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MAINSTAY INSTITUTIONAL FUNDS INC.
51 MADISON AVENUE
NEW YORK, NEW YORK 10010
STATEMENT OF ADDITIONAL INFORMATION
DATE: MAY 1, 1996 as Supplemented
March 12, 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 Prospectus dated May 1, 1996, 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 the Prospectus.
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 Prospectus, 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 Prospectus 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.
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TABLE OF CONTENTS
INVESTMENT OBJECTIVES AND POLICIES.......................... 1
Arbitrage 1
Borrowing 1
Repurchase Agreements.................................. 2
Lending of Portfolio Securities........................ 2
Municipal Bonds........................................ 3
Banking Industry and Savings and Loan Industry
Obligations.......................................... 3
Floating and Variable Rate Securities.................. 4
Foreign Securities..................................... 5
When-Issued and Firm or Standby Commitment Agreements.. 5
Mortgage-Related and Other Asset-Backed Securities..... 6
Brady Bonds............................................ 13
Loan Participation Interests........................... 14
Options on Securities.................................. 16
Options on Foreign Currencies.......................... 20
Futures Transactions................................... 21
Swap Agreements........................................ 31
Forward Foreign Currency Contracts..................... 33
Foreign Index-Linked Instruments....................... 36
Warrants 37
Short Sales Against the Box............................ 37
High Yield/High Risk Securities........................ 38
INVESTMENT RESTRICTIONS..................................... 38
MANAGEMENT OF THE COMPANY................................... 42
Directors and Officers................................. 42
Compensation Table..................................... 45
Investment Advisers.................................... 45
The Administrator...................................... 47
Distributor............................................ 49
Service Fees........................................... 50
PURCHASES AND REDEMPTIONS................................... 51
PORTFOLIO TRANSACTIONS AND BROKERAGE........................ 51
NET ASSET VALUE............................................. 55
TAX INFORMATION............................................. 57
PERFORMANCE INFORMATION..................................... 67
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OTHER INFORMATION........................................... 71
Capitalization......................................... 71
Effective Maturity..................................... 71
Beneficial Ownership of the Funds...................... 71
Code of Ethics......................................... 74
Independent Accountants................................ 74
Legal Counsel.......................................... 74
Financial Statements................................... 74
Registration Statement................................. 75
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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 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
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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.
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
"Obligation") and the seller agrees, at the time of sale, to repurchase the
Obligation at a specified time and price. A repurchase agreement 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 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.
LENDING OF PORTFOLIO SECURITIES
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, letters of credit, cash equivalents or U.S. Government
securities maintained
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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. 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 an Adviser to be creditworthy and approved by the
Board, and when, in the judgment of an Adviser, the consideration which can be
earned currently from securities loans of this type justifies the attendant
risk. If an Adviser determines to make securities loans, it is intended that the
value of the securities loaned would not exceed one-third of the value of the
total assets of the lending Fund.
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
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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.
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 deemed to be illiquid securities for purposes of a
Fund's limitation on investments in such securities.
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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.
Investments in foreign securities may involve considerations different from
investments in domestic securities due to limited publicly available
information, non-uniform accounting standards, lower trading volume and lower
liquidity, the possible imposition of withholding, confiscatory and other taxes,
the possible adoption of foreign governmental restrictions affecting the payment
of principal and interest, changes in currency exchange rates and currency
exchange control regulations, expropriation, or other adverse political or
economic developments. In addition, it may be more difficult to obtain and
enforce a judgment against a foreign issuer or a foreign branch of a domestic
bank. Further, to the extent investments in foreign securities are denominated
in currencies of foreign countries, a Fund may be affected favorably or
unfavorably by changes in currency exchange rates and in exchange control
regulations and may incur costs in connection with conversion between
currencies. See "Tell Me The Details -- Foreign Securities" in the Prospectus
for additional information.
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 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
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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
Mortgage Pass-Through Securities. Interests in pools of mortgage-related
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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.
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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 savings and loan institutions, 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
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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
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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.
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,
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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. 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
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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 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
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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
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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.
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FHLMC Collateralized Mortgage Obligations. FHLMC CMOs are debt obligations
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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
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' investment 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 investment adviser will, consistent with the
Fund's investment objectives, policies and quality standards, consider making
investments in such new types of mortgage-related securities.
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CMO Residuals. CMO residuals are derivative mortgage securities issued by
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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 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.
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
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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 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 an Adviser to forecast interest rates and other economic
factors correctly. If an 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
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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 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
Receivables\\sm\\ ("CARS\\sm\\"). CARS\\sm\\ 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 CARS\\sm\\ 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 CARS\\sm\\ 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.
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<PAGE>
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
investment adviser also may invest in other types of asset-backed 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 under a debt restructuring plan introduced by former U.S.
Secretary of the Treasury, Nicholas F. Brady (the "Brady Plan"). Brady Bonds are
not considered U.S. Government securities. Brady Plan debt restructurings have
been implemented in a number of countries, including Argentina, Bolivia,
Bulgaria, Costa Rica, the Dominican Republic, Ecuador, Jordan, Mexico, Niger,
Nigeria, the Philippines, Poland, Uruguay, and Venezuela (collectively, the
"Brady countries"). In addition, Brazil has concluded a Brady-like plan. It is
expected that other countries will undertake a Brady Plan in the future,
including Panama and Peru.
Brady Bonds have been issued only recently, and accordingly do not have a
long payment history. Brady Bonds may be collateralized or uncollateralized,
are issued in various currencies (primarily the U.S. dollar) and are actively
traded in the over-the-counter secondary market. 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").
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<PAGE>
Most Mexican Brady Bonds issued to date have principal repayments at final
maturity fully collateralized by U.S. Treasury zero coupon bonds (or comparable
collateral denominated in other currencies) and interest coupon payments
collateralized on an 18-month rolling-forward basis by funds held in escrow by
an agent for the bondholders. A significant portion of the Venezuelan Brady
Bonds and the Argentine Brady Bonds issued to date have principal repayments at
final maturity collateralized by U.S. Treasury zero coupon bonds (or comparable
collateral denominated in other currencies) and/or interest coupon payments
collateralized on a 14-month (for Venezuela) or 12-month (for Argentina)
rolling-forward basis by securities held by the Federal Reserve Bank of New York
as collateral agent.
In light of the residual risk of Brady Bonds and, among other factors, 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
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.
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<PAGE>
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 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
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<PAGE>
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 loan 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 loan
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 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 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
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<PAGE>
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 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.
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<PAGE>
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 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 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 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 Code for qualification as a
regulated investment company and the Company's intention that each Fund qualify
as such.
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<PAGE>
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 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. Each Fund has undertaken
to a state securities commission that it will not purchase a put, call, straddle
or spread if, as a result, the amount of premiums paid for such positions would
exceed 5% of the value of the Fund's net assets.
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<PAGE>
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. 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.
A Fund, as specified for the Fund in the Prospectus, 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
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<PAGE>
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.
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. Each of such Funds 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
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<PAGE>
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.
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 cash or U.S. Government securities ("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
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<PAGE>
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 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
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<PAGE>
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 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
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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 an Adviser anticipates that 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 an 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
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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 an
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.
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
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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 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.
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<PAGE>
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 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 of 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
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<PAGE>
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 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. A purchase or sale of a futures contract may result in losses in
excess of the amount invested in the futures contract. There can be no
guarantee that
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<PAGE>
there will be a correlation between price movements in the hedging vehicle and
in the Fund's securities being hedged. 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 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.
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
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<PAGE>
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 EAFE Index Fund may enter into index and currency exchange rate swap
agreements, the Indexed Bond Fund may enter into 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 which
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
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<PAGE>
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.
Whether a Fund's use of swap agreements will be successful in furthering
its investment objective will depend on the 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 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.
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<PAGE>
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 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
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<PAGE>
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 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 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 an 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
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<PAGE>
(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).
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 an 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
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in an amount equal to the value of the Fund's total assets committed to the
consummation of the subject hedge. The assets in the Segregated Account will
consist of cash (denominated in U.S. dollars or foreign currency), U.S.
government securities, liquid domestic or foreign debt rated in one of the top
three categories by a U.S. nationally recognized rating organization, or any
other asset which may be deemed by the Securities and Exchange Commission's
Division of Investment Management to be permissible for such purpose. 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 Fund will mark-to-market the value of the assets in
the Segregated Account. If the value of the securities placed in the separate
account declines, additional cash or securities 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.
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.
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
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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
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.
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. Short sales "against the box" will be limited to no more
than 5% of a Fund's net assets.
- 37 -
<PAGE>
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. 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.
HIGH YIELD/HIGH RISK SECURITIES
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. 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.
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
- 38 -
<PAGE>
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, including real estate limited partnership
interests (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, commodities contracts, or oil, gas or
mineral programs or interests in oil, gas or mineral leases (other than
securities of companies that invest in or sponsor those programs), except that,
subject to restrictions described in the Prospectus and elsewhere in this
Statement of Additional Information (i) a Fund may enter into futures contracts
and options on futures contracts; (ii) a Fund may enter into forward foreign
currency contracts and foreign currency options; and (iii) the International
Bond Fund and International Equity Fund may purchase or sell currencies on a
spot or forward basis and may enter into futures contracts on securities,
currencies or on indexes of such securities or currencies, or any other
financial instruments, and may purchase and sell options on such futures
contracts; or
(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 stockholder 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
- 39 -
<PAGE>
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) purchase or retain securities of any issuer if, to the knowledge of
the Fund, any of the Directors or Officers of the Company, or any of the
directors or officers of any of the Funds' investment advisers, individually own
more than 1/2 of 1% of the outstanding securities of the issuer and together own
beneficially more than 5% of such issuer's securities;
(2) invest more than 5% of the value of its total assets in securities of
issuers (other than issuers of Federal agency obligations) having a record,
together with predecessors or unconditional guarantors, of less than three
years;
(3) (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;
(4) 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);
(5) purchase securities of an investment company, except (i) in connection
with a merger, consolidation, reorganization or acquisition of assets, or (ii)
to the extent permitted by the 1940 Act and then only securities of money market
funds (where the Fund's investment adviser undertakes to forego the fees they
would otherwise receive on the assets so invested and where there is no
- 40 -
<PAGE>
commission or profit to a sponsor or dealer other than the customary broker's
commission that may result from such purchase) or securities of closed-end
investment company (where there is no commission or profit to a sponsor or
dealer other than the customary broker's commission that may result from such
purchase) as permitted under applicable state securities law; provided,
however, that foreign banks or their agencies or subsidiaries and foreign
insurance companies are not considered investment companies for the purposes of
this limitation as permitted by the 1940 Act;
(6) invest in other companies for the purpose of exercising control;
(7) the International Bond Fund and International Equity 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;
(8) the International Bond Fund and International Equity 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;
(9) the International Bond Fund and International Equity Fund may not
purchase warrants, valued at the lower of cost or market, in excess of 5% of the
Fund's net assets. Included within that amount, but not to exceed 2% of net
assets, are warrants whose underlying securities are not traded on principal
domestic or foreign exchanges. Warrants acquired by a Fund in units or attached
to securities are not subject to these restrictions; or
(10) the International Bond Fund and International Equity Fund may not
acquire or retain the securities of any other investment company if, as a
result, more than 3% of such investment company's outstanding shares would be
held by the Fund, more than 5% of the value of the Fund's total assets would be
invested in shares of such investment company or more than 10% of the value of
the Fund's assets would be invested in shares of investment companies in the
aggregate, except in connection with a merger, consolidation, acquisition, or
reorganization.
A Fund may make commitments more restrictive than the restrictions listed
above so as to permit the sale of shares in certain states. Should a Fund
determine that any commitment is no longer in the best interests of the Fund's
shareholders, the Fund
- 41 -
<PAGE>
will revoke the commitment by terminating the sale of shares in the relevant
state.
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>
Alice T. Kane, 48 Director and Chairperson of the Executive Vice President, New York Life Insurance
Board of Directors* Company, 1992 to present; General Counsel, New
York Life Insurance Company, 1992 to 1995; Senior
Vice President and General Counsel, New York Life
Insurance Company, 1986 to 1992; Corporate
Secretary, New York Life Insurance Company,
1989-1994; Vice President and General Counsel, New
York Life Insurance Company, 1985 to 1986; Trustee
and Chairperson, The MainStay Funds, 1994 to
present; Director, New York Life Foundation, 1992
to 1995; Director, New York Life International
Investment Inc., 1988 to present; Director, NYLIFE
Inc., 1990 to present; Vice President, NYLIFE
Inc., 1989 to present; and Secretary, NYLIFE Inc.,
1989 to 1994; Director, MacKay-Shields Financial
Corporation, 1994 to present; Director, NYL
Benefit Services Company, Inc., (pension
consultant and third party administrator), 1994 to
present; Director, NYLIFE Securities Inc., 1994 to
present; Director, Eagle Strategies Corp.
(broker-dealer and registered investment adviser),
1994 to present; Director, NYLIFE Distributors
Inc., 1994 to present; Director, Greystone Realty
Corporation, 1994 to present; Director, Monitor
Capital Advisors, Inc., 1994 to present; Director,
Quorum Capital Management Limited, 1995 to
present; Director, Sanus Corp. Health Systems;
1984 to November 1995; Director, NYLCare Health
Plans, Inc. (formerly Sanus Corp. Health Systems);
November 1995 to present; Director, NYL Trust
Company, (a limited purpose trust company), 1995
to present; Member, Board of Governors of the
National Association of Securities Dealers, Inc.,
1994 to present; Member, American Council of Life
Insurance Deputies Solvency Oversight Committee,
1991 to 1995; Board of Governors, Association of
Life Insurance Counsel, 1992 to present.
</TABLE>
- 42 -
<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, 42 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 present; Director,
Monitor Capital Advisors, Inc., 1991 to present;
Director, NYL Trust Company, 1995 to present;
Director, Quorum Capital Management Limited, 1994
to present; Member, American Council of Life
Insurance Pension Committee, 1992 to present.
Lawrence Glacken, 68 Director Retired, 1987 to present; Vice President,
353 Canterbury Drive Investment Banking, The First Boston Corporation,
Ramsey, NJ 07446 1964-1987.
Robert P. Mulhearn, 49 Director Private Investor, 1987 to present; Managing
1200 East Ridgewood Ave. Director, Morgan Stanley, 1979-1987.
Ridgewood, NJ 07450
Susan B. Kerley, 44 Director President, Global Research Associates, 1990 to
P.O. 9572 present; Manager, Special Investments, Rockefeller
New Haven, CT 06535 & Co., 1988-1990; Director of Research, Rogers,
Casey and Barksdale, 1983-1988.
Linda M. Livornese, 44 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.
Jefferson C. Boyce, 39 Senior Vice President Senior Vice President, New York Life Insurance
Company, 1994 to present; Senior Vice President,
The MainStay Funds, 1995 to present; Director,
NYLIFE Distributors Inc., 1993 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 Fenster, 46 Vice President Vice President, Pension Department, New York Life
Insurance Company, 1988 to present; Director NYL
Trust Company, 1995 to present.
Michael J. Harrington, 46 Vice President Vice President, Pension Department, New York Life
Insurance Company, 1989 to present.
Richard Zuccaro, 46 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, NAFCO, 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
</TABLE>
- 43 -
<PAGE>
<TABLE>
<CAPTION>
Name, Position(s) with Principal Occupation(s)
Address and Age the Company During Past 5 Years
- --------------------------- ---------------------------------- ---------------------------------------------------
<S> <C> <C>
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, New
York Life MFA Series Fund, 1991 to present; Tax
Vice President, CNP Realty, 1991 to present; Tax
Vice President, New York Life Worldwide Holding
Inc., 1992 to present; Tax Vice President, NYLIFE
Structured Asset Management Co. Ltd., 1992 to
present; Tax Vice President, The MainStay Funds,
1991 to present; Tax Vice President, Eagle
Strategies Corp. (broker-dealer and 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
present; Vice President, NYLCARE Health Plans,
Inc., 1995 to present; Vice President - Tax, New
York Life and Health Insurance Co., 1996 to
present; Tax Vice President, NYL Trust Company,
1996 to present.
Anthony W. Polis, 52 Treasurer (Principal Financial Vice President, New York Life Insurance Company,
and 1988 to present; Director, Vice President and
Accounting Officer) 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, The MainStay Funds, 1990 to present;
Treasurer, New York Life MFA Series Fund, Inc.,
1993 to present; Assistant Treasurer, New York
Life MFA Series Fund, 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.
A. Thomas Smith III, 39 Secretary Associate General Counsel, New York Life Insurance
Company, 1994 to present; Secretary, The MainStay
Funds, New York Life MFA Series Fund, Inc., New
York Life Fund Inc., and Eclipse Financial Asset
Trust, 1994 to present; Assistant General Counsel,
Dreyfus Corporation, 1991-1993; Senior Associate,
Willkie, Farr & Gallagher, 1989-1991; Staff
Attorney, Chief Counsel's Office, U.S. Securities
and Exchange Commission, Division of Investment
Management, 1986-1988.
</TABLE>
* Mr. Boyle and Ms. Kane are Directors who are "interested persons" of the
Company as that term is defined in the 1940 Act.
- 44 -
<PAGE>
COMPENSATION TABLE
The following table sets forth information regarding compensation received
by the Directors of the Company for the year ended December 31, 1995.
<TABLE>
<CAPTION>
Aggregate Compensation
Name and Position from Company/1/
- ----------------------------------- ----------------------
<S> <C>
Lawrence Glacken $25,250
Director
Robert P. Mulhearn $25,250
Director
Susan B. Kerley $25,250
Director
</TABLE>
1 Commencing with the third quarter of 1995, compensation paid to Directors,
other than those affiliated with New York Life Insurance Company, MacKay-
Shields Financial Corporation, Monitor Capital Advisors, Inc. or New York
Life Distributors Inc. was increased so that such Directors are paid an
annual fee of $24,000 and $1,000 for each Directors meeting and Audit
Committee meeting attended plus reimbursement for travel and out-of-pocket
expenses.
INVESTMENT ADVISERS
MacKay-Shields Financial Corporation ("MacKay-Shields") serves as the
investment adviser to the Growth Equity Fund, Value Equity Fund, Bond Fund
and Short-Term Bond pursuant to a Master Investment Advisory Agreement,
dated December 28, 1990, between the Company and MacKay-Shields, and to the
International Equity Fund and International Bond Fund pursuant to a
supplement thereto dated December 6, 1994. New York Life Insurance Company
("New York Life") serves as the investment adviser to the Money Market Fund
pursuant to a Master Investment Advisory Agreement, dated December 28,
1990, between the Company and New York Life. Monitor Capital Advisors,
Inc. ("Monitor") serves as the investment adviser to the EAFE Index Fund,
Indexed Equity Fund, Multi-Asset Fund, and Indexed Bond Fund, pursuant to a
Master Investment Advisory Agreement, dated December 28, 1990, between the
Company and Monitor.
Each Master Investment Advisory Agreement was most recently approved by the
Board of Directors, including a majority of the Directors who are not
"interested persons" of the Company or the
- 45 -
<PAGE>
investment advisers, on March 5, 1996, and by the shareholders of the Company on
April 30, 1992. The services provided and the fees paid under the Master
Investment Advisory Agreements are described in the Prospectus.
Each Master Investment Advisory Agreement will continue in effect with
respect to a Fund, provided such continuance is approved annually by (i) the
holders of a majority of the outstanding voting securities of that Fund or by
the Board of Directors, and (ii) a majority of the Directors who are not parties
to such Master Investment Advisory Agreement or "interested persons" (as defined
in the 1940 Act) of any such party. Each Master Investment Advisory Agreement
may be terminated with respect to a Fund, without payment of any penalty, by a
vote of the majority of the outstanding voting securities of that Fund (as
defined in the 1940 Act) on 60 days' written notice to the investment adviser,
by the vote of a majority of the Company's Board of Directors on 60 days'
written notice to the investment adviser, or by the investment adviser on 60
days' written notice to the Company.
For the fiscal years ended December 31, 1995, 1994 and 1993, the amount of
the advisory fee paid by each Fund to New York Life, MacKay-Shields or Monitor
was as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
Fund 12/31/95 12/31/94 12/31/93
---- ---------- ---------- ----------
<S> <C> <C> <C>
EAFE Index Fund $ 115,497 $106,887 $ 74,305
Growth Equity Fund 879,351 676,347 562,280
Indexed Equity Fund 295,487 238,454 192,811
International Equity Fund 290,777 N/A N/A
Multi-Asset Fund 372,064 374,026 354,246
Value Equity Fund 1,275,060 890,814 661,939
Bond Fund 378,811 427,182 427,345
Indexed Bond Fund 168,137 167,785 145,436
International Bond Fund 121,813 N/A N/A
Money Market Fund 59,918 63,676 61,137
Short-Term Bond Fund 79,193 156,983 236,667
</TABLE>
Each Master Investment Advisory Agreement provides that the investment
adviser shall not be liable to the Company for any error of judgment or for any
loss suffered by the Company except a loss resulting from willful misfeasance,
bad faith or gross negligence on its part in the performance of, or from
reckless disregard by the investment adviser of its duties and obligations
under, the Master Investment Advisory Agreement.
- 46 -
<PAGE>
THE ADMINISTRATOR
New York Life serves as the Funds' administrator (the "Administrator")
pursuant to the Master Administration Agreement, dated December 28, 1990, and a
supplement thereto for the International Equity Fund and International Bond Fund
dated December 6, 1994, between the Company and the Administrator. The Master
Administration 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 Administrator on March 5, 1996.
The services provided and the fees paid under the agreement are more fully
described in the Prospectus.
Except for the expenses to be paid by the Funds' investment advisers
and the Administrator, each Fund is responsible under the Master Administration
Agreement for the payment of all other expenses related to its operations,
including, but not limited to: (i) the fees payable to the Fund's investment
adviser and the Administrator; (ii) the fees and expenses of Directors who are
not affiliated with the Funds' investment advisers or the Administrator; (iii)
certain fees and expenses of the Company's custodians and transfer agent, and
fees paid to pricing agents; (iv) the charges and expenses of the Company's
legal counsel and independent accountants; (v) brokers' commissions and any
issue or transfer taxes chargeable to the Fund, in connection with its
securities transactions; (vi) the fees of any trade association of which the
Fund or the Company is a member; (vii) the cost of share certificates, if any,
representing shares of the Fund; (viii) reimbursement of the organization
expenses of the Fund and the fees and expenses involved in registering and
maintaining registration of the Company and of the Fund's shares with the SEC,
registering the Company as a broker or dealer, and qualifying its shares under
state securities laws, including the preparation and printing of the Company's
registration statements and prospectuses for such purposes; (ix) allocable
communications expenses with respect to investor services and all expenses of
shareholders' and Directors' meetings and preparing, printing and mailing
prospectuses and reports to shareholders; (x) litigation and indemnification
expenses and other extraordinary expenses not incurred in the ordinary course of
the Company's business; (xi) any expenses assumed by the Fund pursuant to a plan
of distribution adopted in conformity with Rule 12b-1 under the 1940 Act; and
(xii) all taxes and business fees payable by the Fund to Federal, state or other
governmental agencies. Fees and expenses of legal counsel, registering shares,
holding meetings and communicating with shareholders include an allocable
portion of the cost of maintaining an internal legal and compliance department.
- 47 -
<PAGE>
For the fiscal years ended December 31, 1995, 1994 and 1993, the
amount of the administration fee paid by each Fund to New York Life was as
follows:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
Fund 12/31/95 12/31/94 12/31/93
- -------------------------------- ---------- ---------- ----------
<S> <C> <C> <C>
EAFE Index Fund $ 615,986 $ 570,064 $ 396,293
Growth Equity Fund 2,110,442 1,623,233 1,349,471
Indexed Equity Fund 1,181,947 953,814 771,241
International Equity Fund 415,395 N/A N/A
Multi-Asset Fund 1,240,213 1,246,753 1,180,819
Value Equity Fund 3,060,145 2,137,952 1,588,655
Bond Fund 1,041,729 1,174,749 1,175,199
Indexed Bond Fund 672,553 671,140 581,746
International Bond Fund 203,021 N/A N/A
Money Market Fund 239,673 254,704 244,548
Short-Term Bond Fund 237,578 470,949 710,000
</TABLE>
In connection with the voluntary expense limitation, the Administrator
assumed the following expenses for the Funds for the fiscal years ended December
31, 1995, 1994 and 1993.
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
Fund 12/31/95 12/31/94 12/31/93
- -------------------------------- --------- --------- ---------
<S> <C> <C> <C>
EAFE Index Fund $ 165,321(1) $ N/A(2) $ 0(3)
Growth Equity Fund N/A(2) N/A(2) 70,601
Indexed Equity Fund 272,396 194,838 283,397
International Equity Fund 60,652 N/A N/A
Multi-Asset Fund 167,833 130,798 365,589
Value Equity Fund N/A(2) N/A(2) 75,533
Bond Fund 198,399 148,020 301,850
Indexed Bond Fund 225,553 177,755 228,649
International Bond Fund 31,528 N/A N/A
Money Market Fund 136,576 116,556 137,422
Short-Term Bond Fund 114,433 121,241 201,842
</TABLE>
1 Fund expense limitation resumed April 1, 1995.
2 Fund had no expense limitation during period.
3 Fund did not exceed expense limitation during period.
As long as the temporary expense limitation continues, it may lower the
Funds' expenses and increase their respective yields. After December 31, 1996,
(December 31, 1997 for the EAFE Index 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. Thereafter, the Administrator will comply with any
applicable state regulations which may require the Administrator to make
reimbursements to a Fund in the event that the Fund's aggregate operating
expenses, including the advisory fee and administrative fee, but generally
excluding interest, taxes, brokerage commissions and extraordinary expenses, are
in excess of specific applicable limitations. The strictest rule currently
applicable to a Fund is 2.5% of the first $30,000,000 of average
- 48 -
<PAGE>
net assets, 2.0% of the next $70,000,000 of average net assets, and 1.5% of the
remainder.
The Master Administration Agreement will continue in effect with respect to
a Fund, provided such continuance is approved annually by (i) the holders of a
majority of the outstanding voting securities of that Fund or by the Board of
Directors, and (ii) a majority of the Directors who are not parties to such
agreements or "interested persons" (as defined in the 1940 Act) of any such
party. The agreement may be terminated with respect to a Fund, without payment
of any penalty, by a vote of the majority of the outstanding voting securities
of that Fund (as defined in the 1940 Act) on 60 days' written notice to the
Administrator, by the vote of a majority of the Company's Board of Directors on
60 days' written notice to the Administrator, or by the Administrator on 60
days' written notice to the Company.
The Master Administration Agreement provides that the Administrator shall
not be liable to the Company for any error of judgment or for any loss suffered
by the Company except a loss resulting from willful misfeasance, bad faith or
gross negligence on its part in the performance of, or from reckless disregard
by the Administrator of its duties and obligations under, the agreement.
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 5, 1996. 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 "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,
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<PAGE>
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, 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, 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
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<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 investment 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 investment 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, which currently excludes
the following holidays: New Year's Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
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.
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 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
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<PAGE>
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 investment adviser will seek the best execution of the Fund's
orders. The investment 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' investment 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 investment 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 investment adviser.
Although there is no specified formula for allocating such transactions, the
various allocation methods used by a Fund's investment adviser, and the results
of such allocations, are subject to periodic review by the Company's Directors.
It has for many years been a common practice in the investment advisory
business for advisers of investment companies and other institutional investors
to receive research services from
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<PAGE>
broker-dealers which execute portfolio transactions for the clients of such
advisers. Consistent with this practice, the investment adviser for a Fund may
receive research services from many broker-dealers with which the investment
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 investment 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 is not reduced because the investment adviser and its affiliates
receive such services.
As permitted by Section 28(e) of the Securities Exchange Act of 1934, an
investment 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 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, 1995, 1994 and 1993 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
12/31/95 12/31/94 12/31/93 12/31/95 12/31/94 12/31/93
--------- --------- ---------- --------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
EAFE Index Fund............. $ 44,798 $ 79,676 $ 62,872 0(0%)(1) 0(0%)(1) 0(0%)(1)
Growth Equity Fund.......... 306,776 254,728 380,943 0(0%)(1) 1,490(0%)(1)* 1,260(0%)(1)*
Indexed Equity Fund......... 25,484 45,597 64,108 0(0%)(1) 0(0%)(1) 0(0%)(1)
International Equity Fund... 330,914 N/A N/A 0(0%)(1) N/A N/A
Multi-Asset Fund............ 12,451 87,112 75,897 0(0%)(1) 0(0%)(1) 0(0%)(1)
Value Equity Fund........... 945,310 588,653 902,165 0(0%)(1) 720(0%)(1)* 9,409(1%)(1)
Bond Fund................... 15,608 13,436 5,925 0(0%)(1) 0(0%)(1) 0(0%)(1)
Short-Term Bond Fund........ 523 1,939 2,975 0(0%)(1) 0(0%)(1) 0(0%)(1)
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
Total Brokerage
Commissions Paid
Total Amount of Transaction to Brokers that
Where Commissions Paid Provided
---------------------------- Research
Year ended Year ended Year ended Year ended
12/31/95 12/31/94 12/31/93 12/31/95
--------- -------------------- ---------- ----------------
<S> <C> <C> <C> <C>
EAFE Index Fund............. $ 10,362,714(0%)(2) 56,509,039 (0%)(2) $ 18,123,100 (0%)(2) $ 6,580
Growth Equity Fund.......... 173,585,053(0%)(2) 134,977,896 (2%)(2) 189,566,043 (0%)(2)* 70,426
Indexed Equity Fund......... 20,707,836(0%)(2) 339,976,251 (0%)(2) 53,680,888 (0%)(2) 23,175
International Equity Fund. 79,632,317(0%)(2) N/A N/A 331,067
Multi-Asset Fund............ 9,523,672(0%)(2) 72,654,644 (0%)(2) 64,895,513 (0%)(2) 11,526
Value Equity Fund........... 490,519,118(0%)(2) 306,971,001 (0%)(2)* 395,195,006 (1%)(2) 235,537
Bond Fund................... 200,756,257(0%)(2) 179,145,860 (0%)(2) 91,470,565 (0%)(2) 949
Short Term Bond Fund........ 7,828,808(0%)(2) 25,030,765 (0%)(2) 34,240,077 (0%)(2) 126
</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, 1995, 1994 and
1993.
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<PAGE>
As of December 31, 1995, the following Funds held securities in issuers
with whose broker-dealer subsidiaries or affiliates of the Funds regularly
conduct business:
<TABLE>
<CAPTION>
Fund Broker-Dealer Market Value
- --------------------- ------------------------------------ ---------------
<S> <C> <C>
Growth Equity Fund American Express Credit Corp. $1,279,000(1)
Smith Barney Inc. 4,311,000(1)
Schwab (Charles) Corp. 8,150,625(2)
Indexed Equity Fund Alexander & Alexander Services, Inc. 61,978(2)
American Express Company 1,501,250(2)
Dean Witter Discover & Company 598,122(2)
Marsh & McLennan Companies, Inc. 485,463(2)
Merrill Lynch & Co., Inc. 662,490(2)
Morgan Stanley Group, Inc. 451,500(2)
Salomon Inc. 280,308(2)
Multi-Asset Fund Alexander & Alexander Services, Inc. 28,519(2)
American Express Company 686,328(2)
Dean Witter Discover & Company 272,882(2)
Marsh & McLennan Companies, Inc. 225,514(2)
Merrill Lynch & Co., Inc. 303,144(2)
Morgan Stanley Group, Inc. 209,625(2)
Salomon Inc. 130,711(2)
Dean Witter Discover & Company 508,125(3)
PaineWebber Group, Inc. 421,000(3)
Value Equity Fund Prudential Funding Corp. 9,751,000(1)
Bond Fund Smith Barney Holdings Inc. 1,216,958(3)
Money Market Fund Morgan Stanley Group, Inc. 2,958,292(1)
</TABLE>
(1) Represents investment in commercial paper.
(2) Represents investment in common stock.
(3) Represents investment in corporate bond.
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 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
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<PAGE>
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
investment 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 investment 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
investment 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 Fund's investment 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
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<PAGE>
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 investment 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.
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
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<PAGE>
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) derive in each taxable year
less than 30% of its gross income from gains from the sale or other disposition
of certain assets held less than three months, namely: (i) stock or securities,
(ii) options, futures, and forward contracts (other than those on foreign
currencies), and (iii) foreign currencies (including futures, forwards, and
options on such currencies) not directly related to a Fund's principal business
of investing in securities (or options and futures with respect to securities);
(c) 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
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<PAGE>
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
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 (d) 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.
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<PAGE>
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 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.
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<PAGE>
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 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.
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<PAGE>
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 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
- 62 -
<PAGE>
taxable income and distributions by a Fund will be treated as United States
source income.
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
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<PAGE>
intention to qualify annually as a regulated investment company may limit its
elections with respect to PFIC shares.
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.
- 64 -
<PAGE>
Certain of the options, futures contracts, and forward contracts in
which the Funds may invest may be "section 1256 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
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<PAGE>
investment company might be affected. It is possible that developments in the
swap market and the laws relating to swaps, 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.
- 66 -
<PAGE>
Shareholders who are not U.S. persons should consult their tax advisers
regarding U.S. and foreign tax consequences of ownership 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, and the total
return of all Funds in advertisements, sales literature, or reports to
shareholders or prospective investors.
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 365/7, 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)to the 365/7th power] - 1
The current and effective seven-day average yields as of December 27,
1995 for the Money Market Fund were 5.34% and 5.48%, 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 the
Administrator, these yields would have been 5.21% and 5.34%, respectively, for
the Institutional Class, and 4.95% and 5.08%, 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 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
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<PAGE>
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 December 31, 1995, the yield for the Short-Term
Bond Fund was 5.46% for the Institutional Class, and was 5.59% 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 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 expenses on an annual basis, and assume that all dividends and
distributions are reinvested when paid.
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<PAGE>
The average annual total return of the following Funds for the one-year and
five-year periods ended December 31, 1995 and the period from inception to
December 31, 1995 were as follows:
<TABLE>
<CAPTION>
Five Years Average Annual
Year Ended Ended Total Return
Fund 12/31/95 12/31/95 Since Inception
- -------------------------------------- ---------- ---------- ---------------
<S> <C> <C> <C>
EAFE Index Fund
Institutional Class (1).......... 9.03% 7.74% 7.74%
Institutional Service Class(2). 8.63% 7.66% 7.66%
Growth Equity Fund
Institutional Class (1).......... 37.88% 21.12% 21.12%
Institutional Service Class(2). 37.50% 21.05% 21.05%
Indexed Equity Fund
Institutional Class (1).......... 36.88% 16.02% 16.02%
Institutional Service Class(2). 36.70% 15.99% 15.99%
International Equity Fund
Institutional Class (3).......... 7.17% N/A 7.17%
Institutional Service Class(3). 6.86% N/A 6.86%
Multi-Asset Fund
Institutional Class (1).......... 26.81% 11.55% 11.55%
Institutional Service Class(2). 26.70% 11.53% 11.53%
Value Equity Fund
Institutional Class (1).......... 29.42% 19.94% 19.94%
Institutional Service Class(2). 29.32% 19.92% 19.92%
Bond Fund
Institutional Class (1).......... 17.88% 8.69% 8.69%
Institutional Service Class(2). 17.55% 8.63% 8.63%
Indexed Bond Fund
Institutional Class (1).......... 18.07% 8.95% 8.95%
Institutional Service Class(3). 17.97% 8.94% 8.94%
International Bond Fund
Institutional Class (3).......... 18.46% N/A 18.46%
Institutional Service Class(3). 18.26% N/A 18.26%
Short Term Bond Fund
Institutional Class (1).......... 10.27% 6.58% 6.58%
Institutional Service Class(2). 10.07% 6.54% 6.54%
</TABLE>
(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 information for a Fund may be compared, in advertisements,
sales literature, and reports to shareholders to: (i) the S&P 500, the Salomon
Brothers Broad Investment Grade Bond Index, the Dow Jones Industrial Average,
for the Money Market Series, Donoghue Money Market Institutional Averages, for
the Short-Term Bond Fund, the Salomon Brothers 1-3 Year Treasury Index,
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<PAGE>
for those Funds with investments in fixed-income securities, the Shearson Lehman
Brothers Government Corporate Index, for the EAFE Index Fund and the
International Equity Fund, the Morgan Stanley Capital International's EAFE
Index, for the International Bond Fund, the Salomon Brothers After Tax Non-U.S.
Government Bond Index, or other unmanaged indices, so that investors may compare
a Fund's results with those of a group of unmanaged securities widely regarded
by investors as representative of the securities markets in general; (ii) other
groups of mutual funds tracked by Lipper Analytical Services, a widely used
independent research firm which ranks mutual funds by overall performance,
investment objectives, and assets, or tracked by other services, companies,
publications, or persons, such as Morningstar, Inc., who rank mutual funds on
overall performance or other criteria; (iii) the Consumer Price Index (measure
for inflation) to assess the real rate of return from an investment in the
Funds; and (iv) such other measurers as may be devised by New York Life or its
affiliates as permitted by applicable law or regulation. Unmanaged indices may
assume the reinvestment of dividends but generally do not reflect deductions for
administrative and management costs and expenses. The Salomon Brothers After
Tax Non-U.S. Government Bond Index takes into account the deduction of foreign
withholding taxes in calculating performance, as does the International Bond
Fund.
Investment vehicles and products sponsored or offered by New York Life,
such as New York Life's International Equity Account, New York Life's
Convertible Securities Account, New York Life's Large Cap Convertible Securities
Account and various types of Guaranteed Investment Contracts, may be described
in advertisements for the Funds.
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 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, 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.
- 70 -
<PAGE>
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 March 31, 1996, of the Funds' shares by each person who
beneficially owned more than 5% of the voting securities of any Fund:
<TABLE>
<CAPTION>
Shares Percentage of
Name and Address Beneficially Outstanding
of Shareholder Fund Owned/1/ Shares Owned/2/
- ---------------------------------------------- -------------------- ------------ ----------------
<S> <C> <C> <C>
Trustees of the New York Life Insurance Bond 5,855,499 32.0%
Company Retirement Plan and Pension Growth Equity 4,631,161 21.2%
Plan Indexed Bond 3,830,942 30.0%
51 Madison Avenue Indexed Equity 5,923,931 25.5%
New York, NY 10010 International Bond 3,114,083 78.0%
International Equity 1,168,438 12.2%
Value Equity 15,364,650 34.9%
Trustees of the New York Life Insurance Bond 1,821,659 10.0%
Company Retirement Plan Trust Growth Equity 3,161,302 14.5%
51 Madison Avenue Indexed Bond 1,313,982 10.2%
New York, NY 10010 Indexed Equity 5,870,055 25.3%
International Bond 778,520 19.5%
International Equity 2,141,991 22.4%
Value Equity 9,462,752 21.5%
</TABLE>
- 71 -
<PAGE>
<TABLE>
<CAPTION>
Shares Percentage of
Name and Address Beneficially Outstanding
of Shareholder Fund Owned/1/ Shares Owned/2/
- ---------------------------------------------- -------------------- ------------ ----------------
<S> <C> <C> <C>
New York Life Insurance Company/3/ EAFE Index 3,438,888 58.3%
51 Madison Avenue Indexed Bond 3,330,728 25.8%
New York, NY 10010 Multi-Asset 7,323,719 30.6%
Indexed Equity 1,862,553 8.0%
The Pension Board of the United Food Bond 1,762,959 9.6%
and Commercial Workers International
Union Retirement Plan for Employees
as Amended From Time to Time
1775 K Street, N.W.
Washington, D.C. 20006
Banker's Trust Company as Trustee of Money Market 5,421,052 6.0%
The Lockwood Greene Engineer's Inc. Short-Term Bond 757,344 9.5%
Retirement Trust
1500 International Drive
Spartanburg, NY 29304
Trustee of Heavy & General Laborers Money Market 6,924,818 7.7%
Pension Fund Local 472 & 172
700 Raymond Blvd.
Newark, NJ 07105
Trustees of the Lone Star Hourly Money Market 4,537,896 5.0%
Retirement Plan, Day & Zimmermann, Inc.
1818 Market Street
Philadelphia, PA 19103
Trustees of Clay Electric Cooperative, Inc. Short-Term Bond 556,086 7.0%
P. O. Box 308
Keystone Heights, FL 32656
New York Life Insurance Company Money Market 7,271,947 8.1%
Separate Account #20
51 Madison Avenue
New York, NY 10010
Trustees of the New York Life Insurance Growth Equity 4,934,858 22.6%
Co. Employee Progress Sharing Investment Indexed Equity 1,516,504 6.5%
Plan Trust Multi-Asset 1,510,182 6.3%
51 Madison Avenue
New York, NY 10010
</TABLE>
- 72 -
<PAGE>
<TABLE>
<CAPTION>
Shares Percentage of
Name and Address Beneficially Outstanding
of Shareholder Fund Owned/1/ Shares Owned/2/
- ---------------------------------------------- -------------------- ------------ ----------------
<S> <C> <C> <C>
Trustees of the New York Life Insurance Growth Equity 2,627,699 12.0%
Company Agents Progress Sharing
Investment Plan Trust
51 Madison Avenue
New York, NY 10010
New York Life Ins. Co. Employees' Health EAFE Index 323,645 5.5%
and Life Benefit Trust - (Health Benefits)
51 Madison Avenue
New York, NY 10010
New York Life Ins. Co. Agents' Health EAFE Index 330,627 5.6%
and Life Benefit Trust - (Health Benefits)
51 Madison Avenue
New York, NY 10010
Plastics Engineering Company EAFE Index 528,273 8.9%
P. O. Box 758
Sheboygan, WI 53082-0758
NYL Trust Company - Client Accounts Growth Equity 1,760,612 8.1%
51 Madison Avenue Money Market 12,012,410 13.4%
New York, NY 10010 Multi-Asset 1,562,320 6.5%
Value Equity 2,407,975 5.5%
NYLIFE Inc. Short-Term Bond 2,401,963 30.2%
51 Madison Avenue
New York, NY 10010
BHC Securities Inc. Money Market 8,201,867 9.1%
2005 Market Street
One Commerce Square
Philadelphia, PA 19103
</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 Securities Exchange Act of 1934. Fractional
shares have been omitted.
(2) Only the ownership of at least one-tenth of one percent is
listed.
- 73 -
<PAGE>
(3) Jean Hoysradt has the power to vote all of the shares shown in the
above table owned by New York Life. Ms. Hoysradt disclaims beneficial ownership
of such shares.
Consequently, Trustees of the New York Life Insurance Company
Retirement Plan and Pension Plan may be presumed to "control" the Bond Fund, the
Indexed Bond Fund, the Indexed Equity Fund, the International Bond Fund and the
Value Equity Fund, as that term is defined in the 1940 Act. Similarly, the
Trustees of the New York Life Insurance Company Retirement Plan Trust may be
presumed to "control" the Indexed Equity Fund. New York Life may be presumed to
"control" the EAFE Index Fund, the Indexed Bond Fund, and the Multi-Asset Fund.
NYLIFE Inc. may be presumed to control the Short-Term Bond Fund.
As of March 31, 1996, 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 an Investment Adviser unless such power
is the result of their position with the Company or Investment 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.
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
- 74 -
<PAGE>
Investments and the Statements of Operations for the year ended December 31,
1995, and the Statements of Changes in Net Assets for the years ended December
31, 1995 and December 31, 1994, the notes to the Financial Statements, and the
Report of the Independent Accountants, all of which are included in the 1995
Annual Report to Shareholders, are hereby incorporated by reference into this
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.
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