 20.43% 21.73%
Institutional Service Class(2). 23.77% 20.26% 21.60%
- 74 -
<PAGE>
Indexed Equity Fund
Institutional Class (1)....... 34.32% 19.25% 19.03%
Institutional Service Class(2). 33.96% 19.12% 18.93%
International Equity Fund
Institutional Class (3)........ 15.74% N/A 11.73%*
Institutional Service Class(3) 15.49% N/A 11.56%*
Multi-Asset Fund
Institutional Class (1)........ 25.41% 14.48% 13.99%
Institutional Service Class(2). 25.15% 14.37% 13.91%
Value Equity Fund
Institutional Class (1)........ 26.27% 18.18% 20.57%
Institutional Service Class(2). 25.91% 18.07% 20.48%
Bond Fund
Institutional Class (1)........ 7.69% 6.61% 7.54%
Institutional Service Class(2). 7.40% 6.47% 7.43%
Indexed Bond Fund
Institutional Class (1)........ 7.33% 6.59% 7.68%
Institutional Service Class(3). 7.11% 6.51% 7.62%
International Bond Fund
Institutional Class (3)........ 9.64% 10.53%* 10.11%*
Institutional Service Class(3). 9.39% 10.41%* 10.03%*
Short-Term Bond Fund
Institutional Class (1)........ 6.25% 5.27% 6.23%
Institutional Service Class(2). 6.01% 5.14% 6.13%
(1) The inception date of these Institutional Class shares is 1/2/91.
(2) Performance figures for the Institutional Service Class, first offered to
the public on 1/1/95, include the historical performance of the
Institutional Class from the Funds' inception (1/2/91) up to 12/31/94.
(3) The inception date of the International Equity Fund and International Bond
Fund shares is 1/1/95.
* Performance figures include the historical performance of the Separate
Accounts for the period prior to commencement of operations of the
International Bond Fund and the International Equity Fund on January 1,
1995. MacKay-Shields Financial Corporation, the current sub-adviser to
both the International Bond Fund and the International Equity Fund, served
as investment adviser to both corresponding Separate Accounts, and the
objectives, policies, restrictions, guidelines and management styles of
the Separate Accounts were materially equivalent to those of their
corresponding Funds. Performance figures for the period prior to January
1, 1995, have been calculated by measuring the change in value of a unit
in the Separate Account from the time period indicated to January 1, 1995
using the expense structure of each Separate Account, which generally was
higher than the expense structure of its corresponding Fund. Neither
Separate Account was registered under the Investment Company Act of 1940
("1940 Act") and therefore was not subject to certain investment
restrictions imposed under the 1940 Act. If the Separate Accounts had been
registered under the 1940 Act, their
- 75 -
<PAGE>
performance may have been adversely affected. The International Equity
Fund's predecessor Separate Account commenced operations on July 31, 1992;
the International Bond Fund's predecesor Separate Account commenced
operations on January 31, 1990.
In addition, advertising for a Fund may indicate that investors may
consider diversifying their investment portfolios in order to seek protection of
the value of their assets against inflation. From time to time, advertising
materials for a Fund may refer to or discuss current or past business,
political, economic or financial conditions, including events as they relate to
those conditions, such as any U.S. monetary or fiscal policies and the current
rate of inflation. In addition, from time to time, advertising materials for a
Fund may include information concerning retirement and investing for retirement
and may refer to the approximate number of then-current Fund shareholders,
shareholder accounts and Fund assets.
From time to time, advertising and sales literature for a Fund may discuss
the investment philosophy, personnel and assets under management of the Fund's
Sub-Adviser, and other pertinent facts relating to the management of the Fund by
the Sub-Adviser.
From time to time any of the Funds may publish an indication of its past
performance as measured by independent sources such as Lipper Analytical
Services, Incorporated, Weisenberger Investment Companies Service, Donoghue's
Money Fund Report, Spot Market Prices, Barron's, BusinessWeek, Kiplinger's
-------- ------------ -----------
Personal Finance, Financial World, Forbes, Money, Morningstar, Personal
- ---------------- --------------- ------ ----- ----------- --------
Investor, Sylvia Porter's Personal Finance, and The Wall Street Journal.
- -------- -------------------------------- -----------------------
In addition, performance information for a Fund may be compared, in
advertisements, sales literature, and reports to shareholders, to: (i) unmanaged
indexes, such as the Standard & Poor's 500 Composite Stock Price Index, the
Salomon Brothers Broad Investment Grade Bond Index, the Morgan Stanley Capital
International indexes; the Dow Jones Industrial Average, Donoghue Money Market
Institutional Averages, the Merrill Lynch 1 to 3 Year Treasury Index, the
Salomon Brothers World Government Benchmark Bond Index, the Salomon Brothers
non-U.S. Dollar World Government Bond Index, the Lehman Brothers Municipal Bond
Index and the Lehman Brothers Government Corporate Index; (ii) other groups of
mutual funds tracked by Morningstar Inc. or Lipper Analytical Services, widely
used independent research firms which rank mutual funds by overall performance,
investment objectives and assets, or tracked by other services, companies,
publications or persons who rank mutual funds on overall performance or other
criteria; and (iii) the Consumer Price Index (measure for inflation) and other
measures of the performance of the economy to assess the real rate of return
- 76 -
<PAGE>
from an investment in the Funds. Unmanaged indexes may assume the reinvestment
of dividends but generally do not reflect deductions for administrative and
management costs and expenses.
From time to time, advertisements for the Funds may include general
information about the services and products offered by the Funds, The MainStay
Funds and New York Life Insurance Company and its subsidiaries. For example,
such advertisements may include statistical information about those entities
including, but not limited to, the number of current shareholder accounts, the
amount of assets under management, sales information, the distribution channels
through which the entities' products are available, marketing efforts and
statements about this information by the entities' officers, directors and
employees.
OTHER INFORMATION
CAPITALIZATION
The Funds are separate portfolios of the Company, an open-end management
investment company, incorporated under the laws of Maryland on September 21,
1990. The Company was formerly known as New York Life Institutional Funds Inc.
On January 3, 1995 the name of the Company was changed to its present form. 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 Company's shareholders. When issued, shares are fully paid, non-assessable,
redeemable, and freely transferable.
EFFECTIVE MATURITY
Certain Funds may use an effective maturity for determining the maturity
of their portfolio. Effective maturity means the average expected repayment date
of the portfolio taking into account prospective calls, puts and mortgage
prepayments, in addition to the maturity dates of the securities in the
portfolio.
BENEFICIAL OWNERSHIP OF THE FUNDS
The following table sets forth the information concerning beneficial
ownership, as of October 31, 1997, of the Funds' shares by each person who
beneficially owned more than 5% of the voting securities of any Fund:
- 77 -
<PAGE>
<TABLE>
<CAPTION>
Percentage of
Outstanding
NAME AND ADDRESS OF SHAREHOLDER Fund Shares Owned/1/ Shares/2/
<S> <C> <C> <C>
TRUSTEES OF THE NEW YORK LIFE INSURANCE BOND 5,731,200 32.0%
COMPANY RETIREMENT PLAN AND PENSION GROWTH EQUITY 4,825,445 18.6%
PLAN (COMPANY PLAN) INDEXED BOND 3,714,205 33.2%
51 MADISON AVENUE INDEXED EQUITY 6,253,056 18.2%
NEW YORK, NY 10010 INTERNATIONAL BOND 3,140,707 73.3%
INTERNATIONAL EQUITY 1,275,171 12.4%
VALUE EQUITY 17,100,865 31.9%
TRUSTEES OF THE NEW YORK LIFE INSURANCE BOND 1,939,637 10.8%
COMPANY RETIREMENT PLAN (AGENTS) GROWTH EQUITY 3,293,924 12.7%
51 MADISON AVENUE INDEXED BOND 1,407,656 12.6%
NEW YORK, NY 10010 INDEXED EQUITY 6,090,693 17.7%
INTERNATIONAL BOND 894,825 20.9%
INTERNATIONAL EQUITY 2,337,654 22.7%
VALUE EQUITY 10,707,828 20.0%
NEW YORK LIFE INSURANCE COMPANY EAFE INDEX 892,964 23.5%
51 MADISON AVENUE INDEXED EQUITY 3,828,817 11.1%
NEW YORK, NY 10010 MULTI-ASSET 7,604,406 29.9%
THE PENSION BOARD OF THE UNITED FOO BOND 1,877,135 10.5%
AND COMMERCIAL WORKERS INTERNATIONAL
UNION RETIREMENT PLAN FOR EMPLOYEES
1775 K STREET, N.W.
WASHINGTON, D.C. 20006
TRUSTEES OF THE LONE STAR HOURLY MONEY MARKET 15,893,419 6.5%
RETIREMENT PLAN, DAY & ZIMMERMAN, INC. SHORT-TERM BOND 289,533 5.7%
1818 MARKET STREET
PHILADELPHIA, PA 19103
SCAPA GROUP INC. SALARIED EAFE INDEX 195,372 5.1%
EMPLOYEES TRUST
5400 GLENWOOD AVE., SUITE 115
RALEIGH, NC 27612
TRUSTEES OF THE NEW YORK LIFE INSURANCE GROWTH EQUITY 5,644,686 21.8%
COMPANY EMPLOYEE PROGRESS SHARING INDEXED EQUITY 2,273,692 6.6%
INVESTMENT PLAN TRUST MULTI-ASSET 1,898,770 7.5%
51 MADISON AVENUE SHORT-TERM BOND 386,986 7.7%
NEW YORK, NY 10010
TRUSTEES OF THE NEW YORK LIFE INSURANCE GROWTH EQUITY 2,927,236 11.3%
COMPANY AGENTS PROGRESS SHARING
INVESTMENT PLAN TRUST
51 MADISON AVENUE
NEW YORK, NY 10010
NEW YORK LIFE INSURANCE COMPANY EAFE INDEX 485,908 12.8%
EMPLOYEES' HEALTH AND LIFE BENEFIT
TRUST - (HEALTH BENEFITS)
51 MADISON AVENUE
NEW YORK, NEW YORK 10010
</TABLE>
- 78 -
<PAGE>
<TABLE>
<CAPTION>
Percentage of
Outstanding
NAME AND ADDRESS OF SHAREHOLDER Fund Shares Owned/1/ Shares/2/
<S> <C> <C> <C>
NEW YORK LIFE INS. CO EMPLOYEES' HEEAFE INDEX 198,366 5.2%
AND LIFE BENEFIT TRUST
(LIFE BENEFITS)
51 MADISON AVENUE
NEW YORK, NY 10010
NEW YORK LIFE INS. CO. AGENTS' HEALEAFE INDEX 419,009 11.0%
AND LIFE BENEFIT TRUST -
(HEALTH BENEFITS)
51 MADISON AVENUE
NEW YORK, NY 10010
FRANK G. AND FRIEDA K. BROTZ INDEXED BOND 867,484 7.7%
FAMILY FOUNDATION INC.
3518 LAKESHORE ROAD
SHEBOYGAN, WI 53083
PLASTICS ENGINEERING COMPANY EAFE INDEX 544,648 14.3%
P.O. BOX 758
SHEBOYGAN, WI 53082-0758
MERRILL LYNCH TRUST COMPANY INDEXED EQUITY 2,511,194 7.3%
TTBE FBO CHRYSLER 401(K) PLAN
265 DAVIDSON AVENUE
SOMERSET, NJ 08873
NEW YORK LIFE TRUST COMPANY BOND 1,626,153 9.1%
51 MADISON AVENUE, ROOM 117A EAFE INDEX 313,269 8.3%
NEW YORK, NY 10010 GROWTH EQUITY 4,053,353 15.6%
INDEXED BOND 2,438,397 21.8%
INDEXED EQUITY 5,828,158 16.9%
MONEY MARKET 108,659,517 44.5%
MULTI-ASSET 4,868,953 19.2%
SHORT-TERM BOND 675,825 13.4%
VALUE EQUITY 10,059,704 18.8%
TRUSTEES OF THE HARVEST STATES INTERNATIONAL EQUITY 747,555 7.3%
COOPERATIVE COMBINED RETIREMENT FUND
P.O. BOX 64594
ST. PAUL, MN 55164
METHODIST HOME ENDOWMENT FUND INTERNATIONAL EQUITY 685,751 6.7%
1111 HERRING AVENUE
WACO, TX 76708
MACKAY-SHIELDS FINANCIAL CORPORATIO SHORT-TERM BOND 1,028,983 20.3%
9 WEST 57TH STREET
NEW YORK, NY 10019
BHC SECURITIES INC. CORP. MONEY MARKET 58,152,704 23.8%
2005 MARKET STREET
1 COMMERCE SQUARE
PHILADELPHIA, PA 19103-7042
- ----------------------------
</TABLE>
(1) This information, not being within the knowledge of the Company, has
been furnished by each of the above persons. Beneficial ownership is as defined
under Section 13(d) of the
- 79 -
<PAGE>
Securities Exchange Act of 1934. Fractional shares have been
omitted.
(2) Only the ownership of at least one-tenth of one percent is listed.
As of October 31, 1997, the Directors and officers of the Company as a
group owned less than 1% of the shares of any Fund.
CODE OF ETHICS
The Company has adopted a Code of Ethics governing personal trading
activities of all Directors, officers of the Company and persons who, in
connection with their regular functions, play a role in the recommendation of
any purchase or sale of a security by the Company or obtain information
pertaining to such purchase or sale or who have the power to influence the
management or policies of the Company or the Manager or a Sub-Adviser unless
such power is the result of their position with the Company or Manager or Sub-
Adviser. Such persons are generally required to preclear all security
transactions with the Company's Compliance Officer or his designee and to report
all transactions on a regular basis. The Company has developed procedures for
administration of the Code of Ethics.
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP, 1177 Avenue of the Americas, New York, New York
10036, has been selected as independent accountants of the Company.
LEGAL COUNSEL
Dechert Price & Rhoads, 1500 K Street, N.W., Washington, D.C. 20005,
passes upon certain legal matters in connection with the shares offered by the
Company, and also acts as counsel to the Company.
FINANCIAL STATEMENTS
The Company's financial statements for the Funds, including the Statements
of Assets and Liabilities, the Portfolios of Investments and the Statements of
Operations for the year ended December 31, 1996, and the Statements of Changes
in Net Assets for the years ended December 31, 1996 and December 31, 1995, the
notes to the Financial Statements, and the Report of the Independent
Accountants, all of which are included in the 1996 Annual Report to
Shareholders, are hereby incorporated by reference into this Statement of
Additional Information. In addition, unaudited financial statement of each of
the Funds including the Portfolio of Investments as of June 30, 1997, the
Statement of Assets and
- 80 -
<PAGE>
Liabilities as of June 30, 1997, the Statement of Operations for the six months
ended June 30, 1997, the Statement of Changes in Net Assets for the six months
ended June 30, 1997 and the Notes to the Financial Statements are hereby
incorporated by reference into the Statement of Additional Information.
REGISTRATION STATEMENT
This Statement of Additional Information and the Prospectus do not contain
all the information included in the Company's registration statement filed with
the SEC under the Securities Act of 1933 with respect to the securities offered
hereby, certain portions of which have been omitted pursuant to the rules and
regulations of the SEC. The registration statement, including the exhibits filed
therewith, may be examined at the offices of the SEC in Washington, D.C.
Statements contained herein and in the Prospectus as to the contents of
any contract or other documents referred to are not necessarily complete, and,
in each instance, reference is made to the copy of such contract or other
documents filed as an exhibit to the registration statement, each such statement
being qualified in all respects by such reference.
- 81 -
