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MAINSTAY INSTITUTIONAL FUNDS INC.
51 Madison Avenue
New York, New York 10010
STATEMENT OF ADDITIONAL INFORMATION
Date: May 1, 1998
MainStay Institutional Funds Inc. (the "Company") is an open-end
management investment company currently consisting of eleven separate investment
portfolios: EAFE Index Fund, Growth Equity Fund, Indexed Equity Fund,
International Equity Fund, Multi-Asset Fund, Value Equity Fund, Bond Fund,
Indexed Bond Fund, International Bond Fund, Money Market Fund, and Short-Term
Bond Fund (individually or collectively referred to as a "Fund" or the "Funds").
This Statement of Additional Information supplements the information
contained in the Company's Institutional Class, Institutional Service Class and
Money Market Fund-Institutional Service Class Prospectuses dated May 1, 1998
(collectively, the "Prospectus"), and should be read in conjunction with the
Prospectus. The Prospectus is available without charge by writing to MainStay
Institutional Funds Inc., P.O. Box 461, Parsippany, New Jersey 07054-0461, or by
calling 1-800-695-2126. This Statement of Additional Information, although not
in itself a prospectus, is incorporated in its entirety by reference in and is
made a part of each Class' Prospectuses.
No dealer, salesman or any other person has been authorized to give any
information or to make any representations, other than those contained in this
Statement of Additional Information or in the related 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
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ADDITIONAL INVESTMENT POLICIES OF THE MONEY MARKET FUND..................... 1
INVESTMENT OBJECTIVES AND POLICIES.......................................... 3
Arbitrage.......................................................... 3
Borrowing.......................................................... 4
Commercial Paper................................................... 4
Repurchase Agreements and Reverse Repurchase
Agreements....................................................... 5
Government Securities.............................................. 6
Lending of Portfolio Securities.................................... 6
Municipal Bonds.................................................... 7
Banking Industry and Savings and Loan Industry
Obligations...................................................... 8
Floating and Variable Rate Securities.............................. 8
Foreign Securities................................................. 9
American Depositary Receipts ("ADRs").............................. 11
When-Issued and Firm or Standby Commitment Agreements.............. 11
Mortgage-Related and Other Asset-Backed Securities................. 12
Brady Bonds........................................................ 19
Loan Participation Interests....................................... 20
Options on Securities.............................................. 22
Options on Foreign Currencies...................................... 26
Futures Transactions............................................... 28
Swap Agreements.................................................... 38
Forward Foreign Currency Contracts................................. 40
Foreign Index-Linked Instruments................................... 44
Warrants........................................................... 45
Short Sales Against the Box........................................ 45
High Yield/High Risk Securities.................................... 46
Zero Coupon Bonds.................................................. 47
INDEXED EQUITY FUND SPECIAL CONSIDERATIONS.................................. 47
INVESTMENT RESTRICTIONS..................................................... 48
MANAGEMENT OF THE COMPANY................................................... 52
Directors and Officers............................................. 52
Compensation Table................................................. 55
Management Agreement............................................... 56
Sub-Advisory Agreements............................................ 58
Distributor........................................................ 60
Service Fees....................................................... 61
PURCHASES AND REDEMPTIONS................................................... 62
PORTFOLIO TRANSACTIONS AND BROKERAGE........................................ 63
NET ASSET VALUE............................................................. 68
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TAX INFORMATION............................................................. 70
PERFORMANCE INFORMATION..................................................... 79
OTHER INFORMATION........................................................... 84
Capitalization..................................................... 84
Effective Maturity................................................. 84
Beneficial Ownership of the Funds.................................. 85
Code of Ethics..................................................... 87
Independent Accountants............................................ 88
Legal Counsel...................................................... 88
Financial Statements............................................... 88
Registration Statement............................................. 88
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ADDITIONAL INVESTMENT POLICIES OF THE MONEY MARKET FUND
Each Fund has a separate investment objective or objectives which it
pursues through separate investment policies, as described in the Prospectus.
The following discussion elaborates on the presentation of the Money Market
Fund's investment policies contained in the Prospectus.
The Fund may invest its assets in U.S. dollar-denominated securities of
U.S. or foreign issuers and in securities of foreign branches of U.S. banks,
such as negotiable certificates of deposit (Eurodollars). Since the portfolio of
the Fund may contain such securities, an investment therein involves investment
risks that are different in some respects from an investment in a fund which
invests only in debt obligations of U.S. domestic issuers. Such risks may
include future political and economic developments, the possible imposition of
foreign withholding taxes on interest income payable on the securities held in
the portfolio, possible seizure or nationalization of foreign deposits, the
possible establishment of exchange controls or the adoption of other foreign
governmental restrictions which might adversely affect the payment of the
principal of and interest on securities in the portfolio.
All of the assets of the Fund generally will be invested in obligations
which mature in 397 days or less and substantially all of these investments will
be held to maturity; however, securities collateralizing repurchase agreements
may have maturities in excess of 397 days. The Fund will, to the extent
feasible, make portfolio investments primarily in anticipation of or in response
to changing economic and money market conditions and trends. The dollar-weighted
average maturity of the Fund's portfolio may not exceed 90 days. Consistent with
the provisions of a rule of the Securities and Exchange Commission ("SEC"), the
Fund invests only in U.S. dollar-denominated money market instruments that
present minimal credit risk and, with respect to 95% of its total assets,
measured at the time of investment, that are of the highest quality. The
Sub-Adviser shall determine whether a security presents minimal credit risk
under procedures adopted by the Company's Board of Directors. A money market
instrument will be considered to be of the highest quality (1) if rated in the
highest rating category (i.e., Aaa or Prime-1 by Moody's, AAA or A-1 by S&P's)
by (i) any two nationally recognized statistical rating organizations ("NRSROs")
or, (ii) if rated by only one NRSRO, by that NRSRO; (2) if issued by an issuer
that has received a short-term rating from an NRSRO with respect to a class of
debt obligations that is comparable in priority and security, and that are
rated in the highest rating category by (i) any two NRSROs or, (ii) if rated by
only one NRSRO, by that NRSRO; (3) an unrated security that is of comparable
quality to a security in the highest rating category as determined by the Sub-
Adviser; (4)(i) with respect to a security that is subject to any features that
entitle the holder, under certain circumstances, to receive the approximate
amortized cost of the underlying security or securities plus accrued interest
"Demand Feature" or obligations of a person other than the issuer of the
security, under certain circumstances, to undertake to pay the principal amount
of the underlying security plus interest "Guarantee", the Guarantee has received
a rating from an NRSRO or the Guarantee is issued by a guarantor that has
received a rating from an NRSRO with respect to a class of debt obligations that
is comparable in priority and security to the Guarantee, with certain
exceptions, and (ii) the issuer of the Demand Feature or Guarantee, or another
institution, has undertaken promptly to notify the holder of the security in the
event that the Demand Feature or Gurantee is substituted with another Demand
Feature or Guarantee; (5) if it is a security issued by a money market fund
registered with the SEC under the 1940 Act; or (6) if it is a Government
Security. With respect to 5% of its total assets, measured at the time of
investment, the Fund may also invest in money market instruments that are in the
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second-highest rating category for short-term debt obligations (i.e., rated Aa
or Prime-2 by Moody's or AA or A-2 by S&P).
The Fund may not invest more than 5% of its total assets, measured at the
time of investment, in securities of any one issuer that are of the highest
quality, except that the Fund may exceed this 5% limitation with respect to 25%
of its total assets for up to three business days after the purchase of
securities of any one issuer and except that this limitation shall not apply to
U.S. government securities or securities subject to certain Guarantees.
Immediately after the acquisition of any Demand Feature or Guarantee, the Fund,
with respect to seventy five percent of its total assets, shall not have
invested more than ten percent of its assets in securities issued by or subject
to Demand Features or Guarantees from the institution that issued the Demand
Feature or Guarantee, with certain exceptions. In addition, immediately after
the acquisition of any Demand Feature or Guarantee (or a security after giving
effect to the Demand Feature or Guarantee) that is not within the highest
rating category by NRSROs, the Fund shall not have invested more than five
percent of its total assets in securities issued by or subject to Demand
Features or Guarantees from the institution that issued the Demand Feature or
Guarantee. The Fund may not invest more than the greater of 1% of its total
assets or one million dollars, measured at the time of investment, in securities
of any one issuer that are in the second-highest rating category, except that
this limitation shall not apply to U.S. government securities or securities
subject to certain Guarantees. In the event that an instrument acquired by the
Fund is downgraded or otherwise ceases to be of the quality that is eligible for
the Fund, the Sub-Adviser, under procedures approved by the Board,shall promptly
reassess whether such security presents minimal credit risk and shall recommend
to the Valuation Committee of the Board (the "Valuation Committee") that the
Fund take such action as it determines is in the best interest of the Fund and
its shareholders. The Valuation Committee, after consideration of the
recommendation of the Sub-Adviser and such other information as it deems
appropriate, shall cause the Fund to take such action as it deems appropriate,
and shall report promptly to the Board the action it has taken and the reasons
for such action.
Pursuant to the rule, the Fund uses the amortized cost method of valuing
its investments, which facilitates the maintenance of the Fund's per share net
asset value at $1.00. The amortized cost method, which is normally used to value
all of the Fund's portfolio securities, involves initially valuing a security at
its cost and thereafter amortizing to maturity any discount or premium,
regardless of the impact of fluctuating interest rates on the market value of
the instrument.
The Directors have also established procedures designed to stabilize, to
the extent reasonably possible, the Fund's price per share as computed for the
purpose of sales and redemptions at $1.00. Such procedures include review of the
Fund's portfolio by the Directors, at such intervals as they deem appropriate,
to determine whether the Fund's net asset value calculated by using available
market quotations or market equivalents (the determination of value by reference
to interest rate levels, quotations of comparable securities and other factors)
deviates from $1.00 per share based on amortized cost.
The extent of deviation between the Fund's net asset value based upon
available market quotations or market equivalents and $1.00 per share based on
amortized cost will be periodically examined by the Directors. If such deviation
exceeds 1/2 of 1%, the Directors will promptly consider what action, if any,
will be
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initiated. In the event the Directors determine that a deviation exists which
may result in material dilution or other unfair results to investors or existing
shareholders, they will take such corrective action as they regard to be
necessary and appropriate, including the sale of portfolio instruments prior to
maturity to realize capital gains or losses or to shorten average portfolio
maturity; withholding part or all of dividends or payment of distributions from
capital or capital gains; redemptions of shares in kind; or establishing a net
asset value per share by using available market quotations or equivalents. In
addition, in order to stabilize the net asset value per share at $1.00, the
Directors have the authority (1) to reduce or increase the number of shares
outstanding on a pro rata basis, and (2) to offset each shareholder's pro rata
portion of the deviation between the net asset value per share and $1.00 from
the shareholder's accrued dividend account or from future dividends.
The Fund may hold cash for the purpose of stabilizing its net asset value
per share. Holdings of cash, on which no return is earned, would tend to lower
the yield on the Fund's shares.
The Fund may also, consistent with the provisions of the rule, invest in
securities with a face maturity of more than 397 days, provided that the
security is a variable or floating rate security that meets the guidelines of
Rule 2a-7 with respect to maturity.
INVESTMENT OBJECTIVES AND POLICIES
The Prospectus discusses the investment objectives of the Funds and the
policies to be employed to achieve those objectives. This section contains
supplemental information concerning certain of the securities and other
instruments in which the Funds may invest, the investment policies and portfolio
strategies the Funds may utilize, and certain risks involved with those
investments, policies and strategies.
Arbitrage
Each Fund may sell in one market a security which it owns and
simultaneously purchase the same security in another market, or it may buy a
security in one market and simultaneously sell it in another market, in order to
take advantage of differences in the price of the security in the different
markets. The Funds do not actively engage in arbitrage. Such transactions may be
entered into only with respect to debt securities and will occur only in a
dealer's market where the buying and selling dealers involved confirm their
prices to the Fund at the time of the
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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").
Borrowing
A Fund may borrow from a bank up to a limit of 15% of its total assets,
but only for temporary or emergency purposes. This borrowing may be unsecured.
The Investment Company Act of 1940, as amended (the "1940 Act") requires a Fund
to maintain continuous asset coverage (that is, total assets including
borrowings, less liabilities exclusive of borrowings) of 300% of the amount
borrowed. If the 300% asset coverage should decline as a result of market
fluctuations or other reasons, a Fund may be required to sell some of its
portfolio holdings within three days to reduce the debt and restore the 300%
asset coverage, even though it may be disadvantageous from an investment
standpoint to sell securities at that time and could cause the Fund to be unable
to meet certain requirements for qualification as a regulated investment company
for Federal tax purposes. To avoid the potential leveraging effects of a Fund's
borrowings, a Fund will repay any money borrowed in excess of 5% of its total
assets prior to purchasing additional securities. Borrowing may exaggerate the
effect on a Fund's net asset value of any increase or decrease in the market
value of the Fund's portfolio securities. Money borrowed will be subject to
interest costs which may or may not be recovered by appreciation of the
securities purchased. A Fund also may be required to maintain minimum average
balances in connection with such borrowing or to pay a commitment or other fee
to maintain a line of credit; either of these requirements would increase the
cost of borrowing over the stated interest rate.
Commercial Paper
Each Fund may invest in commercial paper. Each Fund will invest in
commercial paper only if rated at the time of investment Prime-1 by Moody's or
A-1 by S&P, or, if not rated by Moody's or S&P, if the Fund's Sub-Adviser
determines that the commercial paper is of comparable quality. Commercial paper
represents short-term unsecured promissory notes issued by banks or bank holding
companies, corporations and finance companies. (See "Appendix A - Description of
Securities Ratings" in the Prospectus.)
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Repurchase Agreements and Reverse 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. Repurchase agreements with foreign
banks may be available with respect to government securities of the particular
foreign jurisdiction. The custody of the Obligation will be maintained by the
Fund's Custodian. The repurchase price may be higher than the purchase price,
the difference being income to the Fund, or the purchase and repurchase prices
may be the same, with interest at a stated rate due to the Fund together with
the repurchase price upon repurchase. In either case, the income to the Fund is
unrelated to the interest rate on the Obligation subject to the repurchase
agreement.
In the event of the commencement of bankruptcy or insolvency proceedings
with respect to the seller of the Obligation before repurchase of the Obligation
under a repurchase agreement, the Fund may encounter delays and incur costs
before being able to sell the security. Delays may involve loss of interest or
decline in price of the Obligation. The Sub-Advisers seek to minimize the risk
of loss from repurchase agreements by analyzing the creditworthiness of the
obligor, in this case the seller of the Obligation. Apart from the risk of
bankruptcy or insolvency proceedings, there is also the risk that the seller may
fail to repurchase the security. However, if the market value of the Obligation
subject to the repurchase agreement becomes less than the repurchase price
(including accrued interest), the Fund will direct the seller of the Obligation
to deliver additional securities so that the market value of all securities
subject to the repurchase agreement equals or exceeds the repurchase price. No
Fund will invest more than 10% of its net assets (taken at current market value)
(15% in the case of the International Equity and International Bond Funds) in
repurchase agreements maturing in more than seven days.
Each Fund may enter into reverse repurchase agreements with banks or
broker-dealers, which involves the sale of a security by a Fund and its
agreement to repurchase the instrument at a specified time and price. The Fund
will maintain a segregated account consisting of liquid assets to cover its
obligations under reverse repurchase agreements. Each Fund will limit its
investments in reverse repurchase agreements and other borrowing to no more than
one-third of its total assets. The use of
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reverse repurchase agreements by a Fund creates leverage which increases a
Fund's investment risk. If the income and gains on securities purchased with the
proceeds of reverse repurchase agreements exceed the cost of the agreements, the
Fund's earnings or net asset value will increase faster than otherwise would be
the case; conversely, if the income and gains fail to exceed the costs, earnings
or net asset value would decline faster than otherwise would be the case.
Government Securities
Government securities are obligations of, or guaranteed by, the U.S.
government or its agencies or instrumentalities. Some U.S. government
securities, such as Treasury bills, notes and bonds, are supported by the full
faith and credit of the United States; others, such as those of the Federal Home
Loan Bank, are supported by the right of the issuer to borrow from the Treasury;
others, such as those of the Federal National Mortgage Association, are
supported by the discretionary authority of the U.S. government to purchase the
agency's obligations; and still others, such as those of the Student Loan
Marketing Association, are supported only by the credit of the instrumentality.
Standard & Poor's 500 Composite Stock Price Index
The Indexed Equity Fund and the Multi-Asset Fund are managed in part to
replicate the Standard & Poor's 500 Composite Stock Price Index (the "S&P 500").
Because of the market-value weighing, the 20 largest companies in the S&P 500
currently account for approximately 29.32% of the Index. As of December 31,
1997, the five largest weightings in the S&P 500 as a percentage of net assets
were: General Electric Company (3.18%); Coca Cola Co. (2.18%); Microsoft
Corporation (2.06%); Exxon Corporation (2.00%); and Merck & Co. (1.68%).
Lending of Portfolio Securities
In accordance with guidelines adopted by the Board of Directors, each Fund
may seek to increase its income by lending portfolio securities. Under present
regulatory policies, such loans may be made to institutions, such as
broker-dealers, and would be required to be secured continuously by collateral
in cash or U.S. Government securities maintained on a current basis at an amount
at least equal to 100% of the current market value of the securities loaned. The
Fund would have the right to call a loan and obtain the securities loaned at any
time generally on less than five days' notice. For the duration of a loan, the
Fund would continue to receive the equivalent of the interest or dividends paid
by the issuer on the securities loaned and would also receive compensation from
the investment of the collateral.
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The Fund would not, however, have the right to vote any securities having voting
rights during the existence of the loan, but the Fund would call the loan in
anticipation of an important vote to be taken among holders of the securities or
of the giving or withholding of their consent on a material matter affecting the
investment. The Company, on behalf of certain of the Funds, has entered into an
agency agreement with Merrill Lynch Portfolio Services, Inc. which acts as the
Funds' agent in making loans of portfolio securities and short-term money market
investments of the cash collateral received, subject to the supervision and
control of the Funds' Sub-Advisers.
As with other extensions of credit there are risks of delay in recovery
of, or even loss of rights in, the collateral should the borrower of the
securities fail financially. However, the loans would be made only to firms
deemed by a Sub-Adviser to be creditworthy and approved by the Board, and when,
in the judgment of a Sub-Adviser, the consideration which can be earned
currently from securities loans of this type justifies the attendant risk. If a
Sub-Adviser determines to make securities loans, it is intended that the value
of the securities loaned would not exceed 33% of the value of the total assets
of the lending Fund. Under the guidelines adopted by the Board of Directors, a
Fund may not enter into a lending agreement with a counterparty which would
cause the Fund to have loans outstanding to that counterparty for securities
having a value greater than 5% of the Fund's total assets.
Municipal Bonds
Municipal bonds are debt obligations of state and local governments,
agencies and authorities, which are issued to obtain funds for various public
purposes. Two principal classifications of municipal bonds are "general
obligation" and "revenue" bonds. General obligation bonds are secured by the
issuer's pledge of its full faith, credit and taxing power for the payment of
principal and interest. Revenue bonds are payable only from the revenues derived
from a particular facility or class of facilities, or, in some cases, from the
proceeds of a special excise or specific revenue source. Industrial development
bonds or private activity bonds are issued by or on behalf of public authorities
to obtain funds for privately operated facilities and are, in most cases,
revenue bonds which do not generally carry the pledge of the full faith and
credit of the issuer of such bonds, but depend for payment on the ability of the
industrial user to meet its obligations (or any property pledged as security).
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Banking Industry and Savings and Loan Industry Obligations
Certificates of deposit are receipts from a bank or savings and loan
association ("S&L"), for funds deposited for a specified period of time at a
specified rate of return. Time deposits in banks or S&Ls are generally similar
to certificates of deposit, but are uncertificated. Bankers' acceptances are
time drafts drawn on commercial banks by borrowers, usually in connection with
international commercial transactions. Each Fund may not invest in time deposits
maturing in more than seven days which are subject to withdrawal penalties. Each
Fund will limit it investment in time deposits for which there is a penalty for
early withdrawal to 10% of its net assets.
Each Fund will not invest in any obligation of a domestic or foreign bank
unless (i) the bank has capital, surplus, and individual profits (as of the date
of the most recently published financial statements) in excess of $100 million,
or the equivalent in other currencies, and (ii) in the case of a U.S. bank, its
deposits are insured by the Federal Deposit Insurance Corporation. These
limitations do not prohibit investments in the securities issued by foreign
branches of U.S. banks, provided such U.S. banks meet the foregoing
requirements.
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
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floaters is associated with greater volatility in their market values.
Accordingly, the duration of an inverse floater may exceed its stated final
maturity. Certain inverse floaters may be determined to be illiquid securities
for purposes of a Fund's limitation on investments in such securities.
Foreign Securities
The EAFE Index Fund, International Bond Fund and International Equity Fund
will, and the Bond Fund, Growth Equity Fund, Multi-Asset Fund, Short-Term Bond
Fund and Value Equity Fund may invest in securities of foreign issuers. The
Money Market Fund may purchase U.S. dollar-denominated securities of foreign
issuers. The Indexed Equity Fund and Indexed Bond Fund will invest in foreign
securities to the extent such securities are included in the securities that
comprise the Standard & Poor's 500 Composite Stock Price Index and the Salomon
Brothers Broad Investment Grade Bond Index, respectively. The International Bond
Fund and International Equity Fund may invest, without limit, subject to the
other investment policies applicable to the Fund, in U.S. dollar-denominated and
non-dollar denominated foreign debt securities and in certificates of deposit
issued by foreign banks and foreign branches of United States banks, to any
extent deemed appropriate by MacKay-Shields. Securities acquired by the
International Bond Fund may be denominated in multinational currency units such
as the European Currency Unit ("ECU"). Securities of issuers within a given
country may be denominated in the currency of another country.
Foreign investing involves the possibility of expropriation,
nationalization or confiscatory taxation, foreign taxation of income earned in
the foreign nation (including withholding taxes on interest and dividends) or
other foreign taxes imposed with respect to investments in the foreign nation,
foreign exchange controls (which may include suspension of the ability to
transfer currency from a given country), default in foreign government
securities, political or social instability or diplomatic developments which
could affect investments in securities of issuers in those nations. In addition,
in many countries there is less publicly available information about issuers
than is available in reports about companies in the United States. Foreign
companies are not generally subject to uniform accounting and auditing and
financial reporting standards, and auditing practices and requirements may not
be comparable to those applicable to U.S. companies. In many foreign countries,
there is less government supervision and regulation of business and industry
practices, stock exchanges, brokers and listed companies than in the United
States. Foreign securities transactions may be subject to higher brokerage and
custodial costs than domestic securities transactions. In addition, the foreign
securities
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markets of many of the countries in which the Funds may invest may also be
smaller, less liquid and subject to greater price volatility than those in the
United States.
The Growth Equity Fund, Indexed Bond Fund, International Bond Fund,
International Equity Fund, Multi-Asset Fund and Value Equity Fund may invest in
emerging market countries, which presents risks in greater degree than, and in
addition to, those presented by investment in foreign issuers in general. A
number of emerging market countries restrict, to varying degrees, foreign
investment in stocks. Repatriation of investment income, capital and the
proceeds of sales by foreign investors may require governmental registration
and/or approval in some emerging market countries. A number of the currencies of
developing countries have experienced significant declines against the U.S.
dollar in recent years and devaluation may occur subsequent to investments in
these currencies by the Funds. Inflation and rapid fluctuations in inflation
rates have had and may continue to have negative effects on the economies and
securities markets of certain emerging market countries.
Many of the emerging securities markets are relatively small, have low
trading volumes, suffer periods of relative illiquidity, and are characterized
by significant price volatility. There is a risk in emerging market countries
that a future economic or political crisis could lead to price controls, forced
mergers of companies, expropriation or confiscatory taxation, seizure,
nationalization or creation of government monopolies, any of which may have a
detrimental effect on the Funds' investments.
To different degrees, the Bond Fund, Indexed Bond Fund, International Bond
Fund, International Equity Fund and Short-Term Bond Fund are permitted to invest
in debt securities or obligations of foreign governments, agencies, and
supranational organizations ("Sovereign Debt"). Investments in Sovereign Debt
can involve greater risks than investing in U.S. Government Securities. The
issuer of the debt or the governmental authorities that control the repayment of
the debt may be unable or unwilling to repay principal or interest when due in
accordance with the terms of such debt, and a Fund may have limited legal
recourse in the event of default.
The occurrence of political, social or diplomatic changes in one or more
of the countries issuing Sovereign Debt could adversely affect a Fund's
investments. Political changes or a deterioration of a country's domestic
economy or balance of trade may affect the willingness of countries to service
their Sovereign Debt. While the investment advisers intend to manage the Funds'
portfolios in a manner that will minimize the exposure
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to such risks, there can be no assurance that adverse political changes will not
cause a Fund to suffer a loss of interest or principal on any of its holdings.
American Depositary Receipts ("ADRs")
ADRs (sponsored or unsponsored) are receipts typically issued by a U.S.
bank or trust company evidencing ownership of the underlying foreign securities.
Most ADRs are traded on a U.S. stock exchange. Issuers of unsponsored ADRs are
not contractually obligated to disclose material information in the U.S. and,
therefore, there may not be a correlation between such information and the
market value of the unsponsored ADR. European Depositary Receipts and
International Depositary Receipts are receipts typically issued by a European
bank or trust company evidencing ownership of the underlying foreign securities.
Global Depositary Receipts are receipts issued by either a U.S. or non-U.S.
banking institution evidencing ownership of the underlying foreign securities.
When-Issued and Firm or Standby Commitment Agreements
Each Fund 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 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
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when-issued or firm commitment basis. Each Fund will establish a segregated
account in which it will maintain liquid assets at least equal in value to any
commitments to purchase securities on a when-issued, firm, or standby commitment
basis. Such segregated securities either will mature or, if necessary, be sold
on or before the settlement date.
Mortgage-Related and Other Asset-Backed Securities
The value of some mortgage-related or asset-backed securities in which the
Funds invest may be particularly sensitive to changes in prevailing interest
rates, and, like the other investments of the Funds, the ability of a Fund to
successfully utilize these instruments may depend in part upon the ability of an
investment adviser to forecast interest rates and other economic factors
correctly. While principal and interest payments on some mortgage-related
securities may be guaranteed by the U.S. government, government agencies or
other guarantors, the market value of such securities is not guaranteed.
A Fund will invest only in mortgage-related (or other asset-backed)
securities either (i) issued by U.S. government-sponsored corporations
(currently GNMA, FHLMC and FNMA), or (ii) privately issued securities rated Baa
or better by Moody's or BBB by S&P or, if not rated, of comparable investment
quality as determined by the Fund's investment adviser. In addition, if any such
security is determined to be illiquid, a Fund will limit its investments in
these and other illiquid instruments to not more than 10% of its net assets (15%
in the case of the International Bond Fund and International Equity Fund).
Mortgage Pass-Through Securities. Mortgage pass-through securities, which
are securities interests in pools of mortgage-related securities, differ from
other forms of debt securities, which normally provide for periodic payment of
interest in fixed amounts with principal payments at maturity or specified call
dates. Instead, these securities provide a monthly payment which consists of
both interest and principal payments. In effect, these payments are a
"pass-through" of the monthly payments made by the individual borrowers on their
residential mortgage loans, net of any fees paid to the issuer or guarantor of
such securities. Additional payments are caused by repayments of principal
resulting from the sale of the underlying residential property, refinancing or
foreclosure, net of fees or costs which may be incurred. Some mortgage-related
securities (such as securities issued by the Government National Mortgage
Association) are described as "modified pass-through." These securities entitle
the holder to receive all interest and principal payments owed on the mortgage
pool, net of certain fees, at
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the scheduled payment dates regardless of whether or not the mortgagor actually
makes the payment.
The principal governmental guarantor of mortgage-related securities is the
Government National Mortgage Association ("GNMA"). GNMA is a wholly owned U.S.
Government corporation within the Department of Housing and Urban Development.
GNMA is authorized to guarantee, with the full faith and credit of the U.S.
Government, the timely payment of principal and interest on securities issued by
institutions approved by GNMA (such as S&Ls, commercial banks and mortgage
bankers) and backed by pools of Federal Housing Administration-insured or
Veterans Administration-guaranteed mortgages.
Government-related guarantors (i.e., not backed by the full faith and
credit of the U.S. Government) include the Federal National Mortgage Association
("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC"). FNMA is a
government-sponsored corporation owned entirely by private stockholders. It is
subject to general regulation by the Secretary of Housing and Urban Development.
FNMA purchases conventional (i.e., not insured or guaranteed by any government
agency) residential mortgages from a list of approved seller/servicers which
include state and federally chartered savings and loan associations, mutual
savings banks, commercial banks, credit unions and mortgage bankers.
Pass-through securities issued by FNMA are guaranteed as to timely payment of
principal and interest by FNMA but are not backed by the full faith and credit
of the U.S. Government.
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.
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However, timely payment of interest and principal of these pools may be
supported by various forms of insurance or guarantees, including individual
loan, title, pool and hazard insurance and letters of credit. The insurance and
guarantees are issued by governmental entities, private insurers and the
mortgage poolers. Such insurance and guarantees and the creditworthiness of the
issuers thereof will be considered in determining whether a mortgage-related
security meets a Fund's investment quality standards. There can be no assurance
that the private insurers or guarantors can meet their obligations under the
insurance policies or guarantee arrangements. Although the market for such
securities is becoming increasingly liquid, securities issued by certain private
organizations may not be readily marketable. Early repayment of principal on
mortgage pass-through securities (arising from prepayments of principal due to
sale of the underlying property, refinancing, or foreclosure, net of fees and
costs which may be incurred) may expose a Fund to a lower rate of return upon
reinvestment of principal. Also, if a security subject to repayment has been
purchased at a premium, in the event of prepayment the value of the premium
would be lost. No Fund will purchase mortgage-related securities or any other
assets which in the opinion of the Fund's Sub-Adviser are illiquid if, as a
result, more than 10% of the value of the Fund's net assets will be illiquid
(15% in the case of the International Bond or International Equity Funds).
Collateralized Mortgage Obligations ("CMOs"). A CMO is a hybrid between a
mortgage-backed bond and a mortgage pass-through security. Similar to a bond,
interest and prepaid principal is paid, in most cases, semiannually. CMOs may be
collateralized by whole mortgage loans, but are more typically collateralized by
portfolios of mortgage pass-through securities guaranteed by GNMA, FHLMC, or
FNMA, and their income streams.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral. CMOs provide for a modified form of call
protection through a de facto breakdown of the underlying pool of mortgages
according to how quickly the loans are repaid. Monthly payment of principal
received from the pool of underlying mortgages, including prepayments, is first
returned to investors holding the shortest maturity class. Investors holding the
longer maturity classes receive principal only after the first class has been
retired. An investor is partially guarded against a sooner than desired return
of principal because of the sequential payments.
In a typical CMO transaction, a corporation ("issuer") issues multiple
series (e.g., A, B, C, Z) of CMO bonds ("Bonds"). Proceeds of the Bond offering
are used to purchase mortgages or
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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.
The Funds will not invest in any privately issued CMOs that do not meet
the requirements of Rule 3a-7 under the 1940 Act if, as a result of such
investment, more than 5% of a Fund's net assets would be invested in any one
CMO, more than 10% of a Fund's net assets would be invested in CMOs and other
investment company securities in the aggregate, or a Fund would hold more than
3% of any outstanding issue of CMOs.
FHLMC Collateralized Mortgage Obligations. FHLMC CMOs are debt obligations
of FHLMC issued in multiple classes having different maturity dates which are
secured by the pledge of a pool of conventional mortgage loans purchased by
FHLMC. Unlike FHLMC Pcs, payments of principal and interest on the CMOs are made
semiannually, as opposed to monthly. The amount of principal payable on each
semiannual payment date is determined in accordance with FHLMC's mandatory
sinking fund schedule, which, in turn, is equal to approximately 100% of Federal
Housing Administration ("FHA") prepayment experience applied to the mortgage
collateral pool. All sinking fund payments in the CMOs are allocated to the
retirement of the individual classes of bonds in the order of their stated
maturities. Payment of principal on the mortgage loans in the collateral pool in
excess of the amount of FHLMC's minimum sinking fund obligation for any payment
date are paid to the holders of the CMOs as additional sinking fund payments.
Because of the "pass-through" nature of all principal payments received on the
collateral pool in excess of FHLMC's minimum sinking fund 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.
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Criteria for the mortgage loans in the pool backing the CMOs are identical
to those of FHLMC Pcs. FHLMC has the right to substitute collateral in the event
of delinquencies and/or defaults.
Other Mortgage-Related Securities. The Funds' Sub-Advisers expect that
governmental, government-related or private entities may create mortgage loan
pools and other mortgage-related securities offering mortgage pass-through and
mortgage-collateralized investments in addition to those described above. The
mortgages underlying these securities may include alternative mortgage
instruments, that is, mortgage instruments whose principal or interest payments
may vary or whose terms to maturity may differ from customary long-term fixed
rate mortgages. As new types of mortgage-related securities are developed and
offered to investors, a Fund's Sub-Adviser will, consistent with the Fund's
investment objectives, policies and quality standards, consider making
investments in such new types of mortgage-related securities.
CMO Residuals. CMO residuals are derivative mortgage securities issued by
agencies or instrumentalities of the U.S. Government or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
homebuilders, mortgage banks, commercial banks, investment banks and special
purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs
is applied first to make required payments of principal and interest on the CMOs
and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess cash
flow remaining after making the foregoing payments. Each payment of such excess
cash flow to a holder of the related CMO residual represents income and/or a
return of capital. The amount of residual cash flow resulting from a CMO will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of CMO, prevailing interest rates, the amount of
administrative expenses and the prepayment experience on the mortgage assets. In
particular, the yield to maturity on CMO 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
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may fail to recoup fully its initial investment in a CMO residual.
CMO residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The CMO
residual market has only very recently developed and CMO residuals currently may
not have the liquidity of other more established securities trading in other
markets. Transactions in CMO residuals are generally completed only after
careful review of the characteristics of the securities in question. In
addition, CMO residuals may or, pursuant to an exemption therefrom, may not have
been registered under the Securities Act of 1933, as amended. CMO residuals,
whether or not registered under such Act, may be subject to certain restrictions
on transferability, and may be deemed "illiquid" and subject to a portfolio's
limitations on investment in illiquid securities. Each of the Funds limits its
investment in CMO residuals to less than 5% of its net assets.
Stripped Mortgage-Backed Securities. Stripped mortgage-backed securities
("SMBS") are derivative multi-class mortgage securities. SMBS may be issued by
agencies or instrumentalities of the U.S. Government, or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
mortgage banks, commercial banks, investment banks and special purpose entities
of the foregoing.
SMBS are usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. A common type of SMBS will have one class receiving some of the interest
and most of the principal from the mortgage assets, while the other class will
receive most of the interest and the remainder of the principal. In the most
extreme case, one class will receive all of the interest (the IO class), while
the other class will receive all of the principal (the principal-only or "PO"
class). The yield to maturity on an IO class is extremely sensitive to the rate
of principal payments (including prepayments) on the related underlying mortgage
assets, and a rapid rate of principal payments may have a material adverse
effect on a Fund's yield to maturity from these securities. If the underlying
mortgage assets experience greater than anticipated 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
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developed and, accordingly, these securities may be deemed "illiquid" and
subject to a Fund's limitations on investment in illiquid securities.
Risks Associated with Mortgage-Backed Securities. Like other fixed income
securities, when interest rates rise the value of a mortgage-related security
generally will decline; however, when interest rates are declining, the value of
mortgage-related securities with prepayment features may not increase as much as
other fixed income securities. The value of some mortgage-backed securities in
which the Funds may invest may be particularly sensitive to changes in
prevailing interest rates, and, like the other investments of the Funds, the
ability of a Fund to successfully utilize these instruments may depend in part
upon the ability of a Sub-Adviser to forecast interest rates and other economic
factors correctly. If a Sub-Adviser incorrectly forecasts such factors and has
taken a position in mortgage-backed securities that is or becomes contrary to
prevailing market trends, the Funds could be exposed to the risk of a loss.
Investment in mortgage-backed securities poses several risks, including
prepayment, market, and credit risk. Prepayment risk reflects the chance that
borrowers may prepay their mortgages faster than expected, thereby affecting the
investment's average life and perhaps its yield. Whether or not a mortgage loan
is prepaid is almost entirely controlled by the borrower. Borrowers are most
likely to exercise their prepayment options at a time when it is least
advantageous to investors, generally prepaying mortgages as interest rates fall,
and slowing payments as interest rates rise. Besides the effect of prevailing
interest rates, the rate of prepayment and refinancing of mortgages may also be
affected by home value appreciation, ease of the refinancing process and local
economic conditions.
Market risk reflects the chance that the price of the security may
fluctuate over time. The price of mortgage-backed securities may be particularly
sensitive to prevailing interest rates, the length of time the security is
expected to be outstanding, and the liquidity of the issue. In a period of
unstable interest rates, there may be decreased demand for certain types of
mortgage-backed securities, and a Fund invested in such securities wishing to
sell 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
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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' Sub-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 Receivabless
("CARSs"). CARSs 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 CARSs 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 CARSs may
be affected by early prepayment of principal on the underlying vehicle sales
contracts. If the letter of credit is exhausted, the trust may be prevented from
realizing the full amount due on a sales contract because of state law
requirements and restrictions relating to foreclosure sales of vehicles and the
obtaining of deficiency judgments following such sales or because of
depreciation, damage or loss of a vehicle, the application of Federal and state
bankruptcy and insolvency laws, or other factors. As a result, certificate
holders may experience delays in payments or losses if the letter of credit is
exhausted.
Consistent with a Fund's investment objective and policies, a Fund's
Sub-Adviser also may invest in other types of 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. Brady Bonds are not considered U.S. Government securities.
Brady Bonds may be collateralized or uncollateralized and are issued in
various currencies (primarily the U.S. dollar). U.S. dollar-denominated,
collateralized Brady Bonds, which may be fixed rate par bonds or floating rate
discount bonds, are generally collateralized in full as to principal by U.S.
Treasury zero coupon bonds having the same maturity as the Brady Bonds.
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Interest payments on these Brady Bonds generally are collateralized on a
one-year or longer rolling-forward basis by cash or securities in an amount
that, in the case of fixed rate bonds, is equal to at least one year of interest
payments or, in the case of floating rate bonds, initially is equal to at least
one year's interest payments based on the applicable interest rate at that time
and is adjusted at regular intervals thereafter. Certain Brady Bonds are
entitled to "value recovery payments" in certain circumstances, which in effect
constitute supplemental interest payments but generally are not collateralized.
Brady Bonds are often viewed as having three or four valuation components: (i)
the collateralized repayment of principal at final maturity; (ii) the
collateralized interest payments; (iii) the uncollateralized interest payments;
and (iv) any uncollateralized repayment of principal at maturity (these
uncollateralized amounts constitute the "residual risk").
Brady Bonds involve various risk factors, including the history of
defaults with respect to commercial bank loans by public and private entities of
countries issuing Brady Bonds. Investments in Brady Bonds are to be viewed as
speculative. There can be no assurance that Brady Bonds in which the Fund may
invest will not be subject to restructuring arrangements or to requests for new
credit, which may cause the Fund to suffer a loss of interest or principal on
any of its holdings.
Loan Participation Interests
A Fund's investment in loan participation interests may take the form of
participation interests in, assignments or novations of a corporate loan
("Participation Interests"). The Participation Interests may be acquired from an
agent bank, co-lenders or other holders of Participation Interests
("Participants"). In a novation, a Fund would assume all of the rights of the
lender in a corporate loan, including the right to receive payments of principal
and interest and other amounts directly from the borrower and to enforce its
rights as a lender directly against the borrower. As an alternative, a Fund may
purchase an assignment of all or a portion of a lender's interest in a corporate
loan, in which case, the Fund may be required generally to rely on the assigning
lender to demand payment and enforce its rights against the borrower, but would
otherwise be entitled to all of such lender's rights in the corporate loan. A
Fund also may purchase a Participation Interest in a portion of the rights of a
lender in a corporate loan. In such a case, the Fund will be entitled to 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
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sole negotiator of a structure with respect to a corporate loan.
In a typical corporate loan involving the sale of Participation Interests,
the agent bank administers the terms of the corporate loan agreement and is
responsible for the collection of principal and interest and fee payments to the
credit of all lenders which are parties to the corporate loan agreement. The
agent bank in such cases will be qualified under the 1940 Act to serve as a
custodian for a registered investment company such as the Company. A Fund
generally will rely on the agent bank or an intermediate Participant to collect
its portion of the payments on the corporate loan. The agent bank monitors the
value of the collateral and, if the value of the collateral declines, may take
certain action, including accelerating the corporate loan, giving the borrower
an opportunity to provide additional collateral or seeking other protection for
the benefit of the Participants in the corporate loan, depending on the terms of
the corporate loan agreement. Furthermore, unless under the terms of a
participation agreement a Fund has direct recourse against the borrower (which
is unlikely), the Fund will rely on the agent bank to use appropriate creditor
remedies against the borrower. The agent bank also is responsible for monitoring
compliance with covenants contained in the corporate loan agreement and for
notifying holders of corporate loans of any failures of compliance. Typically,
under corporate loan agreements, the agent bank is given broad discretion in
enforcing the corporate loan agreement, and is obligated to use only the same
care it would use in the management of its own property. For these services, the
borrower compensates the agent bank. Such compensation may include special fees
paid on structuring and funding the corporate loan and other fees paid on a
continuing basis.
A financial institution's employment as an agent bank may be terminated in
the event that it fails to observe the requisite standard of care or becomes
insolvent, or has a receiver, conservator, or similar official appointed for it
by the appropriate bank regulatory authority or becomes a debtor in a bankruptcy
proceeding. A successor agent bank generally will be appointed to replace the
terminated bank, and assets held by the agent bank under the corporate loan
agreement should remain available to holders of corporate loans. If, however,
assets held by the agent bank for the benefit of a Fund were determined by an
appropriate regulatory authority or court to be subject to the claims of the
agent bank's general or secured creditors, the Fund might incur certain costs
and delays in realizing payment on a corporate loan, or suffer a loss of
principal and/or interest. In situations involving intermediate Participants
similar risks may arise.
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When a Fund acts as co-lender in connection with a Participation Interest
or when a Fund acquires a Participation Interest the terms of which provide that
the Fund will be in privity of contract with the corporate borrower, the Fund
will have direct recourse against the borrower in the event the borrower fails
to pay scheduled principal and interest. In all other cases, the Fund will look
to the agent bank to enforce appropriate credit remedies against the borrower.
In acquiring Participation Interests a Fund will conduct analysis and evaluation
of the financial condition of each such co-lender and participant to ensure that
the Participation Interest meets the Fund's qualitative standards. There is a
risk that there may not be a readily available market for 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 Participation
Interests not subject to puts to be illiquid.
Options on Securities
Writing Call Options. Each Fund, as specified for that Fund in the
Prospectus, may sell ("write") covered call options on its portfolio securities
in an attempt to enhance investment performance. A call option sold by a Fund is
a short-term contract, having a duration of nine months or less, which gives the
purchaser of the option the right to buy, and the writer of the option--in
return for a premium received--the obligation to sell, the underlying security
at the exercise price upon the exercise of the option at any time prior to the
expiration date, regardless of the market price of the security during the
option period. A call option on a stock or bond index gives the purchaser of the
option, in return for the premium paid, the right to receive from the seller
cash equal to the difference between the closing price of the index and the
exercise price of the option. A call option may be covered by, among other
things, the writer's owning the underlying security throughout the option
period, or by holding, on a share-for-share basis, a call on the same security
as the call written, where the exercise price of the call held is equal to or
less than the price of the call written, or greater than the exercise price of a
call written if the difference is maintained by the Fund in liquid assets in a
segregated account with its custodian.
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A Fund will write covered call options both to reduce the risks associated
with certain of its investments and to increase total investment return through
the receipt of premiums. In return for the premium income, the Fund will give up
the opportunity to profit from an increase in the market price of the underlying
security above the exercise price so long as its obligations under the contract
continue, except insofar as the premium represents a profit. Moreover, in
writing the call option, the Fund will retain the risk of loss should the price
of the security decline, which loss the premium is intended to offset in whole
or in part. A Fund, in writing "American Style" call options, must assume that
the call may be exercised at any time prior to the expiration of its obligations
as a writer, and that in such circumstances the net proceeds realized from the
sale of the underlying securities pursuant to the call may be substantially
below the prevailing market price. In contrast, "European Style" options may
only be exercised on the expiration date of the option. Covered call options and
the securities underlying such options will be listed on national securities
exchanges, except for certain transactions in options on debt securities and
foreign securities.
A Fund may protect itself from further losses due to a decline in value of
the underlying security or from the loss of ability to profit from appreciation
by buying an identical option, in which case the purchase cost may offset the
premium. In order to do this, the Fund makes a "closing purchase
transaction"--the purchase of a call option on the same security with the same
exercise price and expiration date as the covered call option which it has
previously written on any particular security. The Fund will realize a gain or
loss from a closing purchase transaction if the amount paid to purchase a call
option in a closing transaction is less or more than the amount received from
the sale of the covered call option. Also, because increases in the market price
of a call option will generally reflect increases in the market price of the
underlying security, any loss resulting from the closing out of a call option is
likely to be offset in whole or in part by unrealized appreciation of the
underlying security owned by the Fund. When a security is to be sold from the
Fund's portfolio, the Fund will first effect a closing purchase transaction so
as to close out any existing covered call option on that security.
A closing purchase transaction may be made only on a national or foreign
securities exchange (an "Exchange") which provides a secondary market for an
option with the same exercise price and expiration date. There is no assurance
that a liquid secondary market on an Exchange or otherwise will exist for any
particular option, or at any particular time, and for some options no secondary
market on an Exchange or otherwise may
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exist. If a Fund is unable to effect a closing purchase transaction involving an
exchange-traded option, the Fund will not sell the underlying security until the
option expires or the Fund delivers the underlying security upon exercise.
Over-the-counter options differ from exchange-traded options in that they are
two-party contracts with price and other terms negotiated between buyer and
seller, and generally do not have as much market liquidity as exchange-traded
options. Therefore, a closing purchase transaction for an over-the-counter
option may in many cases only be made with the other party to the option.
Each Fund pays brokerage commissions and dealer spreads in connection with
writing covered call options and effecting closing purchase transactions, as
well as for purchases and sales of underlying securities. The writing of covered
call options could result in significant increases in a Fund's portfolio
turnover rate, especially during periods when market prices of the underlying
securities appreciate. Subject to the limitation that all call and put option
writing transactions be covered, the International Bond Fund and International
Equity Fund may, to the extent determined appropriate by the Sub-Adviser, engage
without limitation in the writing of options on their portfolio securities.
Writing Put Options. Each Fund, as specified for the Fund in the
Prospectus, may also write covered put options. A put option is a short-term
contract which gives the purchaser of the put option, in return for a premium,
the right to sell the underlying security to the seller of the option at a
specified price during the term of the option. A put option written by the Fund
is "covered" if the Fund maintains liquid assets with a value equal to the
exercise price in a segregated account with its custodian. A put option is also
"covered" if the Fund holds on a share-for-share basis a put on the same
security as the put written, where the exercise price of the put held is equal
to or greater than the exercise price of the put written, or less than the
exercise price of the put written if the difference is maintained by the Fund in
liquid assets in a segregated account with its custodian.
The premium which the Funds receive from writing a put option will
reflect, among other things, the current market price of the underlying
security, the relationship of the exercise price to such market price, the
historical price volatility of the underlying security, the option period,
supply and demand and interest rates.
The Funds may effect a closing purchase transaction to realize a profit on
an outstanding put option or to prevent an outstanding put option from being
exercised. If a Fund is able
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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 may also write straddles (combinations of covered
puts and calls on the same underlying security). The extent to which the Funds
may write covered call options and enter into so-called "straddle" transactions
involving put or call options may be limited by the requirements of the Internal
Revenue Code for qualification as a regulated investment company and the
Company's intention that each Fund qualify as such.
Purchasing Options. Each Fund, as specified for the Fund in the
Prospectus, may purchase put or call options which are traded on an Exchange or
in the over-the-counter market. Options traded in the over-the-counter market
may not be as actively traded as those listed on an Exchange. Accordingly, it
may be more difficult to value such options and to be assured that they can be
closed out at any time. The Funds will engage in such transactions only with
firms of sufficient creditworthiness so as to minimize these risks.
The Funds may purchase put options on securities to protect their holdings
in an underlying or related security against a substantial decline in market
value. Securities are considered related if their price movements generally
correlate with one another. The purchase of put options on securities held in
the portfolio or related to such securities will enable a Fund to preserve, at
least partially, unrealized gains occurring prior to the purchase of the option
on a portfolio security without actually selling the security. In addition, the
Fund will continue to receive interest or dividend income on the security.
The Funds may also purchase call options on securities the Funds intend to
purchase to protect against substantial increases in prices of such securities
pending their ability to invest in an orderly manner in such securities. In
order to terminate an option position, the Funds may sell put or call options
identical to those previously purchased, which could result in a net gain or
loss depending on whether the amount received on the sale is more or less than
the premium and other transaction costs paid on the put or call option when it
was purchased.
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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.
Options on Foreign Currencies
Each Fund, as specified for the Fund in the Prospectus, may purchase and
write options on foreign currencies for hedging purposes in a manner similar to
that of the Fund's transactions in currency futures contracts or forward
contracts. A Fund may purchase and write put and call options on foreign
currencies for the purpose of protecting against declines in the dollar value of
foreign portfolio securities and against increases in the U.S. dollar cost of
foreign securities to be acquired. A fund may also use foreign currency options
to protect against potential losses in positions denominated in one foreign
currency against another foreign currency in which the Fund's assets are or may
be invested. For example, a decline in the dollar value of a foreign currency in
which portfolio securities are denominated will reduce the dollar value of such
securities, even if their value in the foreign currency remains constant. In
order to protect against such diminutions in the value of portfolio securities,
a Fund may purchase put options on the foreign currency. If the value of the
currency does decline, that Fund will have the right to sell such currency for a
fixed amount of dollars which exceeds the market value of such currency,
resulting in a gain that may offset, in whole or in part, the negative effect of
currency depreciation on the value of the Fund's securities denominated in that
currency.
Conversely, if a rise in the dollar value of a currency in which
securities to be acquired are denominated is projected, thereby increasing the
cost of such securities, a Fund may purchase call options on such currency. If
the value of such currency does increase, the purchase of such call options
would enable the Fund to purchase currency for a fixed amount of dollars which
is less than the market value of such currency, resulting in a gain that may
offset, at least partially, the effect of any currency-related increase in the
price of securities the Fund intends to acquire. As in the case of other
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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 may also write options on foreign currencies for hedging purposes.
For example, if a Fund anticipates a decline in the dollar value of foreign
currency-denominated securities due to declining exchange rates, it could,
instead of purchasing a put option, write a call option on the relevant
currency. If the expected decline occurs, the option will most likely not be
exercised, and the diminution in value of portfolio securities will be offset by
the amount of the premium received by the Fund.
Similarly, instead of purchasing a call option to hedge against an
anticipated increase in the dollar cost of securities to be acquired, a Fund
could write a put option on the relevant currency. If rates move in the manner
projected, the put option will expire unexercised and allow the Fund to offset
such increased cost up to the amount of the premium. As in the case of other
types of options transactions, however, the writing of a foreign currency option
will constitute only a partial hedge up to the amount of the premium, and only
if rates move in the expected direction. If unanticipated exchange rate
fluctuations occur, the option may be exercised and a Fund would be required to
purchase or sell the underlying currency at a loss which may not be fully offset
by the amount of the premium. As a result of writing options on foreign
currencies, a Fund also may be required to forego all or a portion of the
benefits which might otherwise have been obtained from favorable movements in
currency exchange rates.
A call option written on foreign currency by a Fund is "covered" if that
Fund owns the underlying foreign currency subject to the call or securities
denominated in that currency or has an absolute and immediate right to acquire
that foreign currency without additional cash consideration (or for additional
cash consideration held in a segregated account by its custodian) upon
conversion or exchange of other foreign currency held in its portfolio. A call
option is also covered if a Fund holds a call on the same foreign currency for
the same principal amount as the call written where the exercise price of the
call held (a) is equal to or less than the exercise price of the call written or
(b) is greater than the exercise price of the call written if the amount of the
difference is maintained by a Fund in liquid assets in a segregated account with
its custodian.
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Options on foreign currencies to be written or purchased by a Fund will be
traded on U.S. and foreign exchanges or over-the-counter. Exchange-traded
options generally settle in cash, whereas options traded over-the-counter may
settle in cash or result in delivery of the underlying currency upon exercise of
the option. As with other kinds of option transactions, however, the writing of
an option on foreign currency will constitute only a partial hedge up to the
amount of the premium received and a Fund could be required to purchase or sell
foreign currencies at disadvantageous exchange rates, thereby incurring losses.
The purchase of an option on foreign currency may constitute an effective hedge
against exchange rate fluctuations, although, in the event of rate movements
adverse to a Fund's position, a Fund may forfeit the entire amount of the
premium plus related transaction costs.
Futures Transactions
Each Fund, as specified for the Fund in the Prospectus, may purchase and
sell futures contracts on securities, interest rates, foreign currency and on
indexes of securities, to hedge against anticipated changes in interest rates
and other economic factors that might otherwise have an adverse effect upon the
value of a Fund's portfolio securities. An interest rate or stock index futures
contract is an agreement to take or make delivery of an amount of cash based on
the difference between the value of the index at the beginning and at the end of
the contract period. A futures contract on a foreign currency is an agreement to
buy or sell a specified amount of a currency for a set price on a future date.
The Funds, as specified in the Prospectus, may also enter into such futures
contracts in order to lengthen or shorten the average maturity or duration of
the Fund's portfolio. For example, a Fund may purchase futures contracts as a
substitute for the purchase of longer-term debt securities to lengthen the
average duration of a Fund's portfolio of fixed-income securities. A Fund may
purchase and sell stock index futures to hedge its securities portfolio with
regard to market (systematic) risk (involving the market's assessment of overall
economic prospects), as distinguished from stock-specific risk (involving the
market's evaluation of the merits of the issuer of a particular security).
The Funds, as specified for the Fund in the Prospectus, may also purchase
and sell other futures when deemed appropriate, in order to hedge the equity or
non-equity portions of their portfolios. In addition, each Fund, as specified
for the Fund in the Prospectus, may enter into contracts for the future delivery
of foreign currencies to hedge against changes in currency exchange rates. Each
of the Funds, as specified for the Fund in the Prospectus, may also purchase and
write put and call options
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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 liquid assets ("initial margin") as a partial guarantee of
its performance under the contract. The margin required for a futures contract
is set by the exchange on which the contract is traded and may be modified
during the term of the contract. The initial margin is in the nature of a
performance bond or good faith deposit on the futures contract which is returned
to the Fund upon termination of the contract assuming all contractual
obligations have been satisfied. Each Fund expects to earn interest income on
its initial margin deposits. A futures contract held by a Fund is valued daily
at the official settlement price of the exchange on which it is traded. Each
day, as the value of the security, currency or index fluctuates, the Fund pays
or receives cash, called "variation margin," equal to the daily change in value
of the futures contract. This process is known as "marking to market." Variation
margin does not represent a borrowing or loan by a Fund but is instead a
settlement between the Fund and the broker of the amount one would owe the other
if the futures contract expired. In computing daily net asset value, each Fund
will mark to market its open futures positions.
A Fund is also required to deposit and maintain margin with respect to put
and call options on futures contracts written by it. Such margin deposits will
vary depending on the nature of
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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 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
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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 may enter into futures on debt securities indexes to
the extent they have debt securities in their portfolios. By establishing an
appropriate "short" position in securities index futures, a Fund may seek to
protect the value of its portfolio against an overall decline in the market for
securities. Alternatively, in anticipation of a generally rising market, a Fund
can seek to avoid losing the benefit of apparently low current prices by
establishing a "long" position in securities index futures and later liquidating
that position as particular securities are in fact acquired. To the extent that
these hedging strategies are successful, the Fund will be affected to a lesser
degree by
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adverse overall market price movements, unrelated to the merits of specific
portfolio securities, than would otherwise be the case. A Fund 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 may sell a currency futures contract if a Sub-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 a
Sub-Adviser anticipates that exchange rates will rise, the Fund may purchase a
currency futures contract to protect against an increase in the price of
securities denominated in a particular currency the Fund intends to purchase.
Although the terms of currency futures contracts specify actual delivery or
receipt, in most instances the contracts are closed out before the settlement
date without the making or taking of delivery of the currency. Closing out of a
currency futures contract is effected by entering into an offsetting purchase or
sale transaction. To offset a currency futures contract sold by a Fund, the Fund
purchases a currency futures contract for the same aggregate amount of currency
and delivery date. If the price in the sale exceeds the price in the offsetting
purchase, the Fund is immediately paid the difference. Similarly, to close out a
currency futures contract purchased by the Fund, the Fund sells a currency
futures contract. If the offsetting sale price exceeds the purchase price, the
Fund realizes a gain, and if the offsetting sale price is less than the purchase
price, the Fund realizes a loss.
A risk in employing currency futures contracts to protect against the
price volatility of portfolio securities denominated in a particular currency is
that changes in currency exchange rates or in the value of the futures position
may correlate imperfectly with changes in the cash prices of a Fund's
securities. The degree of correlation may be distorted by the fact that the
currency futures market may be dominated by short-term traders seeking to profit
from changes in exchange rates. This would reduce the value of such contracts
for hedging purposes over a short-term period. Such distortions are generally
minor and would diminish as the contract approached maturity. Another risk is
that a Sub-Adviser could be incorrect in its expectation as to the direction or
extent of various
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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 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 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
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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.
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
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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 or futures option contract if, immediately thereafter, the
aggregate initial margin deposits relating to such positions plus premiums paid
by it for open futures option positions, less the amount by which any such
options are "in-the-money," would exceed 5% of the Fund's total assets. A call
option is "in-the-money" if the value of the futures contract that is the
subject of the option exceeds the exercise price. A put option is "in-the-money"
if the exercise price exceeds the value of the futures contract that is the
subject of the option.
When purchasing a futures contract, a Fund will maintain with its
custodian (and mark-to-market on a daily basis) liquid assets that, when added
to the amounts deposited with a futures commission merchant as margin, are equal
to the market value of the futures contract. Alternatively, the Fund may "cover"
its position by purchasing a put option on the same futures contract with a
strike price as high or higher than the price of the contract held by the Fund.
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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. There can be no assurance that hedging strategies using futures will
be successful. A purchase or sale of a futures contract may result in losses in
excess of the amount invested in the futures contract, which in some cases may
be unlimited. There can be no guarantee that there will be a correlation between
price movements in the hedging vehicle and in the Fund's securities
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being hedged. An incorrect correlation could result in a loss on both the hedged
securities or currencies and the hedging vehicle so that the portfolio return
might have been better had hedging not be attempted. In addition, there are
significant differences between the securities and futures markets that could
result in an imperfect correlation between the markets, causing a given hedge
not to achieve its objectives. The degree of imperfection of correlation depends
on circumstances such as variations in speculative market demand for futures and
futures options on securities, including technical influences in futures trading
and futures options, and differences between the financial instruments being
hedged and the instruments underlying the standard contracts available for
trading in such respects as interest rate levels, maturities, and
creditworthiness of issuers. A decision as to whether, when and how to hedge
involves the exercise of skill and judgment, and even a well-conceived hedge may
be unsuccessful to some degree because of market behavior or unexpected interest
rate trends.
Futures exchanges may limit the amount of fluctuation permitted in certain
futures contract prices during a single trading day. The daily limit establishes
the maximum amount that the price of a futures contract may vary either up or
down from the previous day's settlement price at the end of the current trading
session. Once the daily limit has been reached in a futures contract subject to
the limit, no more trades may be made on that day at a price beyond that limit.
The daily limit governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may work to prevent
the liquidation of unfavorable positions. For example, futures prices have
occasionally moved to the daily limit for several consecutive trading days with
little or no trading, thereby preventing prompt liquidation of positions and
subjecting some holders of futures contracts to substantial losses.
There can be no assurance that a liquid market will exist at a time when a
Fund seeks to close out a futures or a futures option position, and that Fund
would remain obligated to meet margin requirements until the position is closed.
In addition, many of the contracts discussed above are relatively new
instruments without a significant trading history. As a result, there can be no
assurance that an active secondary market will develop or continue to exist.
Lack of a liquid market for any reason may prevent the Fund from liquidating an
unfavorable position and the Fund would remain obligated to meet margin
requirements until the position is closed.
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Additional Risks of Options on Securities, Futures Contracts, Options on
Futures Contracts, and Forward Currency Exchange Contracts and Options Thereon.
Options on securities, futures contracts, options on futures contracts,
currencies and options on currencies may be traded on foreign exchanges. Such
transactions may not be regulated as effectively as similar transactions in the
United States; may not involve a clearing mechanism and related guarantees; and
are subject to the risk of governmental actions affecting trading in, or the
prices of, foreign securities. The value of such positions also could be
adversely affected by (i) other complex foreign political, legal and economic
factors, (ii) lesser availability than in the United States of data on which to
make trading decisions, (iii) delays in a Fund's ability to act upon economic
events occurring in foreign markets during non-business hours in the United
States, (iv) the imposition of different exercise and settlement terms and
procedures and margin requirements than in the United States, and (v) lesser
trading volume.
Swap Agreements
The International Bond Fund, International Equity Fund and Multi-Asset
Fund may enter into interest rate, index and currency exchange rate swap
agreements for purposes of attempting to obtain a particular desired return at a
lower cost to the Fund than if the Fund had invested directly in an instrument
that yielded that desired return or for other portfolio management purposes. The
EAFE Index Fund may enter into index and currency exchange rate swap agreements,
the Indexed Bond Fund may invest up to 10% of its total assets in interest rate
and index swap agreements and the Indexed Equity Fund may enter into index swap
agreements. Swap agreements are two party contracts entered into primarily by
institutional investors for periods ranging from a few weeks to more than one
year. In a standard "swap" transaction, two parties agree to exchange the
returns (or differentials in rates of return) earned or realized on particular
predetermined investments or instruments. The gross returns to be exchanged or
"swapped" between the parties are calculated with respect to a "notional
amount," i.e., the return on or increase in value of a particular dollar amount
invested at a particular interest rate, in a particular foreign currency, or in
a "basket" of securities representing a particular index. The "notional amount"
of the swap agreement is only a fictive basis on which to calculate the
obligations that the parties to a swap agreement have agreed to exchange. Most
swap agreements entered into by the Funds would calculate the obligations of the
parties to the agreement on a "net" basis. Consequently, a Fund's obligations
(or rights) under a swap agreement will generally be equal only to the net
amount to be paid or received under the agreement based on the relative values
of the positions held by
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each party to the agreement (the "net amount"). A Fund's obligations under a
swap agreement will be accrued daily (offset against any amounts owing to the
Fund) and any accrued but unpaid net amounts owed to a swap counterparty will be
covered by the maintenance of a segregated account consisting of liquid assets
to avoid any potential leveraging of the Fund's portfolio. The International
Bond Fund and International Equity Fund will not enter into a swap agreement
with any single party if the net amount owed or to be received under existing
contracts with that party would exceed 5% of the Fund's assets. The EAFE Index
Fund, Indexed Bond Fund, Indexed Equity Fund and Multi-Asset Fund may enter into
swap agreements only to the extent that obligations under such agreements
represent not more than 10% of the Fund's total assets.
Commonly used swap agreements include interest rate caps, under which, in
return for a premium, one party agrees to make payments to the other to the
extent that interest rates exceed a specified rate, or "cap"; interest rate
floors, under which, in return for a premium, one party agrees to make payments
to the other to the extent that interest rates fall below a specified level, or
"floor"; and interest rate collars, under which a party sells a cap and
purchases a floor or vice versa in an attempt to protect itself against interest
rate movements exceeding given minimum or maximum levels.
Whether a Fund's use of swap agreements will be successful in furthering
its investment objective will depend on the Sub-Adviser's ability to correctly
predict whether certain types of investments are likely to produce greater
returns than other investments. Because they are two party contracts and because
they may have terms of greater than seven days, swap agreements may be
considered to be illiquid. Moreover, a Fund bears the risk of loss of the amount
expected to be received under a swap agreement in the event of the default or
bankruptcy of a swap agreement counterparty. The Sub-Adviser will cause a Fund
to enter into swap agreements only with counterparties that would be eligible
for consideration as repurchase agreement counterparties under the Fund's
repurchase agreement guidelines. Certain restrictions imposed on the Funds by
the Internal Revenue Code may limit the Funds' ability to use swap agreements.
The swaps market is a relatively new market and is largely unregulated. It is
possible that developments in the swaps market, including potential government
regulation, could adversely affect a Fund's ability to terminate existing swap
agreements or to realize amounts to be received under such agreements.
Certain swap agreements are exempt from most provisions of the Commodity
Exchange Act ("CEA") and, therefore, are not regulated as futures or commodity
option transactions under the
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CEA, pursuant to regulations approved by the Commodity Futures Trading
Commission ("CFTC") effective February 22, 1993. To qualify for this exemption,
a swap agreement must be entered into by "eligible participants," which includes
the following, provided the participants' total assets exceed established
levels: a bank or trust company, savings association or credit union, insurance
company, investment company subject to regulation under the Investment Company
Act of 1940, commodity pool, corporation, partnership, proprietorship,
organization, trust or other entity, employee benefit plan, governmental entity,
broker-dealer, futures commission merchant, natural person, or regulated foreign
person. To be eligible, natural persons and most other entities must have total
assets exceeding $10 million; commodity pools and employee benefit plans must
have assets exceeding $5 million. In addition, an eligible swap transaction must
meet three conditions. First, the swap agreement may not be part of a fungible
class of agreements that are standardized as to their material economic terms.
Second, the creditworthiness of parties with actual or potential obligations
under the swap agreement must be a material consideration in entering into or
determining the terms of the swap agreement, including pricing, cost or credit
enhancement terms. Third, swap agreements may not be entered into and traded on
or through a multilateral transaction execution facility.
This exemption is not exclusive, and participants may continue to rely on
existing exclusions for swaps, such as the Policy Statement issued in July 1989
which recognized a safe harbor for swap transactions from regulation as futures
or commodity option 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
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potential gain which might result should the value of such currencies increase.
While a Fund may enter into forward contracts to reduce currency exchange
risks, changes in currency exchange rates may result in poorer overall
performance for the Fund than if it had not engaged in such transactions.
Moreover, there may be an imperfect correlation between a Fund's portfolio
holdings of securities denominated in a particular currency and forward
contracts entered into by the Fund. Such imperfect correlation may prevent the
Fund from achieving the intended hedge or expose the Fund to the risk of
currency exchange loss.
A Fund will not enter into forward contracts or maintain a net exposure to
such contracts where the consummation of the contracts would obligate the Fund
to deliver an amount of currency in excess of the value of the Fund's portfolio
securities or other assets denominated in that currency.
A Fund will hold liquid assets in a segregated account with its custodian
in an amount equal (on a daily marked-to-market basis) to the amount of the
commitments under these contracts. At the maturity of a forward contract, a Fund
may either accept or make delivery of the currency specified in the contract, or
prior to maturity, enter into a closing purchase transaction involving the
purchase or sale of an offsetting contract. Closing purchase transactions with
respect to forward contracts are usually effected with the currency trader who
is a party to the original forward contract. A Fund will only enter into such a
forward contract if it is expected that there will be a liquid market in which
to close out the contract. However, there can be no assurance that a liquid
market will exist in which to close a forward contract, in which case the Fund
may suffer a loss.
Normally, consideration of the prospect for currency parities will be
incorporated in a longer term investment decision made with regard to overall
diversification strategies. However, each Sub-Adviser believes that it is
important to have the flexibility to enter into such forward contracts when it
determines that the best interest of a Fund will be served. For example, when a
Fund enters into a contract for the purchase or sale of a security denominated
in a foreign currency, it may desire to "lock in" the U.S. dollar price of the
security. By entering into a forward contract for the purchase or sale, for a
fixed amount of U.S. dollars, of the amount of foreign currency involved in the
underlying security transaction, a Fund will be able to insulate itself from a
possible loss resulting from a change in the relationship between the U.S.
dollar and the subject foreign currency during the period between the date on
which the security is purchased or sold and the date on which
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payment is made or received, although a Fund would also forego any gain it might
have realized had rates moved in the opposite direction. This technique is
sometimes referred to as a "settlement" hedge or "transaction" hedge.
When a Sub-Adviser believes that the currency of a particular foreign
country may suffer a substantial decline against the U.S. dollar, it may enter
into a forward contract to sell, for a fixed amount of dollars, the amount of
foreign currency approximating the value of some or all of a Fund's portfolio
securities denominated in such foreign currency. Such a hedge (sometimes
referred to as a "position hedge") will tend to offset both positive and
negative currency fluctuations, but will not offset changes in security values
caused by other factors. The Fund also may hedge the same position by using
another currency (or a basket of currencies) expected to perform in a manner
substantially similar to the hedged currency ("proxy" hedge). The precise
matching of the forward contract amounts and the value of the securities
involved will not generally be possible since the future value of such
securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the forward contract
is entered into and the date it matures. With respect to positions that
constitute "transaction" or "position" hedges (including "proxy" hedges), a Fund
will not enter into forward contracts to sell currency or maintain a net
exposure to such contracts if the consummation of such contracts would obligate
the Fund to deliver an amount of foreign currency in excess of the value of the
Fund's portfolio securities or other assets denominated in that currency (or the
related currency, in the case of a "proxy" hedge).
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.
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If a Fund chooses to make delivery of the foreign currency, it may be required
to obtain such currency for delivery through the sale of portfolio securities
denominated in such currency or through conversion of other assets of the Fund
into such currency. If a Fund engages in an offsetting transaction, the Fund
will realize a gain or a loss to the extent that there has been a change in
forward contract prices. Closing purchase transactions with respect to forward
contracts are usually effected with the currency trader who is a party to the
original forward contract.
A Fund's dealing in forward contracts will be limited to the transactions
described above. Of course, a Fund is not required to enter into such
transactions with regard to its foreign currency-denominated securities and will
not do so unless deemed appropriate by a Sub-Adviser. A Fund generally will not
enter into a forward contract with a term of greater than one year.
In cases of transactions which constitute "transaction" or "settlement"
hedges or "position" hedges (including "proxy" hedges) or "cross-currency"
hedges that involve the purchase and sale of two different foreign currencies
directly through the same forward foreign currency contact, a Fund may deem its
forward currency hedge position to be covered by underlying Fund portfolio
securities or may establish a Segregated Account with its Custodian in an amount
equal to the value of the Fund's total assets committed to the consummation of
the subject hedge. The Segregated Account will consist of liquid assets. In the
case of "anticipatory" hedges and "cross-currency" hedges that involve the
purchase and sale of two different foreign currencies indirectly through
separate forward currency contracts, the Fund will establish a Segregated
Account with its Custodian as described above. In the event a Fund establishes a
Segregated Account, the Fund will mark-to-market the value of the assets in the
Segregated Account. If the value of the assets placed in the Segregated Account
declines, additional liquid assets will be placed in the account by the Fund on
a daily basis so that the value of the account will equal the amount of the
Fund's commitments with respect to such contracts.
It should be realized that this method of protecting the value of a Fund's
portfolio securities against a decline in the value of a currency does not
eliminate fluctuations in the underlying prices of the securities. It simply
establishes a rate of exchange which can be achieved at some future point in
time. It also reduces any potential gain which may have otherwise occurred had
the currency value increased above the settlement price of the contract.
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The Sub-Advisers believe that active currency management can enhance
portfolio returns through opportunities arising from interest rate differentials
between securities denominated in different currencies and/or changes in value
between currencies. Moreover, the Sub-Advisers believe active currency
management can be employed as an overall portfolio risk management tool. For
example, in their view, foreign currency management can provide overall
portfolio risk diversification when combined with a portfolio of foreign
securities and the market risks by currency strategies which may not involve the
currency in which the foreign security is denominated.
Forward contracts are intended to minimize the risk of loss to a Fund from
adverse changes in the relationship between the U.S. dollar and foreign
currencies. Such contracts do not eliminate fluctuations in the underlying
prices of securities held by the Funds. Although such contracts tend to minimize
the risk of loss due to a decline in the value of a currency that has been sold
forward, and the risk of loss due to an increase in the value of a currency that
has been purchased forward, at the same time they tend to limit any potential
gain that might be realized should the value of such currency increase.
The Funds cannot assure that their use of forward contracts will always be
successful. Successful use of forward contracts depends on the Sub-Adviser's
skill in analyzing and predicting relative currency values. Forward contracts
alter a Fund's exposure to currency exchange rate activity and could result in
losses to the Fund if currencies do not perform as the Sub-Adviser anticipates.
A Fund may also incur significant costs when converting assets from one currency
to another.
A Fund's foreign currency transactions may be limited by the requirements
of Subchapter M of the Code for qualification as a regulated investment company.
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
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return principal and/or pay interest to investors in amounts which are linked to
the level of a particular foreign index ("foreign index-linked instruments"). A
foreign index may be based upon the exchange rate of a particular currency or
currencies or the differential between two currencies, or the level of interest
rates in a particular country or countries or the differential in interest rates
between particular countries. In the case of foreign index-linked instruments
linking the interest components to a foreign index, the amount of interest
payable will adjust periodically in response to changes in the level of the
foreign index during the term of the foreign index-linked instrument. The risks
of such investments would reflect the risks of investing in the index or other
instrument, the performance of which determines the return for the instrument.
Tax considerations may limit the Funds' ability to invest in foreign
index-linked instruments.
Warrants
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.
Each of the Funds will only enter into short sales against the box. A Fund may
enter into a short sale against the box among other reasons, to hedge against a
possible market decline in the value of a security owned. If the value of a
security sold short against the box increases, the Fund would suffer a loss when
it purchases or delivers to the selling broker the security sold short. The
proceeds of the short sale are retained by the broker pursuant to applicable
margin rules. In addition, the Fund may segregate assets, equal in value to 50%
of the value of the short sale, in a special account with the Fund's custodian.
The segregated assets are pledged to the broker pursuant to
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applicable margin rules. If a broker, with which the Fund has open short sales,
were to become bankrupt, a Fund could experience losses or delays in recovering
gains on short sales. The Funds will only enter into short sales against the box
with brokers they believe are creditworthy. Short sales against the box will be
limited to no more than 25% of a Fund's total assets.
High Yield/High Risk Securities
Analysis of the creditworthiness of issuers of high yield/high risk bonds
may be more complex than for issuers of higher quality debt securities, and the
ability of the Fund to achieve its investment objective may, to the extent of
its investment in high yield/high risk bonds, be more dependent upon such
creditworthiness analysis than would be the case if the Fund were investing in
higher quality bonds.
High yield/high risk bonds may be more susceptible to real or perceived
adverse economic and competitive industry conditions than higher grade bonds.
The prices of high yield/high risk bonds have been found to be less sensitive to
interest rate changes than more highly rated investments, but more sensitive to
adverse economic downturns or individual corporate developments. If the issuer
of high yield/high risk bonds defaults, the Fund may incur additional expenses
to seek recovery. In the case of high yield/high risk bonds structured as zero
coupon or payment-in-kind securities, the market prices of such securities are
affected to a greater extent by interest rate changes and, therefore, tend to be
more volatile than securities which pay interest periodically and in cash.
The secondary market on which high yield/high risk bonds are traded may be
less liquid than the market for higher grade bonds. Less liquidity in the
secondary trading market could adversely affect the price at which the Fund
could sell a high yield/high risk bond, and could adversely affect and cause
large fluctuations in the daily net asset value of the Fund's shares. A
projection of an economic downturn or of a period of rising interest rates, for
example, could cause a decline in high yield/high risk bond prices because the
advent of a recession could lessen the ability of a highly leveraged company to
make principal and interest payments on its debt securities. Adverse publicity
and investor perceptions, whether or not based on fundamental analysis, may
decrease the values and liquidity of high yield/high risk bonds, especially in a
thinly traded market.
Legislation designed to limit the use of high yield/high risk bonds in
corporate transactions may have a material adverse effect on the International
Bond Fund's net asset value and investment practices. In addition, there may be
special tax
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considerations associated with investing in high yield/high risk bonds
structured as zero coupon or payment-in-kind securities. Interest on these
securities is recorded annually as income even though no cash interest is
received until the security's maturity or payment date. As a result, the amounts
which have accrued each year are required to be distributed to shareholders and,
such amounts will be taxable to shareholders. Therefore, the Fund may have to
sell some of its assets to distribute cash to shareholders. These actions are
likely to reduce the Fund's assets and may thereby increase its expense ratios
and decrease its rate of return.
The use of credit ratings as the sole method for evaluating high
yield/high risk bonds also involves certain risks. For example, credit ratings
evaluate the safety of principal and interest payments, not the market value
risk of high yield/high risk bonds. Also, credit rating agencies may fail to
change credit ratings on a timely basis to reflect subsequent events.
Zero Coupon Bonds
Zero coupon bonds are debt obligations issued without any requirement for
the periodic payment of interest. Zero coupon bonds are issued at a significant
discount from the face value. The discount approximates the total amount of
interest the bonds would accrue and compound over the period until maturity at a
rate of interest reflecting the market rate at the time of issuance. Cash to pay
dividends representing unpaid, accrued interest may be obtained from sales
proceeds of portfolio securities and Fund shares and from loan proceeds. Because
interest on zero coupon obligations is not paid to the Fund on a current basis
but is in effect compounded, the value of the securities of this type is subject
to greater fluctuations in response to changing interest rates than the value of
debt obligations which distribute income regularly. Zero coupon bonds tend to be
subject to greater market risk than interest paying securities of similar
maturities. The discount represents income a portion of which a Fund must accrue
and distribute every year even though the Fund receives no payment on the
investment in that year.
INDEXED EQUITY FUND SPECIAL CONSIDERATIONS
Standard & Poor's, "S&P 500", "S&P", "S&P 500", "Standard & Poor's 500"
and "500" are trademarks of Standard & Poor's Corporation and have been licensed
for use by Monitor Capital Advisors, Inc. S&P does not sponsor, endorse, sell or
promote the Fund or represent the advisability of investing in the Fund.
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The Fund is not sponsored, endorsed, sold or promoted by S&P. S&P makes no
representation or warranty, express or implied, to the owners of the Fund or any
member of the public regarding the advisability of investing in securities
generally or in the fund particularly or the ability of the S&P 500 Index to
track general stock market performance. S&P's only relationship to Monitor is
the licensing of certain trademarks and trade names of S&P and of the S&P 500
Index which is determined, composed and calculated by S&P without regard to
Monitor or the Fund. S&P has no obligation to take the needs of Monitor or the
owners of the Fund into consideration in determining, composing or calculating
the S&P 500 Index. S&P is not responsible for and has not participated in the
determination of the prices and amount of the Fund or the timing of the issuance
or sale of the Fund or in the determination or calculation of the equation by
which the Fund is to be converted into cash. S&P has no obligation or liability
in connection with the administration, marketing or trading of the Fund.
S&P does not guarantee the accuracy and/or the completeness of the S&P 500
Index or any data included therein and S&P shall have no liability for any
errors, omissions, or interruptions therein. S&P makes no warranty, express or
implied, as to results to be obtained by Monitor, owners of the Fund, or any
other person or entity from the use of the S&P Index or any data included
therein. S&P makes no express or implied warranties, and expressly disclaims all
warranties of merchantability or fitness for a particular purpose or use with
respect to the S&P 500 Index or any data included therein. Without limiting any
of the foregoing, in no event shall S&P have any liability for any special,
punitive, indirect, or consequential damages (including lost profits), even if
notified of the possibility of such damages.
INVESTMENT RESTRICTIONS
The Funds' investment restrictions set forth 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, as defined in
the 1940 Act. Except for those investment policies of a Fund specifically
identified as fundamental in the Prospectus and this Statement of Additional
Information, all other investment policies and practices described may be
changed by the Board of Directors without the approval of shareholders.
Unless otherwise indicated, all of the percentage limitations below, and
in the investment restrictions recited
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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.
Each Fund has adopted a fundamental restriction that it may not:
(1) invest in a security if, as a result of such investment, 25% or more
of its total assets would be invested in the securities of issuers in any
particular industry, except that this restriction does not apply to securities
issued or guaranteed by the U.S. Government or its agencies or instrumentalities
(or repurchase agreements with respect thereto) and at such time that the 1940
Act is amended to permit a registered investment company to elect to be
"periodically industry concentrated," (i.e., a fund that does not concentrate
its investments in a particular industry would be permitted, but not required,
to invest 25% or more of its assets in a particular industry) the Funds elect to
be so classified and the foregoing limitation shall no longer apply with respect
to the Funds;
(2) invest in a security if, with respect to 75% of its total assets, more
than 5% of its total assets would be invested in the securities of any one
issuer, except that this restriction does not apply to securities issued or
guaranteed by the U.S. Government, its agencies or instrumentalities (this
restriction is not applicable to the International Bond Fund);
(3) invest in a security if, with respect to 75% of its assets, it would
hold more than 10% of the outstanding voting securities of any one issuer,
except that this restriction does not apply to U.S. Government securities (this
restriction is not applicable to the International Bond Fund);
(4) borrow money or issue senior securities, except that a Fund may (i)
borrow from banks or enter into reverse repurchase agreements, but only if
immediately after each borrowing there is asset coverage of 300%, and (ii) issue
senior securities to the extent permitted under the 1940 Act;
(5) lend any funds or other assets, except that a Fund may, consistent
with its investment objectives and policies: (i) invest in debt obligations
including bonds, debentures or other debt securities, bankers' acceptances and
commercial paper, even though the purchase of such obligations may be deemed to
be the making of loans; (ii) enter into repurchase agreements; and (iii)
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lend its portfolio securities in accordance with applicable guidelines
established by the Securities and Exchange Commission and any guidelines
established by the Company's Directors;
(6) purchase or sell real estate (although it may purchase securities
secured by real estate or interests therein, or securities issued by companies
which invest in real estate, or interests therein);
(7) purchase or sell commodities or commodities contracts, except that,
subject to restrictions described in the Prospectus and in this Statement of
Additional Information, (i) a Fund may enter into futures contracts on
securities, currencies or on indexes of such securities or currencies, or any
other financial instruments and options on such futures contracts; (ii) a Fund
may enter into spot or forward foreign currency contracts and foreign currency
options; or
(8) act as an underwriter of securities of other issuers, except to the
extent that in connection with the disposition of portfolio securities, it may
be deemed to be an underwriter under the Federal securities laws.
ADDITIONAL RESTRICTIONS
Each Fund has adopted the following additional restrictions which are not
fundamental and which may be changed without shareholder approval, to the extent
permitted by applicable law, regulation or regulatory policy.
Unless otherwise indicated, all percentage limitations apply to each Fund
on an individual basis, and apply only at the time a transaction is entered
into. Accordingly, if a percentage restriction is adhered to at the time of
investment, a later increase or decrease in the percentage which results from a
relative change in values or from a change in a Fund's net assets will not be
considered a violation.
Under these restrictions, a Fund may not:
(1) (except for the International Bond Fund and International Equity Fund)
purchase puts, calls, straddles, spreads and any combination thereof if, as a
result, the value of its aggregate investment in such classes of securities
would exceed 5% of its total assets;
(2) purchase securities that may not be sold without first being
registered under the Securities Act of 1933, as amended ("restricted
securities") other than Rule 144A securities and Section 4(2) commercial paper
determined to be liquid pursuant to
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<PAGE>
guidelines adopted by the Company's Board of Directors; enter into repurchase
agreements having a duration of more than seven days; purchase loan
participation interests that are not subject to puts; purchase instruments
lacking readily available market quotations ("illiquid instruments"); or
purchase or sell over-the-counter options, if as a result of the purchase or
sale, the Fund's aggregate holdings of restricted securities, repurchase
agreements having a duration of more than seven days, loan participation
interests that are not subject to puts, illiquid instruments, and
over-the-counter options purchased by the Fund and the assets used as cover for
over-the-counter options written by the Fund exceed 10% of the Fund's net assets
(15% of net assets in the case of the International Bond Fund and International
Equity Fund);
(3) invest in other companies for the purpose of exercising control;
(4) purchase the securities of other investment companies, except to the
extent permitted by the 1940 Act or in connection with a merger, consolidation,
acquisition or reorganization;
(5) a Fund may not purchase securities on margin, except that the Fund may
obtain such short-term credits as are necessary for the clearance of
transactions, and provided that margin payments in connection with futures
contracts and options on futures contracts shall not constitute the purchase of
securities on margin;
(6) a Fund may not sell securities short, except for covered short sales
or unless it owns or has the right to obtain securities equivalent in kind and
amount to the securities sold short, and provided that transactions in options,
futures and forward contracts are deemed not to constitute short sales of
securities.
The Directors have the ultimate responsibility for determining whether
specific securities are liquid or illiquid. The Directors have delegated the
function of making day-to-day determinations of liquidity to the
Sub-Advisers,pursuant to guidelines approved by the Directors.
Each Sub-Adviser takes into account a number of factors in determining
whether a Rule 144A security being considered for purchase by a Fund is liquid,
including at least the following:
(i) the frequency and size of trades and quotes for the Rule 144A security
relative to the size of the Fund's holding;
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<PAGE>
(ii) the number of dealers willing to purchase or sell the 144A security
and the number of other potential purchasers;
(iii) dealer undertaking to make a market in the 144A security; and
(iv) the nature of the 144A security and the nature of the market for the
144A security (i.e., the time needed to dispose of the security, the method of
soliciting offers, and the mechanics of transfer).
To make the determination that an issue of 4(2) commercial paper is liquid, a
Sub-Adviser must conclude that the following conditions have been met:
(a) the 4(2) commercial paper is not traded flat or in default as to
principal or interest;
(b) the 4(2) commercial paper is rated:
(i) in one of the two highest rating categories by at least two nationally
recognized statistical rating organizations ("NRSROs"); or
(ii) if only one NRSRO rates the security, the 4(2) commercial paper is
rated in one of the two highest rating categories by that NRSRO; or
(iii) if the security is unrated, the Sub-Adviser has determined that the
security is of equivalent quality based on factors commonly used by rating
agencies; and
(c) there is a viable trading market for the specific security,
taking into account all relevant factors (e.g., whether the security is the
subject of a commercial paper program that is administered by an issuing and
paying agent bank and for which there exists a dealer willing to make a market
in the security, the size of trades relative to the size of the Fund's holding
or whether the 4(2) commercial paper is administered by a direct issuer pursuant
to a direct placement program).
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):
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Name Position(s) with Principal Occupation(s)
Address and Age the Company During Past 5 Years
- --------------- ---------------- -------------------
Stephen C. Roussin, 35 Director and Chairperson President, Chief
of the Board of Directors* Executive Officer and
Trustee, The MainStay
Funds, 1997-present;
Senior Vice President,
New York Life Insurance
Company, 1997 to present;
Senior Vice President,
Smith Barney, 1994 to
1997; and Division Sales
Manager, Prudential
Securities, 1989 to 1994.
Director, New York Life
Trust Company, 1997 to
present; Director, New
York Life Benefit
Services, Inc., 1997 to
present; Director, NYLIFE
Securities, Inc., 1997 to
present; Director,
MainStay Shareholder
Services Inc., 1997 to
present; Director, Eagle
Strategies Corp., 1997 to
present; Director,
President and Chief
Executive Officer,
MainStay Management,
Inc., 1997 to present.
Patrick G. Boyle, 44 Director* Senior Vice President,
Pension Department, New
York Life Insurance
Company, 1991 to present;
Vice President, Pension
Department, New York Life
Insurance Company,
1988-1991; Pension Vice
President, Pension
Department, New York Life
Insurance Company,
1986-1988; Assistant Vice
President, Pension
Department, New York Life
Insurance Company,
1985-1986; Director,
NYLIFE Distributors Inc.,
1993 to 1996; Chairman,
Monitor Capital Advisors,
Inc., 1996 to present,
and Director, 1991 to
present; Director, New
York Life Benefit
Services, Inc., 1994 to
present; Director, New
York Life International
Investment Inc., 1995 to
present; Director, New
York Life Trust Company,
1995 to present;
Director, NYL Capital
Management Limited, 1994
to present; Member,
American Council of Life
Insurance Pension
Committee, 1992 to
present.
Lawrence Glacken, 70 Director Retired, 1987 to present;
353 Canterbury Drive Vice President,
Ramsey, NJ 07446 Investment Banking, The
First Boston Corporation,
1964-1987.
Robert P. Mulhearn, 51 Director Private Investor, 1987 to
60 Twin Brooks Road present; Managing
Saddle River, NJ 07458 Director, Morgan Stanley,
1979-1987.
Susan B. Kerley, 46 Director President, Global
P.O. 9572 Research Associates, 1990
New Haven, CT 06535 to present; Manager,
Special Investments,
Rockefeller & Co.,
1988-1990; Director of
Research, Rogers, Casey
and Barksdale, 1983-1988;
Director, Citifunds, 1991
to present.
Linda M. Livornese, 46 President Vice President, Pension
Department, New York Life
Insurance Company, 1990
to present; Pension Vice
President, Pension
Department, New York Life
Insurance Company,
1988-1990; Assistant Vice
President, Pension
Department, New York Life
Insurance Company,
1986-1988; Vice
President, NYLIFE
Distributors Inc., 1993
to present; Vice
President, NYLIFE
Securities Inc., 1992 to
present.
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<PAGE>
Name Position(s) with Principal Occupation(s)
Address and Age the Company During Past 5 Years
- --------------- ---------------- -------------------
Jefferson C. Boyce, 41 Senior Vice President Senior Vice President,
New York Life Insurance
Company, 1994 to present;
Senior Vice President,
The MainStay Funds, 1995
to present; Director,
Monitor Capital Advisors,
Inc., 1991 to present and
Senior Vice President,
1996 to present;
Director, MSC Holding,
Inc., 1992 to present and
Secretary, 1994 to
present; Director, Eagle
Strategies Corp., 1993 to
present; Director, NYLIFE
Equity, Inc., 1993 to
present; President and
Chief Executive Officer,
NYLIFE Distributors Inc.,
1996 to present and
Director, 1993 to
present; Director, NYLIFE
Inc., 1993 to present;
Director, NYLIFE
Structured Asset
Management Company Ltd.,
1993 to present;
Director, CNP Realty
Investments, Inc., 1994
to present; Director, New
York Life Benefit
Services, Inc., 1994 to
present; Director, NYLIFE
Depositary Corporation,
1994 to present;
Director, NYLIFE Realty
Inc., 1994 to present;
Director, NYLIFE SFD
Holding Inc. (formerly
NAFCO, Inc.), 1994 to
present; Director,
President and Chief
Executive Officer, NYLIFE
Securities Inc., 1996 to
present; Chairman and
Director, MainStay
Shareholder Services
Inc., 1997 to present;
Chief Administrative
Officer, Pension, Mutual
Funds, Structured
Finance, Corporate
Quality, Human Resources
and Employees' Health
Departments, New York
Life Insurance Company,
1992 to 1994; Vice
President, Pension
Department, New York Life
Insurance Company, 1989
to 1992.
Robert S. Fenster, 48 Vice President Vice President, Pension
Department, New York Life
Insurance Company, 1988
to present; Director New
York Life Trust Company,
1995 to present.
Richard W. Zuccaro, 48 Tax Vice President Vice President, New York
Life Insurance Company,
1995 to present; Vice
President -- Tax, New
York Life Insurance
Company, 1986 to 1995;
Tax Vice President,
NYLIFE Securities Inc.,
1987 to present; Tax Vice
President, NYLIFE SFD
Holding Inc., 1990 to
present; Tax Vice
President, NYLIFE
Depositary Inc., 1990 to
present; Tax Vice
President, NYLIFE Inc.,
1990 to present; Tax Vice
President, NYLIFE
Insurance Company of
Arizona, 1990 to present;
Tax Vice President,
NYLIFE Realty Inc., 1991
to present; Tax Vice
President, NYLICO Inc.,
1991 to present; Tax Vice
President, New York Life
Fund Inc., 1991 to
present; Tax Vice
President, New York Life
International Investment,
Inc., 1991 to present;
Tax Vice President NYLIFE
Funding Inc., 1991 to
present; Tax Vice
President, NYLCO, 1991 to
present; Tax Vice
President, NYLIFE Equity
Inc., 1991 to present;
Tax Vice President,
MainStay VP Series Fund,
Inc., 1991 to present;
Tax Vice President, CNP
Realty Investments, Inc.,
1991 to present; Tax Vice
President, New York Life
Worldwide Holding, Inc.,
1992 to present; Tax Vice
President, NYLIFE
Structured Asset
Management Company Ltd.,
1992 to present; Tax Vice
President, The MainStay
Funds, 1991 to present;
Tax Vice President, Eagle
Strategies Corp.
(registered investment
adviser), 1993 to
present; Tax Vice
President, NYLIFE
Distributors Inc., 1993
to present; Vice
President & Assistant
Controller, New York Life
Insurance
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<PAGE>
Name Position(s) with Principal Occupation(s)
Address and Age the Company During Past 5 Years
- --------------- ---------------- -------------------
and Annuity Corp., 1995
to present, and Assistant
Controller, 1991 to 1995;
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, New York
Life Trust Company, 1996
to present; Tax Vice
President, Monitor
Capital Advisors, Inc.,
1996 to present; Tax Vice
President, NYLINK
Insurance Agency
Incorporated, 1996 to
present; Tax Vice
President, MainStay
Shareholder Services
Inc., 1997 to present.
Anthony W. Polis, 54 Treasurer (Principal Vice President, New York
Financial and Accounting Life Insurance Company,
Officer) 1988 to present;
Director, Vice President
and Chief Financial
Officer, NYLIFE
Securities Inc., 1988 to
present; Vice President
and Chief Financial
Officer, NYLIFE
Distributors Inc., 1993
to present; Vice
President and Chief
Financial Officer, Eagle
Strategies Corp., 1993 to
present; Vice President
and Chief Financial
Officer, MainStay
Shareholder Services
Inc., 1997 to present;
Vice President and Chief
Financial Officer, The
MainStay Funds, 1990 to
present; Treasurer,
MainStay VP Series Fund,
Inc., 1993 to present;
Assistant Treasurer,
MainStay VP Series Fund,
Inc., 1992 to 1993; Vice
President and Treasurer,
Eclipse Financial Asset
Trust, 1992 to present;
Vice President, Drexel
Burnham Lambert
Incorporated, DBL
Tax-Free Fund Inc., DBL
Cash Fund Inc., The
Drexel Burnham Fund,
Drexel Series Trust,
Fenimore International
Fund Inc., BT Investment
Trust and BT Tax Free
Investment Trust, 1983 to
1988; Assistant
Treasurer, Drexel
Bond-Debenture Trading
Fund, 1983-1988.
Sara L. Badler, 38 Secretary Assistant General
Counsel, New York Life
Insurance Company, 1996
to present; Associate
Counsel, New York Life
Insurance Company, 1994
to 1996; Secretary,
MainStay VP Series Fund,
Inc., 1997 to present;
Assistant Secretary, the
MainStay Funds, 1994 to
present; Assistant
Secretary, Eclipse
Financial Asset Trust,
1994 to present; Teacher,
New York City Board of
Education, 1993 to 1994;
and Vice President and
Associate Counsel and
Consulting Attorney;
Oppenheimer Management
Corporation, 1987 to
1993.
* Messrs. Boyle and Roussin are Directors who are "interested persons" of
the Company as that term is defined in the 1940 Act.
Compensation Table
The following table sets forth information regarding compensation received
by the Directors of the Company for the year ended December 31, 1997.
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<PAGE>
Aggregate Compensation
Name and Position from Company(1)
----------------- ----------------------
Lawrence Glacken $ 30,000
Director
Robert P. Mulhearn $ 30,000
Director
Susan B. Kerley $ 30,000
Director
(1) Directors, other than those affiliated with New York Life Insurance
Company, MainStay Management, Inc., MacKay-Shields Financial Corporation,
Monitor Capital Advisors, Inc. or NYLIFE Distributors Inc. are paid an
annual fee of $24,000 and $1,000 for each Board of Directors meeting and
Committee meeting attended plus reimbursement for travel and out-of-pocket
expenses.
Management Agreement
Pursuant to the Management Agreement for the Funds dated November 21,
1997, MainStay Management, Inc. (the "Manager"), subject to the supervision of
the Directors of the Company and in conformity with the stated policies of the
Funds, administers the Funds' business affairs and investment advisory
responsibilities.
The Directors, including the Independent Directors, approved the
Management Agreement at an in-person meeting held on September 9, 1997. On
November 17, 1997, the shareholders of each of the Funds approved the Management
Agreement. The Management Agreement will remain in effect for two years
following its effective date, and will continue in effect thereafter only if
such continuance is specifically approved at least annually by the Directors or
by a vote of a majority of the outstanding voting securities of each of the
Funds (as defined in the 1940 Act and the rules thereunder) and, in either case
by a majority of the Directors who are not "interested persons" of the Company
or of the Manager (as the term is defined in the 1940 Act).
The Manager has authorized any of its directors, officers and employees
who have been elected or appointed as Directors of the Company to serve in the
capacities in which the have been elected or appointed.
The Management Agreement provides that the Manager shall not be liable to
a Fund for any error or judgment by the Manager or
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<PAGE>
for any loss sustained by a Fund except in the case of the Manager's willful
misfeasance, bad faith, gross negligence or reckless disregard of duty. The
Management Agreement also provides that it shall terminate automatically if
assigned and that it may be terminated without penalty by either party upon no
more than 60 days' nor less than 30 days' written notice.
In connection with its administration of the business affairs of each of
the Funds, and except as indicated in the Prospectus under the heading "Manager
and Sub-Advisers," the Manager bears the following expenses:
(a) the salaries and expenses of all personnel of the Company and the
Manager, except the fees and expenses of the Directors not affiliated with the
Manager or the Sub-Adviser;
(b) the fees to be paid to the Sub-Advisers pursuant to the Sub-Advisory
Agreements; and
(c) all expenses incurred by the Manager in connection with administering
the ordinary course of the Funds' business, other than those assumed by the
Company.
For its services, each Fund pays the Manager a monthly fee. (See page 48
of the Prospectus (page 22 of the Money Market Fund prospectus), "Manager and
Sub-Advisers.")
Commencing November 21, 1997 through December 31, 1997, the amount of the
management fee paid by each Fund to the Manager was as follows:
November 21, 1997
through
December 31, 1997
-----------------
EAFE Index Fund $ 57,337
Growth Equity Fund 670,493
Indexed Equity Fund 541,630
International Equity Fund 108,499
Multi-Asset Fund 305,965
Value Equity Fund 941,883
Bond Fund 155,008
Indexed Bond Fund 68,007
International Bond Fund 43,865
Money Market Fund 142,675
Short-Term Bond Fund 32,585
As of November 21, 1997, the Manager has limited certain Funds' expenses
as discussed in the Prospectus. In connection with the voluntary expense
limitations, the Manager assumed the
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<PAGE>
following expenses for the period November 21, 1997 through December 31, 1997:
EAFE Index Fund $ 42,915
Indexed Equity Fund 290,267*
International Equity Fund 13,689
Bond Fund 18,927
Indexed Bond Fund 19,676
International Bond Fund 14,104
Money Market Fund 37,695
Short-Term Bond Fund 14,826
* Manager assumed $236,104, Monitor, the Fund's Sub-Adviser, assumed $54,163.
As long as expense limitations continue, they may lower the Funds'
expenses and increase their respective yields. The Money Market Fund's voluntary
expense limitation will terminate after June 30, 1998. After December 31, 1998,
the voluntary expense limitations of the other Funds 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.
Sub-Advisory Agreements
Pursuant to the Sub-Advisory Agreements between the Manager and
MacKay-Shields Financial Corporation ("MacKay-Shields"), between the Manager and
Monitor Capital Advisors, Inc. ("Monitor") and between the Manager and New York
Life Insurance Company ("New York Life") on behalf of each Fund (each a
"Sub-Adviser" and collectively the "Sub-Advisers"), MacKay-Shields, Monitor and
New York Life, subject to the supervision of the Directors of the Company and
the Manager in conformity with the stated policies of each of the Funds and the
Company, manage the Funds' portfolios, including the purchase, retention,
disposition and loan of securities.
The Directors, including the Independent Directors, approved the
Sub-Advisory Agreements at an in-person meeting held September 9, 1997. On
November 17, 1997, the shareholders of each of the Funds approved the
Sub-Advisory Agreements with MacKay-Shields, Monitor and New York Life. The
Sub-Advisory Agreements will remain in effect for two years following its such
continuance is specifically approved at least annually by the Directors or by a
vote of a majority of the outstanding voting securities of each of the Funds (as
defined in the 1940 Act and the rules thereunder) and, in either case by a
majority of the Directors who are not "interested persons" of the Company,
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<PAGE>
the Manager, or any Sub-Adviser (as the term is defined in the 1940 Act).
The Sub-Advisory Agreements provide that the Sub-Advisers shall not be
liable to a Fund for any error of judgment by a Sub-Adviser or for any loss
sustained by a Fund except in the case of the Sub-Adviser's willful misfeasance,
bad faith, gross negligence or reckless disregard of duty. The Sub-Advisory
Agreements also provide that they shall terminate automatically if assigned and
that they may be terminated without penalty by either party upon no more than 60
days' nor less than 30 days' written notice.
In previous years, prior to a change in management structure, each Fund
paid an advisory fee directly to New York Life, MacKay-Shields or Monitor. For
the period January 1, 1997 through November 20, 1997 and the fiscal years ended
December 31, 1996 and 1995, the amount of the advisory fee paid by each Fund to
New York Life, MacKay-Shields or Monitor was as follows:
Period Ended Year Ended Year Ended
Fund 11/20/97 12/31/96 12/31/95
- ---- -------- -------- --------
EAFE Index Fund $ 118,622 $ 124,284 $ 115,497
Growth Equity Fund 1,414,379 1,186,388 879,351
Indexed Equity Fund 719,601 502,686 295,487
International Equity Fund 406,316 395,717 290,777
Multi-Asset Fund 508,530 461,408 372,064
Value Equity Fund 2,008,307 1,768,836 1,275,060
Bond Fund 316,678 355,167 378,811
Indexed Bond Fund 105,411 123,798 168,137
International Bond Fund 136,941 141,296 121,813
Money Market Fund 181,674 100,230 59,918
Short-Term Bond Fund 69,125 98,265 79,193
In previous years, prior to a change in management structure, each Fund
paid an administrative fee directly to New York Life as administrator. For the
period January 1, 1997 through November 20, 1997 and the fiscal years ended
December 31, 1996 and 1995, the amount of the administration fee paid by each
Fund to New York Life was as follows:
Period Ended Year Ended Year Ended
Fund 11/20/97 12/31/96 12/31/95
- ---- -------- -------- --------
EAFE Index Fund $ 632,652 $ 662,846 $ 615,986
Growth Equity Fund 3,394,512 2,847,330 2,110,442
Indexed Equity Fund 2,878,403 2,010,753 1,181,947
International Equity Fund 580,451 565,311 415,395
Multi-Asset Fund 1,695,098 1,538,025 1,240,213
Value Equity Fund 4,819,937 4,245,206 3,060,145
Bond Fund 870,864 976,711 1,041,729
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<PAGE>
Indexed Bond Fund 421,641 495,190 672,553
International Bond Fund 228,235 235,493 203,021
Money Market Fund 726,696 400,921 239,673
Short-Term Bond Fund 207,375 294,794 237,578
Also prior to the above-referenced change in management structure and in
connection with the voluntary expense limitation, New York Life, as
administrator, assumed the following expenses for the Funds for the period
January 1, 1997 through November 20, 1997 and the fiscal years ended December
31, 1996 and 1995.
Period Ended Year Ended Year Ended
Fund 11/20/97 12/31/96 12/31/95
- ---- -------- -------- --------
EAFE Index Fund $ 229,592 $ 238,764 $ 165,321(1)
Growth Equity Fund N/A(2) N/A(2) N/A(2)
Indexed Equity Fund 1,878,195(5) 753,575(3) 272,396
International Equity Fund 35,792 82,203 60,652
Multi-Asset Fund N/A(2) 164,519(4) 167,833
Value Equity Fund N/A(2) N/A(2) N/A(2)
Bond Fund 154,845 188,561 198,399
Indexed Bond Fund 161,693 189,996 225,553
International Bond Fund 60,073 61,961 31,528
Money Market Fund 194,751 170,221 136,576
Short-Term Bond Fund 96,101 122,335 114,433
(1) Fund expense limitation resumed April 1, 1995.
(2) Fund had no expense limitation during period.
(3) New York Life assumed $676,954, Monitor assumed $76,621.
(4) Fund expense limitation expired December 31, 1996.
(5) New York Life assumed $1,518,395, Monitor assumed $359,800.
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
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defined in the 1940 Act) of the Company or the Distributor, on March 4, 1997.
After an initial two-year period, the Distribution Agreement is subject to
annual approval by the Board of Directors. The Distribution Agreement is
terminable with respect to a Fund at any time, without payment of a penalty, by
vote of a majority of the Company's Directors who are not "interested persons"
(as defined in the 1940 Act) of the Company, upon 60 days' written notice to the
Distributor, by vote of a majority of the outstanding voting securities of that
Fund, upon 60 days' written notice to the Distributor, or by the Distributor,
upon 60 days' written notice to the Company. The Distribution Agreement will
terminate in the event of its assignment.
Service Fees
The Company has adopted a Shareholder Services Plan with respect to the
Institutional Service Class of each Fund. Under the terms of the Plan, the
Company is permitted to pay, out of the Institutional Service Class assets of
each Fund, a fee in the amount of 0.25% on an annual basis of the average daily
net assets attributable to that class, to New York Life Insurance Company, its
affiliates or independent third party service providers, for providing services
in connection with the administration of plans or programs that use Fund shares
as their funding medium.
Under the terms of the Shareholder Services Plan, each Fund may pay to
service agents "service fees" as that term is defined in the rules of the
National Association of Securities Dealers for services provided to shareholders
of the Institutional Service Class of the Fund. These fees are for personal
services, including assistance in establishing and maintaining shareholder
accounts and assisting shareholders that have questions or other needs relating
to their accounts.
The Plan provides that it may not be amended to materially increase the
costs which holders of Institutional Service Class of a Fund may bear under the
Plan without the approval of a majority of both (i) the Directors of the Company
and (ii) those Directors who are not "interested persons" of the Company (as
defined in the 1940 Act) and who have no direct or indirect financial interest
in the operation of the Plan or any agreements related to it (the "Plan
Directors"), cast in person at a meeting called for the purpose of voting on the
Plan and any related amendments.
The Plan provides that it may not take effect until approved by vote of a
majority of both (i) the Directors of the Company and (ii) the Plan Directors.
The Plan was approved by the
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<PAGE>
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 connection with the performance of service activities,
and the purposes for which such expenditures were made.
PURCHASES AND REDEMPTIONS
Purchases and redemptions are discussed in the Prospectus under the
headings "Tell Me The Key Facts -- Open an Account and Buy Shares", and "Know
How to Sell and Exchange Shares", and that information is incorporated herein by
reference.
Certain clients of the Company's Sub-Advisers may purchase shares of a
Fund with liquid assets with a value which is readily ascertainable (and not
established only by evaluation procedures) as evidenced by a listing on a bona
fide domestic or foreign exchange and which would be eligible for purchase by
the Fund (consistent with such Fund's investment policies and restrictions).
These transactions will be effected only if the Fund's Sub-Adviser intends to
retain the security in the Fund as an investment. Assets so purchased by a Fund
will be valued in generally the same manner as they would be valued for purposes
of pricing the Fund's shares, if such assets were included in the Fund's assets
at the time of the purchase. The Fund reserves the right to amend or terminate
this practice at any time.
The Company determines the net asset value per share of each Fund on each
day the New York Stock Exchange is open for trading.
The Company reserves the right to suspend or postpone redemptions during
any period when: (a) trading on the New York Stock Exchange is restricted, as
determined by the SEC, or that Exchange is closed for other than customary
weekend and holiday closings; (b) the SEC has by order permitted such
suspension; or (c) an emergency, as determined by the SEC, exists, making
disposal of portfolio securities or valuation of net assets of the Company not
reasonably practicable.
For shares of a Fund redeemed within any 90-day period, each Fund reserves
the right to pay the shareholder a maximum of $250,000 in cash, or cash equal to
1% of the Fund's net assets,
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<PAGE>
whichever is less. To protect the remaining shareholders in the Fund, anything
redeemed above this amount may not be paid in cash, but could be paid entirely,
or in part, in the same kinds of securities held by the Fund. These securities
would be valued at the same value that was assigned to them in calculating the
net asset value of the shares redeemed. Even though it is highly unlikely that
shares would ever actually be redeemed in kind, shareholders would probably have
to pay transaction costs to sell the securities distributed to you, should such
a distribution occur.
Certain of the Funds have entered into a committed line of credit with The
Bank of New York, as agent, and various other lenders, from whom a Fund may
borrow up to 5% of its net assets in order to honor redemptions. The credit
facility is expected to be utilized in periods when the Funds experience
unusually large redemption requests.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Purchases and sales of securities on a securities exchange are effected by
brokers, and the Funds pay a brokerage commission for this service. In
transactions on stock exchanges in the United States, these commissions are
negotiated, whereas on many foreign stock exchanges these commissions are fixed.
In the over-the-counter markets, securities (i.e., municipal bonds and other
debt securities) are generally traded on a "net" basis with dealers acting as
principal for their own accounts without a stated commission, although the price
of the security usually includes a profit to the dealer. Transactions in certain
over-the-counter securities also may be effected on an agency basis when the
total price paid (including commission) is equal to or better than the best
total prices available from other sources. In underwritten offerings, securities
are purchased at a fixed price which includes an amount of compensation to the
underwriter, generally referred to as the underwriter's concession or discount.
On occasion, certain money market instruments may be purchased directly from an
issuer, in which case no commissions or discounts are paid.
In effecting purchases and sales of portfolio securities for the account
of a Fund, the Fund's Sub-Adviser will seek the best execution of the Fund's
orders. The Sub-Adviser attempts to achieve this result by selecting
broker-dealers to execute portfolio transactions on behalf of the Fund and its
other clients on the basis of the broker-dealers' professional capability, the
value and quality of their brokerage services and the level of their brokerage
commissions.
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<PAGE>
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 on an exchange, the commissions, fees or other remuneration
received by the Affiliated Broker must be reasonable and fair compared to the
commissions, fees or other remuneration paid to other brokers in connection with
comparable transactions involving similar securities being purchased or sold on
an exchange during a comparable period of time. This standard would allow the
Affiliated Broker to receive no more than the remuneration which would be
expected to be received by an unaffiliated broker in a commensurate arms-length
transaction. The Funds will not deal with the Affiliated Broker in any portfolio
transaction in which the Affiliated Broker acts as principal.
Some securities considered for investment by the Funds may also be
appropriate for other clients served by the Funds' Sub-Advisers. If a purchase
or sale of securities consistent with the investment policies of a Fund and one
or more of the clients served by the Fund's Sub-Adviser is considered at or
about the same time, transactions in such securities will, to the extent
practicable, be allocated among the Fund and clients in a manner deemed
equitable to the Fund and the clients by the Fund's Sub-Adviser. Although there
is no specified formula for allocating such transactions, the various allocation
methods used by a Fund's Sub-Adviser, and the results of such allocations, are
subject to periodic review by the Company's Directors.
It has for many years been a common practice in the investment advisory
business for advisers (or sub-advisers) of investment companies and other
institutional investors to receive research services from broker-dealers which
execute portfolio transactions for the clients of such advisers. Consistent with
this practice, the Sub-Adviser for a Fund may receive research services from
many broker-dealers with which the Sub-Adviser places the Fund's portfolio
transactions. These services, which in some cases may also be purchased for
cash, include such matters as general economic and security market reviews,
industry and company reviews, evaluations of securities and recommendations as
to the purchase and sale of securities. Some of these services may be of value
to the Sub-Adviser in advising its various clients (including the Fund),
although not all of these services are necessarily useful and of value in
managing a Fund. The management fee paid by the Fund and the sub-advisory fee
paid by the Manager are not reduced because the Sub-Adviser and its affiliates
receive such services.
As permitted by Section 28(e) of the Securities Exchange Act of 1934, an
investment adviser (or sub-adviser) may cause a Fund to pay a broker-dealer
which provides "brokerage and research
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<PAGE>
services" (as defined in that Act) to the investment adviser (or sub-adviser) an
amount of disclosed commission for effecting a securities transaction for the
Fund in excess of the commission which another broker-dealer would have charged
for effecting that transaction.
For the years ended December 31, 1997, 1996 and 1995 each of the following
Funds paid brokerage commissions as follows:
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<PAGE>
<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
12/31/97 12/31/96 12/31/95 12/31/97 12/31/96 12/31/95
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
EAFE Index Fund............... $ 20,593 $ N/A $ 44,798 0(0%)(1) 0(0%)(1) 0(0%)(1)
Growth Equity Fund............ 461,682 296,284 306,776 0(0%)(1) 0(0%)(1) 0(0%)(1)
Indexed Equity Fund........... 120,427 N/A 25,484 0(0%)(1) 0(0%)(1) 0(0%)(1)
International Equity Fund..... 407,665 290,329 330,914 0(0%)(1) 0(0%)(1) 0(0%)(1)
Multi-Asset Fund.............. 22,593 N/A 12,451 0(0%)(1) 0(0%)(1) 0(0%)(1)
Value Equity Fund............. 1,651,353 1,042,205 945,310 0(0%)(1) 0(0%)(1) 0(0%)(1)
Bond Fund..................... N/A 768 15,608 0(0%)(1) 0(0%)(1) 0(0%)(1)
Short-Term Bond Fund.......... 250 106 523 0(0%)(1) 0(0%)(1) 0(0%)(1)
</TABLE>
<TABLE>
<CAPTION>
Total Amount of Transaction Total Brokerage
Where Commissions Paid Commissions Paid
--------------------------- to Brokers that
Provided
Research Year
Year ended Year ended Year ended ended
12/31/97 12/31/96 12/31/95 12/31/97
---------- ---------- ---------- -------------
<S> <C> <C> <C> <C>
EAFE Index Fund................ $ 6,116,892(0%)(2) $ N/A $ 10,362,714(0%)(2) $ N/A
Growth Equity Fund............. 329,107,159(0%)(2) 182,941,279 173,585,053(0%)(2) 461,682
Indexed Equity Fund............ 114,953,870(0%)(2) N/A 20,707,836(0%)(2) N/A
International Equity Fund...... 103,697,052(0%)(N/A) 70,163,300 79,632,317(0%)(2) 407,665
Multi-Asset Fund............... 19,581,960(0%)(2) N/A 9,523,672(0%)(2) N/A
Value Equity Fund.............. 1,082,839,850(0%)(2) 656,491,378 490,519,118(0%)(2) 1,651,353
Bond Fund...................... N/A(2) 17,690,332 200,756,257(0%)(2) N/A
Short Term Bond Fund........... 3,202,719(0%)(2) 1,533,460 7,828,803(0%)(2) 250
</TABLE>
(1) Percent of total commissions paid.
(2) Percent of total transactions involving the payment of commissions
effected through affiliated persons.
The Indexed Bond Fund, International Bond Fund and Money Market Fund paid
no brokerage commissions during the years ended December 31, 1997, 1996 and
1995.
As of December 31, 1997, the following Funds held securities in issuers
with whose broker-dealer subsidiaries or affiliates the Funds regularly conduct
business:
<TABLE>
<CAPTION>
Fund Broker-Dealer Market Value
- ---- ------------- ------------
<S> <C> <C>
Indexed Equity Fund American Express Company 5,381,686(2)
Morgan Stanley, Dean Witter, Discover & Company 4,543,638(2)
Morgan (J.P.) & Co. Inc. 2,601,092(2)
Marsh & McLennan Companies, Inc. 1,641,717(2)
Merrill Lynch & Co., Inc. 3,148,785(2)
Schwab (Charles) Corp. (The) 1,439,672(2)
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
Fund Broker-Dealer Market Value
- ---- ------------- ------------
<S> <C> <C>
Multi-Asset Fund American Express Company 1,402,475(2)
Morgan Stanley, Dean Witter, Discover & Company 1,177,888(2)
Morgan (J.P.) & Co. Inc. 676,008(2)
Marsh & McLennan Companies, Inc. 423,515(2)
Merrill Lynch & Co., Inc. 810,117(2)
Schwab (Charles) Corp. (The) 372,824(2)
Bear Stearns Cos., Inc. (The) 503,750(3)
Morgan (J.P.) & Co. Inc. 552,500(3)
PaineWebber Group, Inc. 421,000(3)
Value Equity Fund American Express Credit Corp. 36,755,000(1)
Prudential Funding Corp. 25,000,000(1)
Bond Fund American Express Credit Corp. 3,000,000(1)
Lehman Brothers Holdings, Inc. 2,094,760(3)
Salomon Inc. 1,734,157(3)
Money Market Fund Goldman, Sachs & Co. 9,838,360(1)
Morgan (J.P.) & Co. Inc. 4,957,747(1)
Morgan Stanley, Dean Witter, Discover & Company 7,928,105(1)
</TABLE>
(1) Represents investment in commercial paper.
(2) Represents investment in common stock.
(3) Represents investment in corporate bond.
A Fund's portfolio turnover rate is calculated by dividing the lesser of
sales or purchases of portfolio securities by the average monthly value of the
Fund's portfolio securities. For purposes of this calculation, portfolio
securities will exclude purchases and sales of debt securities having a maturity
at the date of purchase of one year or less.
The turnover rate for a Fund will vary from year-to-year and depending on
market conditions, turnover could be greater in periods of unusual market
movement and volatility. A higher turnover rate generally would result in
greater brokerage commissions or other transactional expenses which must be
borne, directly or indirectly, by the Fund and, ultimately, by the Fund's
shareholders. High portfolio turnover may result in increased brokerage
commissions and in the realization of a substantial increase in net short-term
capital gains by the Fund which, when distributed to non-tax-exempt
shareholders, will be treated as dividends (ordinary income).
Moreover, certain requirements that must be satisfied in order for the
Fund to qualify as a regulated investment company for Federal income tax
purposes may limit the extent to which the Fund can sell securities held for
less than three months.
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<PAGE>
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 an instrument at its cost and
thereafter assuming a constant amortization to maturity of any premium paid or
discount received. While this method provides certainty in valuation, it may
result in periods during which value, as determined by amortized cost, is higher
or lower than the price the Fund would receive if it sold the instrument. During
such periods, the yield to an investor in a Fund may differ somewhat than that
obtained in a similar investment company which uses available market quotations
to value all of its portfolio securities.
Portfolio securities of each of the other Funds are valued (a) by
appraising common and preferred stocks which are traded on the New York Stock
Exchange at the last sale price of the first session on that day or, if no sale
occurs, the stock is valued at the mean between the closing bid price and asked
price; (b) by appraising other common and preferred stocks as nearly as possible
in the manner described in clause (a) if traded on any other exchange, including
the National Association of Securities Dealers National Market System and
foreign securities exchanges; (c) by appraising over-the-counter common and
preferred stocks quoted on the National Association of Securities Dealers NASDAQ
system (but not listed on the National Market System) at the bid price supplied
through such system; (d) by appraising over-the-counter common and preferred
stocks not quoted on the NASDAQ system and securities listed or traded on
certain foreign exchanges whose operations are similar to the U.S.
over-the-counter market at prices supplied by a pricing agent selected by a
Fund's Sub-Adviser if the prices are deemed to be representative of market
values at the close of the first session of the New York Stock Exchange; (e) by
appraising debt securities at prices supplied by a pricing agent or, determined
using pricing procedures selected by a Fund's Sub-Adviser, which prices
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<PAGE>
reflect broker/dealer-supplied valuations or electronic data processing
techniques and/or matrix pricing if those prices are deemed by a Fund's
Sub-Adviser to be representative of market values at the close of the first
session of the New York Stock Exchange; (f) by appraising options and futures
contracts at the last sale price on the market where any such option or futures
contract is principally traded, and (g) by appraising all other securities and
other assets, including over-the-counter common and preferred stocks not quoted
on the NASDAQ system, securities not listed or traded on foreign exchanges whose
operations are similar to the U.S. over-the-counter market and debt securities
for which prices are supplied by a pricing agent but are not deemed by a Fund's
Sub-Adviser to be representative of market values, but excluding money market
instruments with a remaining maturity of sixty days or less and including
restricted securities and securities for which no market quotation is available,
at fair value in accordance with procedures approved by and determined in good
faith by the Directors, although the actual calculations may be done by others.
Money Market instruments held by the Funds with a remaining maturity of sixty
days or less are valued by the amortized cost method unless such method does not
represent fair value.
Portfolio securities traded on more than one U.S. national securities
exchange or foreign securities exchange are valued at the last sale price on the
business day as of which such value is being determined on the close of the
exchange representing the principal market for such securities. The value of all
assets and liabilities expressed in foreign currencies will be converted into
U.S. dollar values, using the W.M. Company exchange rates that have been adopted
as the standard for exchange rate valuations by major indices. If such
quotations are not available, the rate of exchange will be determined in
accordance with policies established by the Company's Directors. For financial
accounting purposes, the Company recognizes dividend income and other
distributions on the ex-dividend date, except certain dividends from foreign
securities are recognized as soon as the Company is informed on or after the
ex-dividend date.
Trading in securities on European and Far Eastern securities exchanges and
over-the-counter markets is normally completed well before the close of business
on each business day in New York (i.e., a day on which the New York Stock
Exchange is open for trading). In addition, European or Far Eastern securities
trading in a particular country or countries may not take place on all business
days in New York. Furthermore, trading takes place in Japanese markets on
certain Saturdays and in various foreign markets on days which are not business
days in New York and on which the Funds' net asset values are not calculated.
Such calculation does not take place contemporaneously with the
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<PAGE>
determination of the prices of the portfolio securities used in such
calculation. Events affecting the values of portfolio securities that occur
between the time their prices are determined and the close of the New York Stock
Exchange will not be reflected in the Fund's calculation of net asset values
unless a Fund's Sub-Adviser determines that the particular event may materially
affect net asset value, in which case an adjustment will be made.
To the extent that any newly organized fund or class of shares receives,
on or before December 31, any seed capital, the net asset value of such fund(s)
or class(es) will be calculated as of December 31.
TAX INFORMATION
While it is anticipated that many shareholders of the Funds will be
tax-exempt institutions, the following discussion may be of general interest to
these shareholders as well as for those shareholders of the Funds who do not
have tax-exempt status. Although the discussion below refers in certain
instances to distributions and other transactions as being taxable to a
shareholder, tax-exempt shareholders will, of course, not be taxed to the extent
provided by applicable tax exemptions. The discussion herein relating to taxes
is presented for general informational purposes only. Since the tax laws are
complex and tax results can vary depending upon specific circumstances,
investors should consult tax advisers regarding investment in a Fund.
Each Fund intends to qualify annually and elect to be treated as a
regulated investment company under Subchapter M of the Internal Revenue Code of
1986, as amended (the "Code"). If a Fund so qualifies and elects, it generally
will not be subject to Federal income tax on its investment company taxable
income (which includes, among other items, dividends, interest, and the excess,
if any, of net short-term capital gains over net long-term capital losses) and
its net capital gains (net long-term capital gains in excess of net short-term
capital losses) that it distributes to its shareholders.
Each Fund intends to distribute, at least annually, to its shareholders
substantially all of its investment company taxable income and its net capital
gains. In determining amounts of capital gains to be distributed, any capital
loss carryovers from prior years will be applied against capital gains.
To qualify for treatment as a regulated investment company, a Fund
generally must, among other things: (a) derive in each taxable year at least 90%
of its gross income from dividends,
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<PAGE>
interest, payments with respect to securities loans, gains from the sale or
other disposition of securities or foreign currencies, and other income
(including gains from certain options, futures, and forward contracts) derived
with respect to its business of investing in securities or foreign currencies;
(b) diversify its holdings so that at the end of each quarter of the taxable
year, (i) at least 50% of the market value of a Fund's assets is represented by
cash, cash items, U.S. Government securities, the securities of other regulated
investment companies and other securities, with such other securities of any one
issuer limited for the purposes of this calculation to an amount not greater
than 5% of the value of the Fund's total assets and 10% of the outstanding
voting securities of such issuer, and (ii) not more than 25% of the value of its
total assets is invested in the securities of any one issuer (other than U.S.
Government securities or the securities of other regulated investment
companies), or of two or more issuers which the Fund controls and which are
engaged in the same or similar trades or businesses or related trades or
businesses; and (c) distribute in each taxable year at least 90% of the sum of
its investment company taxable income and its net tax-exempt interest income. If
a Fund does not meet all of these Code requirements, it will be taxed as an
ordinary corporation and its distributions (to the extent of available earnings
and profits) will be taxed to shareholders as ordinary income (except to the
extent a shareholder is exempt from tax).
The Treasury Department is authorized to issue regulations to provide that
foreign currency gains that are not directly related to a Fund's principal
business of investing in securities (or options and futures with respect to
securities) may be excluded from the income which qualifies for purposes of the
90% gross income requirement described above. To date, however, no such
regulations have been issued.
Amounts not distributed on a timely basis in accordance with a calendar
year distribution requirement are subject to a nondeductible 4% excise tax. To
prevent imposition of the excise tax, a Fund must distribute for the calendar
year an amount equal to the sum of (1) at least 98% of its ordinary taxable
income (excluding any capital gains or losses) for the calendar year, (2) at
least 98% of the excess of its capital gains over capital losses (adjusted for
certain ordinary losses) for the one-year period ending October 31 of such year,
and (3) all ordinary taxable income and capital gain net income (adjusted for
certain ordinary losses) for previous years that were not distributed during
such years. A distribution will be treated as paid on December 31 of the
calendar year if it is declared by a Fund in October, November or December of
that year to shareholders on a record date in such a month and paid by the Fund
during January
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<PAGE>
of the following calendar year. Such a distribution will be includable in the
gross income of shareholders in the calendar year in which it is declared,
rather than the calendar year in which it is received. To prevent application of
the excise tax, the Funds intend to make distributions in accordance with the
calendar year distribution requirement.
A Fund's deduction for interest expense may be restricted where the Fund
invests in obligations the interest on which is exempt in whole or in part from
Federal income tax.
Distributions of investment company taxable income generally are
characterized as ordinary income. If a Fund's income consists in whole or in
part of dividends paid by U.S. corporations, a portion of the dividends paid by
a Fund may be eligible for the 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 applicable holding period requirements are not
met. 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, will generally be taxable to shareholders as either "20%
Rate Gain" or "28% Rate Gain", depending upon the Fund's holding period for the
assets sold. "20% Rate Gains" arise from sales of assets held by a Fund for more
than 18 months and are subject to a maximum tax rate of 20%; "28% Rate Gains"
arise from sales of assets held by a Fund for more than one year but not more
than 18 months and are subject to a maximum tax rate of 28%. Net capital gains
from assets held for one year or less will be taxed as ordinary income.
Distributions will be subject to these capital gains rates regardless of the
length of time the Fund's shares have been held by a shareholder and will not be
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
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<PAGE>
available for distribution. In that event, distributions in excess of such
earnings and profits would be characterized as a return of capital to
shareholders for Federal income tax purposes, thus reducing each shareholder's
cost basis in his Fund shares. Distributions in excess of a shareholder's cost
basis in his shares would be treated as a gain realized from a sale of such
shares.
Distributions by a Fund reduce the net asset value of the Fund's shares.
Should a distribution reduce the net asset value below a shareholder's cost
basis, such distribution, nevertheless, would be taxable to the shareholder as
ordinary income or capital gain as described above, even though, from an
investment standpoint, it may constitute a partial return of capital. In
particular, investors should be careful to consider the tax implications of
buying shares just prior to a distribution by a Fund. The price of shares
purchased at that time includes the amount of the forthcoming distribution.
Those purchasing just prior to a distribution will receive a distribution which
will nevertheless generally be taxable to them.
Upon the taxable disposition (including a sale or redemption) of shares of
a Fund, a shareholder may realize a gain or loss depending generally upon his
basis in his shares. Such gain or loss will be treated as capital gain or loss
if the shares are 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
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<PAGE>
liabilities generally are treated as ordinary income or ordinary loss.
Similarly, on disposition of debt securities denominated in a foreign currency
and on disposition of certain financial contracts and options, gains or losses
attributable to fluctuations in the value of foreign currency between the date
of acquisition of the security or contract and the date of disposition also are
treated as ordinary gain or loss. These gains and losses, referred to under the
Code as "section 988" gains and losses, may increase or decrease the amount of a
Fund's investment company taxable income to be distributed to its shareholders
as ordinary income. For example, fluctuations in exchange rates may increase the
amount of income that a Fund must distribute in order to qualify for treatment
as a regulated investment company and to prevent application of an excise tax on
undistributed income. Alternatively, fluctuations in exchange rates may decrease
or eliminate income available for distribution. If section 988 losses exceed
other investment company taxable income during a taxable year, a Fund generally
would not be able to make ordinary dividend distributions, or distributions made
before the losses were realized would be recharacterized as return of capital to
shareholders for Federal income tax purposes, rather than as an ordinary
dividend, reducing each shareholder's basis in his Fund shares.
Foreign investing involves the possibility of confiscatory taxation,
foreign taxation of income earned in the foreign nation (including withholding
taxes on interest and dividends) or other 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.
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<PAGE>
Each shareholder will be notified within 60 days after the close of a Fund's
taxable year whether the foreign taxes paid by the Fund will "pass-through" for
that year and, if so, such notification will designate (a) the shareholder's
portion of the foreign taxes paid to each such country and (b) the portion of
the dividend which represents income derived from sources within each such
country.
Generally, a credit for foreign taxes is subject to the limitation that it
may not exceed the shareholder's U.S. tax attributable to his total foreign
source taxable income. For this purpose, if a Fund makes the election described
in the preceding paragraph, the source of a Fund's income flows through to its
shareholders. With respect to the Funds, gains from the sale of securities
generally will be treated as derived from U.S. sources and section 988 gains
generally will be treated as ordinary income derived from U.S. sources. The
limitation on the foreign tax credit is applied separately to foreign source
passive income (as defined for purposes of the foreign tax credit), including
foreign source passive income received from a Fund. In addition, the foreign tax
credit may offset only 90% of the alternative minimum tax imposed on
corporations and individuals. If a Fund is not eligible to make the election
described above, the foreign income and similar taxes it pays generally will
reduce investment company taxable income and distributions by a Fund will be
treated as United States source income.
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
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<PAGE>
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. Alternatively, a Fund may elect to mark to
market its PFIC shares at the end of each taxable year, with the result that
unrealized gains would be treated as though they were realized and reported as
ordinary income. Any mark-to-market losses and any loss from an actual
disposition of PFIC shares would be deductible as ordinary losses to the extent
of any net mark-to-market gains included in income in prior years.
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,
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<PAGE>
therefore, such income would be subject to the distribution requirements of the
Code.
Some of the debt securities may be purchased by a Fund at a discount which
exceeds the original issue discount on such debt securities, if any. This
additional discount represents market discount for Federal income tax purposes.
The gain realized on the disposition of any debt security acquired after April
30, 1993 or any taxable debt security acquired prior to May 1, 1993 having
market discount will be treated as ordinary income to the extent it does not
exceed the accrued market discount on such debt security. Generally, market
discount accrues on a daily basis for each day the debt security is held by a
Fund at a constant rate over the time remaining to the debt security's maturity
or, at the election of a Fund, at a constant yield to maturity which takes into
account the semi-annual compounding of interest.
If a Fund holds zero coupons bonds in its portfolio it will recognize
income currently for Federal tax purposes in the amount of the unpaid, accrued
interest (determined under tax rules) and generally will be required to
distribute dividends representing such income to shareholders currently, even
through funds representing such income have not been received by the Fund.
Certain of the options, futures contracts, and forward contracts in which
the Funds may invest may be "section 1256 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
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<PAGE>
capital gain realized by a Fund which is taxed as ordinary income when
distributed to shareholders.
The Funds may make one or more of the elections available under the Code
which are applicable to straddles. If a Fund makes any of the elections, the
amount, character and timing of the recognition of gains or losses from the
affected straddle positions will be determined under rules that vary according
to the election(s) made. The rules applicable under certain of the elections may
operate to accelerate the recognition of gains or losses from the affected
straddle positions.
Because application of the straddle rules may affect the character of
gains or losses, defer losses and/or accelerate the recognition of gains or
losses from the affected straddle positions, the amount which must be
distributed to shareholders, and which will be taxed to shareholders as ordinary
income or long-term capital gain, may be increased or decreased substantially as
compared to a Fund that did not engage in such transactions.
Rules governing the tax aspects of swap agreements are in a developing
stage and are not entirely clear in certain respects. Accordingly, while the
Funds eligible to enter into swap agreements intend to account for such
transactions in a manner deemed to be appropriate, the Internal Revenue Service
("IRS") might not accept such treatment. If it did not, the status of a Fund as
a regulated investment company might be affected. It is possible that
developments in the swap market and the laws relating to swaps, 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.
Recently enacted rules may affect the timing and character of gain if a
Fund engages in transactions that reduce or eliminate its risk of loss with
respect to appreciated financial positions. If a Fund enters into certain
transactions in property while holding substantially identical property (for
example, a short sale against the box), the Fund would be treated as if it had
sold and immediately repurchased the property and would be taxed on any gain
(but not loss) from the constructive sale. The character of gain from a
constructive sale would depend upon the Fund's holding period in the property.
Loss from a constructive sale would be recognized when the property was
subsequently disposed of, and its character would depend on the
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<PAGE>
Fund's holding period and the application of various loss deferral provisions of
the Code.
Each Fund is required to report to the IRS all distributions except in the
case of certain exempt shareholders. All such distribution and redemption
proceeds generally are subject to withholding of Federal income tax at a rate of
31% ("backup withholding") in the case of non-exempt shareholders if (1) the
shareholder fails to furnish the Fund with and to certify the shareholder's
correct taxpayer identification number, (2) the IRS notifies the Fund or
shareholder that the shareholder has failed to report properly certain interest
and dividend income to the IRS and to respond to notices to that effect, or (3)
when required to do so, the shareholder fails to certify that he is not subject
to backup withholding. If the withholding provisions are applicable, any such
distributions, whether reinvested in additional shares or taken in cash, will be
reduced by the amounts required to be withheld. Backup withholding is not an
additional tax and any amounts withheld may be credited against the
shareholder's U.S. Federal income tax liability. Investors may wish to consult
their tax advisers about the applicability of the backup withholding provisions.
The foregoing discussion relates only to Federal income tax law as
applicable to U.S. persons (i.e., U.S. citizens and residents and U.S. domestic
corporations, partnerships, trusts and estates). Distributions by the Funds also
may be subject to state and local taxes and their treatment under state and
local income tax laws may differ from the Federal income tax treatment.
Shareholders should consult their tax advisers with respect to particular
questions of Federal, state and local taxation. Shareholders who are not U.S.
persons should consult their tax advisers regarding U.S. and foreign tax
consequences of ownership of shares of the Funds including the likelihood that
distributions to them would be subject to withholding of U.S. tax at a rate of
30% (or at a lower rate under a tax treaty).
PERFORMANCE INFORMATION
The Company may, from time to time, include the yield and effective yield
of its Money Market Fund, the yield of the other Funds or Classes, and the total
return of all Funds or Classes in advertisements, sales literature, or reports
to shareholders or prospective investors. Due to the deduction of the
shareholder service fee, performance of the Institutional Service Class of each
Fund will be lower than the performance of the Institutional Class of the Fund.
Each of the Funds began offering Institutional Service Class shares on
January 1, 1995. Thus, the performance figures for
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<PAGE>
Institutional Service Class shares prior to that date have been calculated based
on the historical performance of the Funds' Institutional Class shares from
inception through December 31, 1994.
Current yield for the Money Market Fund will be based on the change in the
value of a hypothetical investment (exclusive of capital charges) over a
particular seven-day period, less a pro rata share of Fund expenses accrued over
that period (the "base period"), and stated as a percentage of the investment at
the start of the base period (the "base period return"). The base period return
is then annualized by multiplying by 366/7, with the resulting yield figure
carried to at least the nearest hundredth of one percent. "Effective yield" for
the Money Market Fund assumes that all dividends received during an annual
period have been reinvested. Calculation of "effective yield" begins with the
same "base period return" used in the calculation of yield, which is then
annualized to reflect weekly compounding pursuant to the following formula:
Effective Yield = [(Base Period Return + 1) to the 366th power divided by 7] - 1
The current and effective seven-day average yields as of December 31, 1997
for the Money Market Fund were 5.31% and 5.45%, respectively, for the
Institutional Class, and were 5.06% and 5.19%, respectively, for the
Institutional Service Class. Had certain expenses not been assumed by the
Manager, these yields would have been 5.15% and 5.28%, respectively, for the
Institutional Class, and 4.90% and 5.02%, 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 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
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<PAGE>
d = the maximum offering price per share on the
last day of the period.
For the 30-day period ended December 31, 1997, the yield for the
Short-Term Bond Fund was 5.68% for the Institutional Class, and was 5.45% for
the Institutional Service Class.
Quotations of average annual total return for a Fund will be expressed in
terms of the average annual compounded rate of return of a hypothetical
investment in the Fund or Class over certain periods that will include a period
of one year (or, if less, up to the life of the Fund), calculated pursuant to
the following formula: P(1 + T) to the nth power = ERV (where P = a hypothetical
initial payment of $1,000, T = the total return for the period, n = the number
of periods, and ERV = the ending redeemable value of a hypothetical $1,000
payment made at the beginning of the period). Quotations of total return may
also be shown for other periods. All total return figures reflect the deduction
of a proportional share of Fund or Class expenses on an annual basis, reflect
fee waivers or reimbursements in effect for each period and assume that all
dividends and distributions are reinvested when paid. Quotations of total return
may also be shown for other periods.
The average annual total return of the following Funds for the one-year
and five-year periods ended December 31, 1997 and the period from inception to
December 31, 1997 were as follows:
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<PAGE>
<TABLE>
<CAPTION>
Five Years Average Annual
Year Ended Ended Total Return
Fund 12/31/97 12/31/97 Since Inception
---- ---------------------- ---------------
<S> <C> <C> <C>
EAFE Index Fund
Institutional Class(1) ........... 0.40% 9.93% 6.47%
-------------------------------
Institutional Service Class(2) ... 0.08% 9.76% 6.35%
-------------------------------
Growth Equity Fund
Institutional Class(1) ........... 24.73% 17.52% 21.68%
-------------------------------
Institutional Service Class(2) ... 24.50% 17.34% 21.55%
-------------------------------
Indexed Equity Fund
Institutional Class(1) ........... 32.88% 19.74% 19.21%
-------------------------------
Institutional Service Class(2) ... 32.60% 19.58% 19.10%
-------------------------------
International Equity Fund*
Institutional Class(3) ........... 5.44% 11.41% 9.35%
-------------------------------
Institutional Service Class(3) ... 4.88% 11.12% 9.10%
-------------------------------
Multi-Asset Fund
Institutional Class(1) ........... 26.69% 15.02% 14.24%
-------------------------------
Institutional Service Class(2) ... 26.30% 14.87% 14.14%
-------------------------------
Value Equity Fund
Institutional Class(1) ........... 22.63% 17.71% 20.65%
-------------------------------
Institutional Service Class(2) ... 22.28% 17.56% 20.54%
-------------------------------
Bond Fund
Institutional Class(1) ........... 8.57% 6.90% 7.81%
-------------------------------
Institutional Service Class(2) ... 8.21% 6.73% 7.69%
-------------------------------
Indexed Bond Fund
Institutional Class(1) ........... 9.01% 6.92% 8.02%
-------------------------------
Institutional Service Class(3) ... 8.75% 6.81% 7.93%
-------------------------------
International Bond Fund*
Institutional Class(3) ........... 2.62% 10.42% 9.80%
-------------------------------
Institutional Service Class(3) ... 2.27% 10.26% 9.70%
-------------------------------
Short-Term Bond Fund
Institutional Class(1) ........... 6.13% 5.35% 6.26%
-------------------------------
Institutional Service Class(2) ... 5.98% 5.21% 6.16%
-------------------------------
</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 figures include the historical performance of the Separate
Accounts for the period prior to commencement of operations of the
International Bond Fund and the International Equity Fund on January 1,
1995. MacKay-Shields Financial Corporation, the current Sub-Adviser to
both the International Bond Fund and the International Equity Fund, served
as investment adviser to both corresponding Separate Accounts, and the
objectives, policies, restrictions, guidelines and management styles of
the Separate Accounts were materially equivalent to those of their
corresponding Funds. Performance figures for the
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<PAGE>
period prior to January 1, 1995, have been calculated by measuring the
change in value of a unit in the Separate Account from the time period
indicated to January 1, 1995 using the expense structure of each Separate
Account, which generally was higher than the expense structure of its
corresponding Fund. Neither Separate Account was registered under the
Investment Company Act of 1940 ("1940 Act") and therefore was not subject
to certain investment restrictions imposed under the 1940 Act. If the
Separate Accounts had been registered under the 1940 Act, their
performance may have been adversely affected. The International Equity
Fund's predecessor Separate Account commenced operations on July 31, 1992;
the International Bond Fund's predecessor Separate Account commenced
operations on January 31, 1990.
In addition, advertising for a Fund may indicate that investors may
consider diversifying their investment portfolios in order to seek protection of
the value of their assets against inflation. From time to time, advertising
materials for a Fund may refer to or discuss current or past business,
political, economic or financial conditions, including events as they relate to
those conditions, such as any U.S. monetary or fiscal policies and the current
rate of inflation. In addition, from time to time, advertising materials for a
Fund may include information concerning retirement and investing for retirement
and may refer to the approximate number of then-current Fund shareholders,
shareholder accounts and Fund assets.
From time to time, advertising and sales literature for a Fund may discuss
the investment philosophy, personnel and assets under management of the Fund's
Sub-Adviser, and other pertinent facts relating to the management of the Fund by
the Sub-Adviser.
From time to time any of the Funds may publish an indication of its past
performance as measured by independent sources such as Lipper Analytical
Services, Incorporated, Weisenberger Investment Companies Service, Donoghue's
Money Fund Report, Spot Market Prices, Barron's, BusinessWeek, Kiplinger's
Personal Finance, Financial World, Forbes, Money, Morningstar, Personal
Investor, Sylvia Porter's Personal Finance, and The Wall Street Journal.
In addition, performance information for a Fund may be compared, in
advertisements, sales literature, and reports to shareholders, to: (i) unmanaged
indexes, such as the Standard & Poor's 500 Composite Stock Price Index, the
Salomon Brothers Broad Investment Grade Bond Index, the Morgan Stanley Capital
International indexes; the Dow Jones Industrial Average, Donoghue Money Market
Institutional Averages, the Merrill Lynch 1 to 3 Year Treasury Index, the
Salomon Brothers World Government
- 83 -
<PAGE>
Benchmark Bond Index, the Salomon Brothers non-U.S. Dollar World Government Bond
Index, the Lehman Brothers Municipal Bond Index and the Lehman Brothers
Government Corporate Index; (ii) other groups of mutual funds tracked by
Morningstar Inc. or Lipper Analytical Services, widely used independent research
firms which rank mutual funds by overall performance, investment objectives and
assets, or tracked by other services, companies, publications or persons who
rank mutual funds on overall performance or other criteria; and (iii) the
Consumer Price Index (measure for inflation) and other measures of the
performance of the economy to assess the real rate of return from an investment
in the Funds. Unmanaged indexes may assume the reinvestment of dividends but
generally do not reflect deductions for administrative and management costs and
expenses.
From time to time, advertisements for the Funds may include general
information about the services and products offered by the Funds, The MainStay
Funds and New York Life Insurance Company and its subsidiaries. For example,
such advertisements may include statistical information about those entities
including, but not limited to, the number of current shareholder accounts, the
amount of assets under management, sales information, the distribution channels
through which the entities' products are available, marketing efforts and
statements about this information by the entities' officers, directors and
employees.
OTHER INFORMATION
Capitalization
The Funds are separate portfolios of the Company, an open-end management
investment company, incorporated under the laws of Maryland on September 21,
1990. The Company was formerly known as New York Life Institutional Funds Inc.
On January 3, 1995 the name of the Company was changed to its present form. The
Board of Directors may establish additional portfolios (with different
investment objectives and fundamental policies) at any time in the future.
Establishment and offering of additional portfolios will not alter the rights of
the Company's shareholders. When issued, shares are fully paid, non-assessable,
redeemable, and freely transferable.
Effective Maturity
Certain Funds may use an effective maturity for determining the maturity
of their portfolio. Effective maturity means the average expected repayment date
of the portfolio taking into account prospective calls, puts and mortgage
prepayments, in addition to the maturity dates of the securities in the
portfolio.
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<PAGE>
Beneficial Ownership of the Funds
The following table sets forth the information concerning beneficial
ownership, as of April 1, 1998, of the Funds' shares by each person who
beneficially owned more than 5% of the voting securities of any Fund:
- 85 -
<PAGE>
<TABLE>
<CAPTION>
Percentage of
Name and Address of Shareholder Fund Shares Owned(1) Outstanding Shares(2)
<S> <C> <C> <C>
TRUSTEES OF THE NEW YORK LIFE INSURANCE COMPANY BOND 6,093.959 35.1%
RETIREMENT PLAN AND PENSION PLAN (COMPANY PLAN) GROWTH EQUITY 5,204,767 18.3%
51 MADISON AVENUE INDEXED BOND 3,966,072 30.9%
NEW YORK, NY 10010 INDEXED EQUITY 7,117,064 17.5%
INTERNATIONAL BOND 3,559,841 71.2%
INTERNATIONAL EQUITY 2,640,050 22.7%
VALUE EQUITY 20,342,583 33.3%
TRUSTEES OF THE NYLIC RETIREMENT PLAN (AGENTS) BOND 2,062,408 11.9%
51 MADISON AVENUE GROWTH EQUITY 3,552,854 12.5%
NEW YORK, NY 10010 INDEXED BOND 2,125,713 36.5%
INDEXED EQUITY 6,753,899 16.6%
INTERNATIONAL BOND 1,014,242 20.3%
INTERNATIONAL EQUITY 2,569,230 22.1%
VALUE EQUITY 12,737,651 20.8%
NEW YORK LIFE INSURANCE COMPANY EAFE INDEX 1,225,734 23.6%
51 MADISON AVENUE INDEXED EQUITY 3,959,310 9.7%
NEW YORK, NY 10010 MULTI-ASSET 8,568,605 28.4%
TRUSTEES OF THE LONE STAR HOURLY RETIREMENT MONEY MARKET 16,000,295 5.7%
PLAN, DAY & ZIMMERMAN, INC. SHORT-TERM BOND 310,235 7.2%
1818 MARKET STREET
PHILADELPHIA, PA 19103
TRUSTEES OF THE VOGEL SHORT-TERM BOND 258,839 6.0%
EMPLOYEES PENSION TRUST
P.O. BOX 380
ORANGE CITY, IA 51041-0380
TRUSTEES OF THE NEW YORK LIFE INSURANCE COMPANY GROWTH EQUITY 6,063,587 21.5%
EMPLOYEE PROGRESS SHARING INVESTMENT PLAN TRUST INDEXED EQUITY 2,554,838 6.3%
51 MADISON AVENUE MULTI-ASSET 2,291,178 7.7%
NEW YORK, NY 10010 SHORT-TERM BOND 449,001 10.4%
TRUSTEES OF THE NEW LIFE INSURANCE COMPANY GROWTH EQUITY 3,187,810 11.2%
AGENTS PROGRESS SHARING INVESTMENT PLAN TRUST
51 MADISON AVENUE
NEW YORK, NY 10010
NEW YORK LIFE INSURANCE COMPANY EMPLOYEES' EAFE INDEX 860,727 16.6%
HEALTH AND LIFE BENEFIT TRUST - (HEALTH
BENEFITS)
51 MADISON AVENUE
NEW YORK, NY 10010
NEW YORK LIFE INSURANCE COMPANY EMPLOYEES' BOND 904,935 5.2%
HEALTH AND LIFE BENEFIT TRUST (LIFE BENEFITS) EAFE INDEX 296,507 5.7%
51 MADISON AVENUE
NEW YORK, NY 10010
NEW YORK LIFE INSURANCE COMPANY AGENTS' HEALTH EAFE INDEX 691,402 13.3%
AND LIFE BENEFIT TRUST
(HEALTH BENEFITS)
51 MADISON AVENUE
NEW YORK, NY 10010
</TABLE>
- 86 -
<PAGE>
<TABLE>
<CAPTION>
Percentage of
Name and Address of Shareholder Fund Shares Owned(1) Outstanding Shares(2)
<S> <C> <C> <C>
PLASTICS ENGINEERING COMPANY EAFE INDEX 747,616 14.4%
P.O. BOX 758
SHEBOYGAM, WI 53082-0758
MERRILL LYNCH TRUST COMPANY INDEXED EQUITY 3,160,780 7.8%
TTEE FBO CHRYSLER 401(K) PLAN
265 DAVIDSON AVENUE
SOMERSET, NJ 08873
NYL TRUST COMPANY CLIENT ACCOUNTS BOND 1,825,709 10.5%
51 MADISON AVENUE, ROOM 117A EAFE INDEX 473,281 9.2%
NEW YORK, NY 10010 GROWTH EQUITY 4,697,577 16.6%
INDEXED BOND 3,856,458 30.0%
INDEXED EQUITY 8,471,592 21.1%
MONEY MARKET 127,236,376 45.2%
MULTI-ASSET 6,820,900 23.1%
SHORT-TERM BOND 694,463 16.2%
VALUE EQUITY 9,787,509 16.6%
TRUSTEES OF THE HARVEST STATES COOPERATIVE INTERNATIONAL EQUITY 843,813 7.3%
COMBINED RETIREMENT FUND
P.O. BOX 64594
ST. PAUL, MN 55169
METHODIST HOME ENDOWMENT FUND INTERNATIONAL EQUITY 706,119 6.1%
1111 HERRING AVENUE
WACO, TX 76708
MACKAY-SHIELDS FINANCIAL CORPORATION SHORT-TERM BOND 401,861 9.3%
9 WEST 57TH STREET
NEW YORK, NY 10019
BHC SECURITIES INC. MONEY MARKET 70,903,910 25.2%
2005 MARKET STREET
1 COMMERCE SQUARE
PHILADELPHIA, PA 19103
TRUSTEES OF THE NEW YORK LIFE INSURANCE COMPANY BOND 6,093,959 35.1%
PENSION PLAN INDEXED BOND 3,966,072 30.9%
51 MADISON AVENUE INTERNATIONAL BOND 3,559,841 71.2%
NEW YORK, NY 10020 VALUE EQUITY 20,342,561 33.3%
TRUSTEES OF THE NYLIC RETIREMENT PLAN INTERNATIONAL EQUITY 3,359,070 28.9%
51 MADISON AVENUE
NEW YORK, NY 10010
NEW YORK LIFE INSURANCE COMPANY MULTI-ASSET 8,568,605 28.4%
51 MADISON AVENUE
NEW YORK, NY 10010
NEW YORK LIFE TRUST COMPANY INDEXED BOND 3,836,458 30.0%
CLIENT ACCOUNTS MONEY MARKET 127,336,376 45.2%
51 MADISON AVENUE, ROOM 117A
NEW YORK, NY 10010
</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.
As of April 1, 1998, 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
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<PAGE>
policies of the Company or the Manager or a Sub-Adviser unless such power is the
result of their position with the Company or Manager or Sub-Adviser. Such
persons are generally required to preclear all security transactions with the
Company's Compliance Officer or his designee and to report all transactions on a
regular basis. The Company has developed procedures for administration of the
Code of Ethics.
Independent Accountants
Price Waterhouse LLP, 1177 Avenue of the Americas, New York, New York
10036, has been selected as independent accountants of the Company.
Legal Counsel
Dechert Price & Rhoads, 1775 Eye Street, N.W., Washington, D.C. 20006,
passes upon certain legal matters in connection with the shares offered by the
Company, and also acts as counsel to the Company.
Financial Statements
The Company's financial statements for the Funds, including the Statements
of Assets and Liabilities, the Portfolios of Investments and the Statements of
Operations for the year ended December 31, 1997, and the Statements of Changes
in Net Assets for the years ended December 31, 1997 and December 31, 1996, the
notes to the Financial Statements, and the Report of the Independent
Accountants, all of which are included in the 1997 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
- 88 -
<PAGE>
to the registration statement, each such statement being qualified in all
respects by such reference.
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