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MAINSTAY INSTITUTIONAL FUNDS INC.
51 MADISON AVENUE
NEW YORK, NEW YORK 10010
STATEMENT OF ADDITIONAL INFORMATION
DATE: MARCH 1, 2000
AS SUPPLEMENTED APRIL 19, 2000
This Statement of Additional Information supplements the information
contained in the Company's Prospectus dated March 1, 2000, as amended or
supplemented from time to time (the "Prospectus"), and should be read in
conjunction with the Prospectus. The Prospectus is available without charge by
writing to MainStay Institutional Funds Inc., 260 Cherry Hill Road, Parsippany,
New Jersey 07054-1108, or by calling 1-800-695-2126. This Statement of
Additional Information, although not in itself a prospectus, is incorporated in
its entirety by reference in and is made a part of the Prospectus.
No dealer, salesman or any other person has been authorized to give
any information or to make any representations, other than those contained in
this Statement of Additional Information or in the related Prospectus, in
connection with the offer contained herein, and, if given or made, such other
information or representations must not be relied upon as having been
authorized by the Funds or NYLIFE Distributors, Inc. (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.
Shareholder inquiries should be made by writing directly to MainStay
Institutional Funds Inc., 260 Cherry Hill Road, Parsippany, New Jersey
07054-1108, or by calling 1-800-695-2126. In addition, you can make inquiries
through your registered representatives.
The financial statements of each of the Funds, including the Statement
of Assets and Liabilities and the Portfolios of Investments for the ten months
ended October 31, 1999, the Statement of Operations for the ten months ended
October 31, 1999 and the year ended December 31, 1998, the Statement of Changes
in Net Assets for the ten months ended October 31, 1999 and the years ended
December 31, 1998 and 1997, the notes to the Financial Statements, and the
Report of the Independent Accountants, all of which are included in the
Company's 1999 Annual Report to Shareholders, are hereby incorporated by
reference into this Statement of Additional Information.
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TABLE OF CONTENTS
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ADDITIONAL INFORMATION ABOUT THE FUNDS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
EAFE INDEX FUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
GROWTH EQUITY FUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
INDEXED EQUITY FUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
INTERNATIONAL EQUITY FUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
ASSET MANAGER FUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
VALUE EQUITY FUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
BOND FUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
INDEXED BOND FUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
INTERNATIONAL BOND FUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
SHORT-TERM BOND FUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
MONEY MARKET FUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
INVESTMENT PRACTICES AND INSTRUMENTS COMMON TO MULTIPLE FUNDS . . . . . . . . . . . . . . . . . . . . . . . 10
ARBITRAGE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
BORROWING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
COMMERCIAL PAPER . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
REPURCHASE AGREEMENTS AND REVERSE REPURCHASE AGREEMENTS . . . . . . . . . . . . . . . . . . . . . 11
U.S. GOVERNMENT SECURITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
CORPORATE DEBT SECURITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
LENDING OF PORTFOLIO SECURITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
RESTRICTED SECURITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
MUNICIPAL SECURITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
BANKING INDUSTRY AND SAVINGS AND LOAN INDUSTRY OBLIGATIONS . . . . . . . . . . . . . . . . . . . . 13
FLOATING AND VARIABLE RATE SECURITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
FOREIGN SECURITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
FORWARD FOREIGN CURRENCY CONTRACTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
FOREIGN INDEX-LINKED INSTRUMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
AMERICAN DEPOSITARY RECEIPTS ("ADRS") . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
WHEN-ISSUED AND FIRM OR STANDBY COMMITMENT AGREEMENTS . . . . . . . . . . . . . . . . . . . . . . 17
MORTGAGE-RELATED AND OTHER ASSET-BACKED SECURITIES . . . . . . . . . . . . . . . . . . . . . . . . 18
MORTGAGE DOLLAR ROLLS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
BRADY BONDS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
LOAN PARTICIPATION INTERESTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
REAL ESTATE INVESTMENT TRUSTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
RISK MANAGEMENT TECHNIQUES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
OPTIONS ON SECURITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
OPTIONS ON FOREIGN CURRENCIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
FUTURES TRANSACTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
SWAP AGREEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
WARRANTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
SHORT SALES AGAINST THE BOX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
RISKS ASSOCIATED WITH DEBT SECURITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
HIGH YIELD/HIGH RISK SECURITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
ZERO COUPON BONDS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
SPECIAL CONSIDERATIONS FOR EAFE INDEX FUND, INDEXED EQUITY FUND, ASSET
MANAGER FUND AND INDEXED BOND FUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
FUNDAMENTAL INVESTMENT RESTRICTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
</TABLE>
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DIRECTORS AND OFFICERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
THE MANAGER, THE SUBADVISORS AND THE DISTRIBUTOR . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
MANAGEMENT AGREEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
SUB-ADVISORY AGREEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
SUB-ADMINISTRATION AGREEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
DISTRIBUTION AGREEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
SERVICE FEES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
PURCHASES AND REDEMPTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
PORTFOLIO TRANSACTIONS AND BROKERAGE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
NET ASSET VALUE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
TAX INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
PERFORMANCE INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
OTHER INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
CAPITALIZATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
EFFECTIVE MATURITY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
SHARE OWNERSHIP OF THE FUNDS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
CODE OF ETHICS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
INDEPENDENT ACCOUNTANTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
LEGAL COUNSEL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
TRANSFER AGENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
CUSTODIAN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
REGISTRATION STATEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
APPENDIX A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
MOODY'S INVESTORS SERVICE, INC. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
STANDARD & POOR'S . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
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THE MAINSTAY INSTITUTIONAL FUNDS
MainStay Institutional Funds Inc. (the "Company") is an open-end
management investment company (or mutual fund) currently consisting of eleven
separate investment portfolios: Asset Manager Fund (formerly known as
Multi-Asset Fund), EAFE Index Fund, Growth Equity Fund, Indexed Equity Fund,
International Equity 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"). Each
Fund, other than the International Bond Fund, is a diversified fund as defined
by the Investment Company Act of 1940, as amended (the "1940 Act").
MainStay Management LLC (the "Manager") serves as the manager for the
Funds and has entered into Sub-Advisory agreements with Monitor Capital
Advisors LLC ("Monitor" or "Monitor Capital") with respect to the EAFE Index
Fund, Indexed Bond Fund, Indexed Equity Fund, and the Asset Manager Fund;
MacKay Shields LLC ("MacKay Shields") with respect to the Bond Fund, Growth
Equity Fund, International Bond Fund, International Equity Fund, Short-Term
Bond Fund, and the Value Equity Fund; and New York Life Asset Management
Operating Company LLC with respect to the Money Market Fund ("NYLAMOC" and
together with Monitor and MacKay Shields, each a "Subadvisor" and collectively
the "Subadvisors").
ADDITIONAL INFORMATION ABOUT THE FUNDS
The Prospectus discusses the investment objectives, principal
investment strategies and principal risks of the Funds. 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.
NONE OF THE FUNDS ALONE CONSTITUTES A COMPLETE INVESTMENT PROGRAM.
Investment decisions for each Fund are made independently from those
of the other accounts and investment companies that may be managed by a
Subadvisor. However, if such other accounts or investment companies are
prepared to invest in, or desire to dispose of, securities in which one Fund
invests at the same time as another Fund managed by the same Subadvisor,
available investments or opportunities for sales will be allocated equitably to
each. In some cases, this procedure may adversely affect the size of the
position obtained for or disposed of by a Fund or the price paid or received by
a Fund.
EAFE INDEX FUND
The EAFE Index Fund will generally invest in stocks in the Morgan
Stanley Capital International Europe, Australasia and Far East Index ("EAFE
Index"), however, not all EAFE Index companies within a country will be
represented in the Fund's portfolio of securities at the same time. The Fund
may not invest in certain stocks (numbering approximately 50) included in the
EAFE Index because corporate charters have provisions prohibiting ownership by
foreign investors.
In addition to the investments discussed in the Prospectus, the EAFE
Index Fund may invest up to 20% of total assets in stock index options, futures
contracts and options on futures to maintain cash reserves while fully
invested, to facilitate trading, or to reduce transaction costs. The Fund may
also invest up to 10% of its total assets in index and currency exchange rate
swap agreements. The Fund may engage in foreign currency exchange transactions
using currencies, options, futures or options on futures, or forward contracts
for any legally permissible purpose, including to protect against foreign
currency exchange risks involving securities the Fund owns or plans to own.
There are a variety of risks associated with using options and
futures. For example, some options on foreign currencies could force the
Subadvisor to buy or sell foreign currencies at unfavorable exchange rates,
creating losses. It is also possible that the Fund could forfeit the entire
amount of the premium paid for the purchased options plus transaction costs. A
lack of market activity may keep the Subadvisor from closing out a futures
contract or a futures option position when it wants to. The Fund would remain
obligated to make margin deposits until it could close the position.
Furthermore, there are no guarantees that hedging transactions or the use of
options and futures will successfully protect investments, or lead to better
Fund performance. In some instances, the Fund may lose money.
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GROWTH EQUITY FUND
The Growth Equity Fund will invest at least 65% of its total assets,
under normal market conditions, in equity securities, including common stocks,
nonconvertible preferred stocks, securities convertible into or exchangeable
for common stocks (e.g., convertible preferred stocks and convertible
debentures) and warrants. Convertible preferred stocks and debentures must be
rated when purchased Baa or better by Moody's Investors Service Inc.
("Moody's") or BBB or better by Standard & Poor's ("S&P" or "Standard &
Poor's"), or if unrated, considered by the Subadvisor to be of comparable
quality.
The Growth Equity Fund may also invest in options on common stocks and
stock indices, futures contracts and related options, stocks represented by
American Depositary Receipts ("ADRs") or European Depositary Receipts ("EDRs"),
foreign equity securities, obligations issued or guaranteed by the U.S.
Government or any of its agencies or instrumentalities or by any of the states,
cash equivalents, or cash.
The Fund may enter into foreign currency exchange transactions using
currencies, options, futures or options on futures, or forward contracts to
help protect against foreign currency exchange risks involving foreign
securities the Fund owns or plans to own. Use of these contracts do, however,
involve risks. See "Risk Management Techniques" and related sections in this
SAI.
Although it is not the Fund's policy generally to invest or trade for
short-term profits, portfolio securities may be disposed of without regard to
the length of time held whenever the Subadvisor is of the opinion that a
security no longer has an appropriate appreciation potential or has reached its
anticipated level of performance, or when another security appears to offer
relatively greater appreciation potential or a relatively greater anticipated
level of performance.
However, 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 and other
assets held for less than three months. (See "Tax Information".)
INDEXED EQUITY FUND
In addition to the investments discussed in the Prospectus, the
Indexed Equity Fund may invest up to 20% of total assets in options and futures
contracts to maintain cash reserves while being fully invested, to facilitate
trading or to reduce transaction costs. The Fund may also invest up to 10% of
its total assets in index swap agreements.
INTERNATIONAL EQUITY FUND
The International Equity Fund will primarily invest in a diversified
portfolio of securities, including common stocks, preferred stocks, warrants
and other comparable equity securities of corporations which do business mainly
outside of the United States.
The International Equity Fund may invest in ADRs, EDRs, GDRs (Global
Depository Receipts); IDRs (International Depositary Receipts) or other similar
securities convertible into securities of foreign issuers.
To enhance returns, manage risk more efficiently and protect against
price changes in securities, the Fund may invest in currencies on a spot or
forward basis, securities and securities index options, foreign currency
options, futures contracts and related options, and may enter into swap
agreements. Futures and related options may be used for any legal purpose
including to reduce trading costs.
The Fund may also invest in U.S. equity securities; notes and bonds
which, when purchased, are rated in one of the top four categories by Moody's
or Standard & Poor's; cash, including foreign currency, or cash equivalents
such as obligations of banks, commercial paper and short-term obligations of
U.S. or foreign issuers.
The Fund is actively managed and invests primarily in international
(non-U.S.) stocks, but the Fund may acquire other securities including cash
equivalents. Eligible investments for the Fund include any equity-related
investment, domestic or foreign, whether denominated in foreign currencies or
U.S. dollars.
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In selecting investments for the Fund, the Fund's Subadvisor considers
factors such as prospects for currency exchange, interest and inflation rates,
relative economic growth, government policies influencing exchange rates and
business conditions, and the quality of individual issuers. MacKay Shields will
also determine, using good faith judgment, (1) country allocation among the
international equity markets, (2) currency exposure (asset allocation across
currencies), and (3) diversified security holdings within each market.
The Fund may use futures and options contracts (1) in an effort to
manage cash flow and remain fully invested in the stock and currency markets,
instead of, or in addition to, buying and selling stocks and currencies; or (2)
in an effort to hedge against a decline in the value of securities or
currencies owned by it or an increase in the price of securities which it plans
to purchase. The Fund may also purchase and sell foreign currency exchange
contracts and foreign currency options for purposes of seeking to enhance
portfolio returns or to manage risk more efficiently.
MacKay Shields also believes that active currency management can
enhance portfolio returns through opportunities arising from interest rate
differentials between instruments denominated in different currencies and/or
changes in value between currencies. Moreover, MacKay Shields believes active
currency management can be employed as an overall portfolio risk management
tool. For example, in its view, foreign currency management can provide overall
portfolio risk diversification when combined with a portfolio of foreign
securities, and the market risks of investing in specific foreign markets can
at times be reduced by currency strategies which may not involve the currency
in which the foreign security is denominated. See "Risk Management Techniques"
and related sections of this SAI.
ASSET MANAGER FUND
Within the asset class constraints discussed in the prospectus, the
Asset Manager Fund may also invest up to 20% of total its assets in foreign
securities (defined as "traded primarily in a market outside the United
States") of developed and emerging market countries; up to 10% of total assets
in interest rate, index, and currency exchange rate swap agreements; and in
futures transactions to rebalance or alter its portfolio composition and risk
profile and to diversify the Fund's holdings where futures transactions are
more efficient than direct investment transactions.
Within the asset class constraints discussed in the prospectus, the
Fund may also invest in foreign currency exchange transactions using
currencies, options, futures or options on futures, or forward contracts for
any legally permissible purpose, including to protect against foreign currency
exchange risks involving securities the Fund owns or plans to own.
At times, the actual allocation for each asset class may differ from
the constraints, due to market fluctuations or cash entering or leaving the
Fund. This could happen for instance, if the Subadvisor has positioned the
assets close to a minimum or maximum for one or more asset classes, and the
Fund's cash position changes because of investors buying or selling the Fund's
shares. To correct the situation, the Subadvisor will move cash or reallocate
assets within seven days.
The Fund's allocation among the three asset groups is then structured
to take advantage of perceived imbalances in relative pricing. Monitor Capital
believes that short-term imbalances occur periodically but tend to be corrected
fairly quickly. The models used by the Subadvisor to estimate returns on
domestic and foreign stock markets may from time to time cause significant
shifts in the Fund's allocation among the asset groups which may in turn result
in greater portfolio volatility.
The Fund may buy common stocks that the EAFE Index Fund and Indexed
Equity Fund may buy, fixed income securities that the Indexed Bond Fund may buy
and money market instruments that the Money Market Fund may buy.
VALUE EQUITY FUND
The Fund intends to purchase those securities which it believes to be
undervalued in the market relative to comparable securities. In assessing
whether a stock is undervalued, MacKay Shields, the Fund's Subadvisor,
considers, among other factors, a company's financial strength and earnings
predictability. The Fund may provide some protection on the downside through
its investment in companies whose current stock prices reflect, in MacKay
Shields' opinion, either unwarranted pessimism or unrecognized value.
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Equity securities in which the Value Equity Fund may invest include
common stocks and securities that can be exchanged for or converted into common
stocks (e.g., convertible preferred stocks and convertible debentures),
nonconvertible preferred stocks and warrants.
The Fund may also invest up to 35% of its total assets in options on
common stocks and stock indices, stocks represented by ADRs or EDRs, foreign
equity securities, zero coupon bonds, obligations issued or guaranteed by the
U.S. Government or any of its agencies or instrumentalities or by any of the
states, cash equivalents or cash.
The convertible preferred stocks, debentures and zero coupon bonds in
which the Fund may invest, when purchased, must be, rated Baa or better by
Moody's or BBB or better by Standard & Poor's; or unrated but judged by the
Subadvisor to be of comparable quality.
The Fund may also invest in stock index futures contracts and related
options to protect against changes in stock prices.
The Fund may participate in foreign currency exchange transactions
using currencies, options, futures or options on futures, or forward contracts
to help protect against foreign currency exchange risks involving foreign
securities the Fund owns or plans to own.
BOND FUND
In addition to the investment discussed in the Prospectus, the Fund
may invest up to 20% of total assets in securities denominated in foreign
currencies. To the extent possible, the Fund will attempt to protect these
investments against risks stemming from differences in foreign exchange rates.
The Fund may enter into foreign currency exchange transactions using
currencies, options, futures or options on futures, or forward contracts to
protect against foreign exchange risks involving securities the Fund owns or
plans to own.
The Fund may also invest in interest rate and bond index futures
contracts, and options on these contracts, and options on debt securities.
The Subadvisor will alter the average maturity of the portfolio in
accordance with the research and other methods.
INDEXED BOND FUND
The Indexed Bond Fund invests primarily in a representative sample of
the securities in the Salomon Smith Barney Broad Investment Grade Bond Index
(the "BIG Index"). Bonds are selected for inclusion in the Fund's portfolio
based on credit quality, sector, maturity, coupon, current yield, yield to
maturity, duration, and convexity. Monitor Capital believes the indexing
approach is an effective method of the Fund's Subadvisor simulating percentage
changes in the BIG Index. It is a reasonable expectation that there will be a
close correlation between the Fund's performance and that of the BIG Index in
both rising and falling markets.
The Indexed Bond Fund may invest up to 20% of total assets in bond
and interest rate index options and futures and options on these futures to
maintain cash reserves while fully invested, to facilitate trading, or reduce
transaction costs.
Monitor Capital may effect certain portfolio transactions involving
when-issued, delayed delivery and other types of securities that may have the
effect of increasing nominal portfolio turnover of the Fund.
INTERNATIONAL BOND FUND
The International Bond Fund may invest in any debt or debt-related
investment, domestic or foreign, denominated in foreign or U.S. currency.
However, the Fund will invest at least 65% of total assets, under normal market
conditions, in foreign bonds which include debt securities of foreign
governments, agencies and supranational organizations denominated in foreign
currencies or U.S. dollars. The Fund may also purchase debt securities of
corporate issuers. Some of these securities may be privately issued and/or
convertible into common stock or they may be traded together with warrants for
the purchase of common stock.
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To enhance returns, manage risk more efficiently and help protect
against price changes in securities the Fund owns or may own, the Fund may also
invest in currencies on a spot or forward basis, securities or securities index
options, foreign currency options, futures contracts and related options on
futures contracts. The Fund also may enter into swap agreements. Futures and
related options may be used for any legal purpose including to reduce trading
costs. The Fund may also purchase and sell foreign exchange contracts and
foreign currency options for purposes of seeking to enhance portfolio returns
or to manage portfolio risk more efficiently. See "Risk Management Techniques"
and related sections in this SAI.
In selecting investments for the Fund, the Fund's Subadvisor considers
factors such as prospects for currency exchange, interest and inflation rates,
relative economic growth, government policies influencing exchange rates and
business conditions, and the quality of individual issuers. MacKay Shields will
also determine, using good faith judgment, (1) country allocation, (2) currency
exposure (asset allocation across currencies), and (3) diversified security
holdings within each market.
Generally, the Fund's average maturity will be shorter when interest
rates worldwide or in a particular country are expected to rise, and longer
when interest rates are expected to fall. The Fund may use various techniques
to shorten or lengthen the dollar-weighted average maturity of its portfolio,
including transactions in futures and options on futures, interest rate swaps,
caps, floors and short sales against the box.
SHORT-TERM BOND FUND
The Short-Term Bond Fund may invest in obligations issued or
guaranteed by the U.S. government, its agencies or instrumentalities;
mortgage-related and other asset-backed securities; certificates of deposits,
time deposits and bankers' acceptances issued by domestic or foreign banks or
savings and loan associations and denominated in U.S. dollars or foreign
currencies.
The Fund may also invest in domestic and foreign corporate debt
securities, municipal bonds, zero coupon bonds and variable or floating rate
securities rated Baa or better by Moody's or BBB or better by S&P when
purchased; or, if unrated, determined by the Subadvisor to be of comparable
quality.
The Fund may invest up to 20% of total assets in securities
denominated in foreign currencies. To the extent possible, the Fund's
Subadvisor will attempt to protect against risks stemming from differences in
foreign exchange rates. The Fund may invest in foreign currency exchange
transactions using currencies, options, futures or options on futures, or
forward contracts to protect against foreign currency exchange risks involving
securities the Fund owns or plans to own. See "Risk Management Techniques" and
related sections in this SAI.
The Fund may invest in interest rate and bond index futures contracts
and options on these contracts; and options on debt securities and in U.S.
dollar- or foreign currency-denominated obligations of foreign governments or
their subdivisions, agencies or instrumentalities, international agencies or
supranational entities.
In seeking to achieve capital appreciation, as an integral component
of total return, the Fund may use, among other research methods, historical
yield spread analysis, economic analysis, fundamental credit analysis and
technical (supply/demand) analysis.
The Fund may, to the extent permitted by law, invest in leveraged
inverse floating rate debt instruments ("inverse floaters"). Certain inverse
floaters may be deemed to be illiquid securities for purposes of the Fund's 10%
limitation on investments in such securities.
MONEY MARKET FUND
The Money Market 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.
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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 Rule 2a-7 under the 1940 Act, 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 Fund's Subadvisor,
NYLAMOC, 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 Subadvisor; (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 Guarantee is
substituted with another Demand Feature or Guarantee; (5) if it is a security
issued by a money market fund registered with the Securities and Exchange
Commission ("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 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, 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 "First Tier" 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 75%
of its total assets, shall not have invested more than 10% 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 5% 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 invest up to 5% of its
total assets in securities that were "Second Tier" when acquired. The Fund may
not invest more than the greater of 1% of its total assets or $1 million,
measured at the time of investment, in "Second Tier" securities of any one
issuer, 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, NYLAMOC, the Fund's Subadvisor, 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
Subadvisor 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.
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The extent of deviation between the Fund's net asset value based upon
available market quotations or market equivalents and $1.00 per share based on
amortized cost will be periodically examined by the Directors. If such
deviation exceeds 1/2 of 1%, the Directors will promptly consider what action,
if any, will be initiated. In the event the Directors determine that a
deviation exists which may result in material dilution or other unfair results
to investors or existing shareholders, they will take such corrective action as
they regard to be necessary and appropriate, 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.
The Fund may borrow money for temporary or emergency purposes,
purchase securities on a when-issued basis, and enter into firm or standby
commitments to purchase securities.
In addition, the weighted average portfolio maturity may not exceed
90 days.
INVESTMENT PRACTICES AND INSTRUMENTS COMMON TO MULTIPLE FUNDS
The Funds may engage in the following investment practices, or invest
in the following instruments to the extent permitted in the Prospectus and
elsewhere in this SAI.
ARBITRAGE
Each Fund may sell in one market a security which it owns and
simultaneously purchase the same security in another market, or it may buy a
security in one market and simultaneously sell it in another market, in order
to take advantage of differences in the price of the security in the different
markets. The Funds do not actively engage in arbitrage. Such transactions may
be entered into only with respect to debt securities and will occur only in a
dealer's market where the buying and selling dealers involved confirm their
prices to the Fund at the time of the transaction, thus eliminating any risk to
the assets of a Fund. Such transactions, which involve costs to a Fund, may be
limited by the requirements imposed on each Fund to qualify as a "regulated
investment company" under the Internal Revenue Code of 1986, as amended (the
"Code").
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 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.
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COMMERCIAL PAPER
Each Fund may invest in commercial paper. Each Fund will invest in
commercial paper 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 Subadvisor 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.
REPURCHASE AGREEMENTS AND REVERSE REPURCHASE AGREEMENTS
The Funds may enter into domestic or foreign repurchase agreements
with certain sellers determined by the Manager or Subadvisor to be
creditworthy. 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 a custodian appointed by the Fund. The Fund attempts to assure
that the value of the purchased securities, including any accrued interest,
will at all times exceed the value of the repurchase agreement. 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 Subadvisors 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 involve 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 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.
The Directors have reviewed and approved certain sellers who they
believe to be creditworthy and have authorized each Fund to enter into
repurchase agreements with such sellers. If the other party to a repurchase
agreement were to become bankrupt, a Fund could experience delays in recovering
its investment or losses.
U.S. 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 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.
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CORPORATE DEBT SECURITIES
A Fund's investments in U.S. dollar- or foreign currency-denominated
corporate debt securities of domestic or foreign issuers are limited to
corporate debt securities (corporate bonds, debentures, notes and other similar
corporate debt instruments) which meet the credit quality and maturity criteria
set forth for the particular Fund. The rate of return or return of principal on
some debt obligations may be linked to indexes or stock prices or indexed to
the level of exchange rates between the U.S. dollar and foreign currency or
currencies.
Corporate debt securities with a rating lower than BBB by S&P, and
corporate debt securities rated Baa or lower by Moody's, have speculative
characteristics and changes in economic conditions or individual corporate
developments are more likely to lead to a weakened capacity to make principal
and interest payments than in the case of high grade bonds. Should any
individual bond held by a Fund, other than the International Bond Fund or
International Equity Fund, fall below a rating of BBB by S&P or Baa by Moody's,
the Fund's Subadvisor will dispose of such bond as soon as reasonably
practicable in light of then-existing market and tax considerations. The
International Bond Fund may invest up to 25% of its net assets in debt
securities which are rated below investment grade.
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 the market value of the securities loaned. The total
market value of securities loaned will not exceed 33% of the total assets of a
Fund. The Fund would have the right to call a loan and obtain the securities
loaned at any time generally on less than five days' notice. For the duration
of a loan, the Fund would continue to receive the equivalent of the interest or
dividends paid by the issuer on the securities loaned and would also receive
compensation from the investment of the collateral. The Fund would not,
however, have the right to vote any securities having voting rights during the
existence of the loan, but the Fund would call the loan in anticipation of an
important vote to be taken among holders of the securities or of the giving or
withholding of their consent on a material matter affecting the investment. The
Company, on behalf of certain of the Funds, has entered into an agency
agreement with Metropolitan West Securities, 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' Subadvisors.
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 or breach its agreement with a Fund. However,
the loans would be made only to firms deemed by a Subadvisor to be creditworthy
and approved by the Board, and when, in the judgment of a Subadvisor, the
consideration which can be earned currently from securities loans of this type
justifies the attendant risk. If a Subadvisor determines to make securities
loans, it is intended that the value of the securities loaned will 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 is prohibited from lending more than
5% of the Fund's total assets to any one counterparty.
RESTRICTED SECURITIES
To the extent that they invest in restricted securities, the Funds may
be exposed to additional risks. "Restricted" securities are those securities
which have not been registered under the Securities Act of 1933. Because they
are unregistered, only a limited number of investors are qualified to invest in
such securities. The smaller market may create undesirable delays in selling
restricted securities. A Fund attempting to dispose of restricted securities
may incur additional transaction costs in finding a buyer or, in an extreme
case, the cost of registering the security.
MUNICIPAL SECURITIES
The Bond Fund and Short-Term Bond Fund may purchase municipal
securities which are debt obligations of state and local governments, agencies
and authorities. Municipal securities, which may be issued in various forms,
including notes and bonds, are issued to obtain funds for various public
purposes. The other Funds may purchase municipal securities for temporary
defensive 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,
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revenue bonds which do not generally carry the pledge of the full faith and
credit of the issuer of such bonds, but depend for payment on the ability of
the industrial user to meet its obligations (or any property pledged as
security).
BANKING INDUSTRY AND SAVINGS AND LOAN INDUSTRY OBLIGATIONS
Each Fund may invest in certificates of deposit, time deposits,
bankers' acceptances, and other short-term debt obligations issued by
commercial banks and, with the exception of the Money Market Fund, in
certificates of deposit, time deposits and other short-term obligations issued
by savings and loan associations.
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 its 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
Each Fund, other than the EAFE Index Fund, Growth Equity Fund, Indexed
Equity Fund and Value Equity Fund may invest in floating rate debt instruments.
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. To be an eligible investment for the Money Market Fund,
there must be a reasonable expectation that, at any time until the final
maturity for the floater or the period remaining until the principal amount can
be recovered through demand, the market value of a floater will approximate its
amortized cost.
The Bond Fund, International Bond Fund, International Equity Fund and
Short-Term Bond Fund may invest in leveraged inverse floating rate debt
instruments ("inverse floaters"). The interest rate on an inverse floater
resets in the opposite direction from the market rate of interest to which the
inverse floater is indexed. An inverse floater may be considered to be
leveraged to the extent that its interest rate varies by a magnitude that
exceeds the magnitude of the change in the index rate of interest. The higher
degree of leverage inherent in inverse floaters is associated with greater
volatility in their market values. Accordingly, the duration of an inverse
floater may exceed its stated final maturity. Certain inverse floaters may be
determined to be illiquid securities for purposes of a Fund's limitation on
investments in such securities.
FOREIGN SECURITIES
The EAFE Index Fund, International Bond Fund and International Equity
Fund will, and the Bond Fund, Growth Equity Fund, Asset Manager 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 S&P 500 and the BIG 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
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denominated in multi-national currency units. Securities of issuers within a
given country may be denominated in the currency of another country.
Foreign investing involves the possibility of expropriation,
nationalization, confiscatory taxation, foreign taxation of income earned in
the foreign nation (including withholding taxes on interest and dividends) or
other foreign taxes imposed with respect to investments in the foreign nation,
foreign exchange controls (which may include suspension of the ability to
transfer currency from a given country), default in foreign government
securities, political or social instability or diplomatic developments which
could affect investments in securities of issuers in those nations. In
addition, in many countries there is less publicly available information about
issuers than is available in reports about companies in the United States.
Foreign companies are not generally subject to uniform accounting and auditing
and financial reporting standards, and auditing practices and requirements may
not be comparable to those applicable to U.S. companies. In many foreign
countries, there is less government supervision and regulation of business and
industry practices, stock exchanges, brokers and listed companies than in the
United States. Foreign securities transactions may be subject to higher
brokerage and custodial costs than domestic securities transactions. In
addition, the foreign securities markets of many of the countries in which the
Funds may invest may also be smaller, less liquid and subject to greater price
volatility than those in the United States.
Many of the foreign securities in which the Funds (other than the
Money Market Fund) invest will be denominated in foreign currencies. Changes in
foreign exchange rates will affect the value of securities denominated or
quoted in foreign currencies. Exchange rate movements can be large and can
endure for extended periods of time, affecting either favorably or unfavorably
the value of the Funds' assets. A Fund may, however, engage in foreign currency
transactions to protect itself against fluctuations in currency exchange rates
in relation to the U.S. dollar. Such foreign currency transactions may include
forward foreign currency contracts, currency exchange transactions on a spot
(i.e., cash) basis, put and call options on foreign currencies, and foreign
exchange futures contracts.
The Growth Equity Fund, Indexed Bond Fund, International Bond Fund,
International Equity Fund, Asset Manager 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 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.
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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. These contracts may
be used to gain exposure to a particular currency or to hedge against the risk
of loss due to changing currency exchange rates.
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, when hedging, to minimize
the risk of loss due to a decline in the value of the hedged currencies, at the
same time, they tend to limit any potential gain which might result should the
value of such currencies increase.
While a Fund may enter into forward contracts to reduce currency
exchange risks, changes in currency exchange rates may result in poorer overall
performance for the Fund than if it had not engaged in such transactions.
Moreover, there may be an imperfect correlation between a Fund's portfolio
holdings of securities denominated in a particular currency and forward
contracts entered into by the Fund. Such imperfect correlation may prevent the
Fund from achieving the intended hedge or expose the Fund to the risk of
currency exchange loss.
A Fund will 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.
Generally, 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 Subadvisor 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 by entering into
such a contract. Generally, the Subadvisor believes that the best interest of a
Fund will be served by entering into such a contract under various
circumstances, some of which are described below. For example, when a Fund
enters into, or anticipates going 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. dollars price of the security. By entering into a forward contract for the
purpose 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 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.
In addition, when the Subadvisor 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).
A Fund also 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
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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.
A Fund may also enter into currency transactions to profit from
changing exchange rates based upon the Subadvisor's assessment of likely
exchange rate movements. These transactions will not necessarily hedge existing
or anticipated holdings of foreign securities and may result in a loss if the
Subadvisor's currency assessment is incorrect.
At the consummation of the forward contract, a Fund may either make
delivery of the foreign currency or terminate its contractual obligation to
deliver the foreign currency by purchasing an offsetting contract obligating it
to purchase at the same maturity date the same amount of such foreign currency.
If a Fund chooses to make delivery of the foreign currency, it may be required
to obtain such currency for delivery through the sale of portfolio securities
denominated in such currency or through conversion of other assets of the Fund
into such currency. If a Fund engages in an offsetting transaction, the Fund
will realize a gain or a loss to the extent that there has been a change in
forward contract prices. Closing purchase transactions with respect to forward
contracts are usually effected with the currency trader who is a party to the
original forward contract.
A Fund's dealing in forward contracts will be limited to the
transactions described above. Of course, a Fund is not required to enter into
such transactions with regard to its foreign currency-denominated securities
and will not do so unless deemed appropriate by a Subadvisor. 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.
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
Subadvisor'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
Subadvisor anticipates. A Fund may also incur significant costs when converting
assets from one currency to another. Contracts to sell foreign currency would
limit any potential gain which might be realized by a Fund if the value of the
hedged currency increases.
The Subadvisors 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 Subadvisors believe active
currency management can be employed as an overall portfolio risk management
tool. For example, in their view, foreign currency
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management can provide overall portfolio risk diversification when combined
with a portfolio of foreign securities, and the market risks of investing in
specific foreign markets can at times be reduced by currency strategies which
may not involve the currency in which the foreign security is denominated.
The Funds cannot assure that their use of forward contracts will
always be successful. Successful use of forward contracts depends on the
Subadvisor'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
Subadvisor anticipates. A Fund may also incur significant costs when converting
assets from one currency to another. Contracts to sell foreign currency would
limit potential gain which might be realized by a Fund if the value of the
hedged currency increases.
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, Asset Manager Fund
and International Bond Fund may, subject to compliance with its respective
limitations applicable to its investment in debt securities, invest in
instruments issued by the U.S. or a foreign government or by private issuers
that return principal and/or pay interest to investors in amounts which are
linked to the level of a particular foreign index ("foreign index-linked
instruments"). Foreign index-linked instruments 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. Foreign
index-linked instruments 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.
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.
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 (60 days for municipal bonds and notes).
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
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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.
The transactions are entered into in order to secure what is
considered to be an advantageous price and yield to a Fund and not for purposes
of leveraging the Fund's assets. However, a Fund will not accrue any income on
these securities prior to delivery. The value of when-issued securities and
firm and standby commitment agreements may vary prior to and after delivery
depending on market conditions and changes in interest rate levels. There is a
risk that a party with whom a Fund has entered into such transactions will not
perform its commitment, which could result in a gain or loss to the Fund.
At the time the Company makes the commitment on behalf of a Fund to
purchase a security on a when-issued, or firm or standby commitment basis, it
will record the transaction and reflect the amount due and the value of the
security in determining the Fund's net asset value. The market value of the
when-issued, or firm or standby commitment securities may be more or less than
the purchase price payable at the settlement date. The Directors do not believe
that a Fund's net asset value or income will be exposed to additional risk by
the purchase of securities on a when-issued or firm commitment basis. Each Fund
will establish a segregated account in which it will maintain liquid assets at
least equal in value to any commitments to purchase securities on a
when-issued, firm, or standby commitment basis. Such segregated securities
either will mature or, if necessary, be sold on or before the settlement date.
MORTGAGE-RELATED AND OTHER ASSET-BACKED SECURITIES
Mortgage-related and asset-back securities, which include
mortgage-backed securities, are securities that derive their value from
underlying pools of loans that may include interests in pools of lower-rate
debt securities, consumer loans or mortgages, or complex instruments such as
collateralized mortgage obligations and stripped mortgage-backed securities.
The value of these securities may be significantly affected by changes in
interest rates, the market's perception of issuers and the creditworthiness of
the parties involved. The ability of a Fund to successfully utilize these
instruments may depend in part upon the ability of the Fund's Subadvisor to
forecast interest rates and other economic factors correctly. Some securities
may have a structure that makes their reaction to interest rate changes and
other factors difficult to predict, making their value highly volatile. These
securities may also be subject to prepayment risk and if the security has been
purchased at a premium the amount of the premium would be lost in the event of
prepayment. The Money Market Fund may only invest in mortgage-backed and
asset-backed securities that meet the requirements of Rule 2a-7 under the 1940
Act. 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. The Money Market Fund
observes the strict SEC mandated requirements of Rule 2a-7. 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 ("GNMA")) are described as "modified
pass-through." These securities entitle the holder to receive all interest and
principal payments owed on the mortgage pool, net of certain fees, at the
scheduled payment dates regardless of whether or not the mortgagor actually
makes the payment. Some mortgage pass-through certificates may include
securities backed by adjustable-rate mortgages which bear interest at a rate
that will be adjusted periodically.
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
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reinvestment of principal. Also, if a security subject to prepayment has been
purchased at a premium, in the event of prepayment, the value of the premium
would be lost.
Payment of principal and interest on some mortgage pass-through
securities (but not the market value of the securities themselves) may be
guaranteed by the full faith and credit of the U.S. government (in the case of
securities guaranteed by GNMA); or guaranteed by agencies or instrumentalities
of the U.S. government (in the case of securities guaranteed by the Federal
National Mortgage Association ("FNMA") or the Federal Home Loan Mortgage
Corporation ("FHLMC"), which are supported only by the discretionary authority
of the U.S. government to purchase the agency's obligations).
The principal governmental guarantor of mortgage-related securities is
the GNMA. GNMA is a wholly-owned U.S. government corporation within the U.S.
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 ("FHA")-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 FNMA and the 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
and acts as a government instrumentality under authority granted by Congress.
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. FNMA is authorized to borrow from the U.S. Treasury to
meet its obligations.
FHLMC was created by Congress in 1970 for the purpose of increasing
the availability of mortgage credit for residential housing. It is a
government- sponsored corporation and acts as a government instrumentality
under authority granted by Congress. FHLMC was formerly owned by the twelve
Federal Home Loan Banks and is now owned entirely by private stockholders.
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.
If either fixed or variable rate pass-through securities issued by the
U.S. government or its agencies or instrumentalities are developed in the
future, the Funds, reserve the right to invest in them.
Commercial banks, savings and loan institutions, private mortgage
insurance companies, mortgage bankers and other secondary market issuers also
create pass-through pools of conventional residential mortgage loans. Such
issuers may, in addition, be the originators and/or servicers of the underlying
mortgage loans as well as the guarantors of the mortgage-related securities.
Pools created by such non-governmental issuers generally offer a higher rate of
interest than government and government-related pools because there are no
direct or indirect government or agency guarantees of payments in the former
pools. However, timely payment of interest and principal of these pools may be
supported by various forms of insurance or guarantees, including individual
loan, title, pool and hazard insurance and letters of credit. The insurance and
guarantees are issued by governmental entities, private insurers and the
mortgage poolers. Such insurance and guarantees and the creditworthiness of the
issuers thereof will be considered in determining whether a mortgage-related
security meets a Fund's investment quality standards. There can be no assurance
that the private insurers or guarantors can meet their obligations under the
insurance policies or guarantee arrangements. A Fund may buy mortgage-related
securities without insurance or guarantees if, through an examination of the
loan experience and practices of the originator/servicers and poolers, the
Fund's Subadvisor determines that the securities meet the Fund's quality
standards. Although the market for such securities is becoming increasingly
liquid, securities issued by certain private organizations may not be readily
marketable. No Fund will purchase mortgage-related securities or any other
assets which in the opinion of the Fund's Subadvisor 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
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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 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 eligible 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 the Fund's net assets would be invested in CMOs and
other investment company securities in the aggregate, or the 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 FHA prepayment experience applied to the mortgage
collateral pool. All sinking fund payments in the CMOs are allocated to the
retirement of the individual classes of bonds in the order of their stated
maturities. Payment of principal on the mortgage loans in the collateral pool
in excess of the amount of FHLMC's minimum sinking fund obligation for any
payment date are paid to the holders of the CMOs as additional sinking fund
payments. Because of the "pass-through" nature of all principal payments
received on the collateral pool in excess of FHLMC's minimum sinking fund
requirement, the rate at which principal of the CMOs is actually repaid is
likely to be such that each class of bonds will be retired in advance of its
scheduled maturity date.
If collection of principal (including prepayments) on the mortgage
loans during any semiannual payment period is not sufficient to meet FHLMC's
minimum sinking fund obligation on the next sinking fund payment date, FHLMC
agrees to make up the deficiency from its general funds.
Criteria for the mortgage loans in the pool backing the CMOs are
identical to those of FHLMC PCS. FHLMC has the right to substitute collateral
in the event of delinquencies and/or defaults.
Other Mortgage-Related Securities. Other mortgage-related securities
include securities other than those described above that directly or indirectly
represent a participation in, or are secured by and payable from, mortgage
loans on real property, including CMO residuals and stripped mortgaged-backed
securities, and may be structured in classes with rights to receive varying
proportions of principal and interest. Other mortgage-related securities may be
equity or debt 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, partnerships, trusts and special purpose
entities of the foregoing.
The Funds' Subadvisors 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
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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 Subadvisor 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 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.
CMOs may offer a higher yield than U.S. government securities, but
they may also be subject to greater price fluctuation and credit risk. In
addition, CMOs typically will be issued in a variety of classes or series,
which have different maturities and are retired in sequence. Privately issued
CMOs are not government securities nor are they supported in any way by any
governmental agency or instrumentality. In the event of a default by an issuer
of a CMO, there is no assurance that the collateral securing such CMO will be
sufficient to pay principal and interest. It is possible that there will be
limited opportunities for trading CMOs in the over-the-counter market, the
depth and liquidity of which will vary from time to time.
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 developed and, accordingly, these securities may be deemed
"illiquid" and subject to a Fund's limitations on investment in illiquid
securities.
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Risks Associated with Mortgage-Related Securities. As in the case with
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-related 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 Subadvisor to
forecast interest rates and other economic factors correctly. If a Subadvisor
incorrectly forecasts such factors and has taken a position in mortgage-related
securities that is or becomes contrary to prevailing market trends, the Funds
could be exposed to the risk of a loss.
Investment in mortgage-related 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 overtime. The price of mortgage-related 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-related 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 enhance has defaulted on its
obligations. Obligations issued by U.S. government-related entities are
guaranteed as to the payment of principal and interest, but are not backed by
the full faith and credit of the U.S. government. The performance of private
label mortgage-related securities, issued by private institutions, is based on
the financial health of those institutions.
Other Asset-Backed Securities. The Funds' Subadvisors expect that
other asset-backed securities (unrelated to mortgage loans) will be offered to
investors in the future. Several types of asset-backed securities have already
been offered to investors, including Certificates for Automobile Receivables
("CARs(SM)"). CARs(SM) represent undivided fractional interests in a trust
("trust") whose assets consist of a pool of motor vehicle retail installment
sales contracts and security interests in the vehicles securing the contracts.
Payments of principal and interest on CARs(SM) are passed-through monthly to
certificate holders, and are guaranteed up to certain amounts and for a certain
time period by a letter of credit issued by a financial institution
unaffiliated with the trustee or originator of the trust. An investor's return
on CARs(SM) may be affected by early prepayment of principal on the underlying
vehicle sales contracts. If the letter of credit is exhausted, the trust may be
prevented from realizing the full amount due on a sales contract because of
state law requirements and restrictions relating to foreclosure sales of
vehicles and the obtaining of deficiency judgments following such sales or
because of depreciation, damage or loss of a vehicle, the application of
Federal and state bankruptcy and insolvency laws, or other factors. 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, and in the
case of the Money Market Fund, the requirements of Rule 2a-7, a Fund 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-related securities.
MORTGAGE DOLLAR ROLLS
A mortgage dollar roll ("MDR") is a transaction in which a Fund sells
mortgage-related securities ("MBS") from its portfolio to a counter party from
whom it simultaneously agrees to buy a similar security on a delayed delivery
basis. The Fund maintains a segregated account with its custodian containing
securities from its portfolio having a value not less than the repurchase
price, including accrued interest. MDR transactions involve certain risks,
including the risk that the MBS returned to the Fund at the end of the roll,
while substantially similar, could be inferior to what was initially sold to
the counter party.
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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 may be collateralized or uncollateralized
and are issued in various currencies (primarily the U.S. dollar). Brady Bonds
are not considered U.S. Government securities. U.S. dollar-denominated,
collateralized Brady Bonds, which may be fixed rate par bonds or floating rate
discount bonds, are generally collateralized in full as to principal by U.S.
Treasury zero coupon bonds having the same maturity as the Brady Bonds.
Interest payments on these Brady Bonds generally are collateralized on a
one-year or longer rolling-forward basis by cash or securities in an amount
that, in the case of fixed rate bonds, is equal to at least one year of
interest payments or, in the case of floating rate bonds, initially is equal to
at least one year's interest payments based on the applicable interest rate at
that time and is adjusted at regular intervals thereafter. Certain Brady Bonds
are entitled to "value recovery payments" in certain circumstances, which in
effect constitute supplemental interest payments but generally are not
collateralized. Brady Bonds are often viewed as having three or four valuation
components: (i) the collateralized repayment of principal at final maturity;
(ii) the collateralized interest payments; (iii) the uncollateralized interest
payments; and (iv) any uncollateralized repayment of principal at maturity
(these uncollateralized amounts constitute the "residual risk").
Brady Bonds involve various risk factors, including the history of
defaults with respect to commercial bank loans by public and private entities
of countries issuing Brady Bonds. Investments in Brady Bonds are to be viewed
as speculative. There can be no assurance that Brady Bonds in which the Fund
may invest will not be subject to restructuring arrangements or to requests for
new credit, which may cause the Fund to suffer a loss of interest or principal
on any of its holdings.
LOAN PARTICIPATION INTERESTS
The Funds may invest in participation interests in loans. A Fund's
investment in loan participation interests may take the form of participation
interests in, assignments of or novations of a corporate loan ("Participation
Interests"). The Participation Interests may be acquired from an agent bank,
co-lenders or other holders of Participation Interests ("Participants"). In a
novation, a Fund would assume all of the rights of the lender in a corporate
loan, including the right to receive payments of principal and interest and
other amounts directly from the borrower and to enforce its rights as a lender
directly against the borrower. As an alternative, a Fund may purchase an
assignment of all or a portion of a lender's interest in a corporate loan, in
which case, the Fund may be required generally to rely on the assigning lender
to demand payment and enforce its rights against the borrower, but would
otherwise be entitled to all of such lender's rights in the corporate loan. A
Fund also may purchase a Participation Interest in a portion of the rights of a
lender in a corporate loan. In such a case, the Fund will be entitled to
receive payments of principal, interest and fees, if any, but generally will
not be entitled to enforce its rights directly against the agent bank or the
borrower; rather the Fund must rely on the lending institution for that
purpose. A Fund will not act as an agent bank, a guarantor or sole negotiator
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
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the agent bank under the corporate loan agreement should remain available to
holders of corporate loans. If, however, assets held by the agent bank for the
benefit of a Fund were determined by an appropriate regulatory authority or
court to be subject to the claims of the agent bank's general or secured
creditors, the Fund might incur certain costs and delays in realizing payment
on a corporate loan, or suffer a loss of principal and/or interest. In
situations involving intermediate Participants similar risks may arise.
When a Fund acts as co-lender in connection with a Participation
Interest or when a Fund acquires a Participation Interest the terms of which
provide that the Fund will be in 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's Subadvisor
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.
The principal credit risk associated with acquiring Participation
Interests from a co-lender or another Participant is the credit risk associated
with the underlying corporate borrower. A Fund may incur additional credit
risk, however, when it is in the position of participant rather than a
co-lender because the Fund must assume the risk of insolvency of the co-lender
from which the Participation Interest was acquired and that of any person
interpositioned between the Fund and the co-lender.
REAL ESTATE INVESTMENT TRUSTS
The Asset Manager Fund may invest in securities issued by equity real
estate investment trusts ("REITs"). REITs pool investors' funds for investment
primarily in income-producing commercial real estate or real-estate related
loans. REITs are similar to holding companies in that they are essentially
holding companies that rely on professional managers to supervise their
investments. A REIT is not taxed on income distributed to shareholders if it
complies with several requirements relating to its organization, ownership,
assets, and income and the requirement that it distribute to its shareholders
at least 95% of its taxable income (other than net capital gains) for each
taxable year.
Investment in REITs may be subject to many of the same risks as a
direct investment in real estate. This is due to the fact that the value of
the REIT may be affected by the value of the real estate owned by the companies
in which it invests. These risks include changes in economic conditions,
interest rates, property values, property tax increases, overbuilding and
increased competition, environmental contamination zoning and natural
disasters.
RISK MANAGEMENT TECHNIQUES
The Funds can use various techniques to increase or decrease their
exposure to changing security prices, interest rates, currency exchange rates,
commodity price or other factors that affect security values. These techniques
may involve derivative transactions such as buying and selling futures
contracts and options on futures contracts, entering into foreign currency
transactions (such as forward foreign currency exchange contracts and options
on foreign currencies) and purchasing or writing put or call options on
securities and securities indexes.
The Funds can use these practices in an attempt to adjust the risk and
return characteristics of their portfolios of investments. When a Fund uses
such techniques in an attempt to reduce risk it is known as "hedging". If a
Fund's Subadvisor judges market conditions incorrectly or employs a strategy
that does not correlate well with the Fund's investments, these techniques
could result in a loss, regardless of whether the intent was to reduce risk or
increase return. These techniques may increase the volatility of a Fund and may
involve a small investment of cash relative to the magnitude of the risk
assumed. In addition, these techniques could result in a loss if the counter
party to the transaction does not perform as promised.
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OPTIONS ON SECURITIES
Writing Call Options. Subject to any limitations stated in the
Prospectus or in this SAI, each Fund 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.
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.
During the option period, the covered call writer has, in return for
the premium received an option, given up the opportunity to profit from a price
increase in the underlying securities above the exercise price, but, as long as
its obligation as a writer continues, has retained the risk of loss should the
price of the underlying security decline.
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, except as
discussed below. There is no assurance that a liquid secondary market on an
Exchange or otherwise will exist for any particular option, or at any
particular time, and for some options no secondary market on an Exchange or
otherwise may exist. If a Fund is unable to effect a closing purchase
transaction involving an exchange-traded option, the Fund will not sell the
underlying security until the option expires or the Fund delivers the
underlying security upon exercise. Over-the-counter options differ from
exchange-traded options in that they are two-party contracts with price and
other terms negotiated between buyer and seller, and generally do not have as
much market liquidity as exchange-traded options. Therefore, a closing purchase
transaction for an over-the-counter option may in many cases only be made with
the other party to the option. Once an option writer has received an exercise
notice, it cannot effect a closing purchase transaction in order to terminate
its obligation under the option and must deliver or purchase the underlying
securities at the exercise price.
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
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that all call and put option writing transactions be covered, and limitations
imposed on regulated investment companies under Federal tax law, the
International Bond Fund and International Equity Fund may, to the extent
determined appropriate by the Subadvisor, engage without limitation in the
writing of options on their portfolio securities.
Writing Put Options. Subject to any limitations in the Prospectus or
in this SAI, each Fund 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 a 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.
A covered put writer assumes the risk that the market price for the
underlying security will fall below the exercise price, in which case the
writer would be required to purchase the security at a higher price than the
then-current market price of the security. In both cases, the writer has no
control over the time when it may be required to fulfill its obligation as a
writer of the option.
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. The Funds may also effect a closing purchase transaction,
in the case of a put option, to permit the Funds to maintain their holdings of
the deposited U.S. Treasury obligations, to write another put option to the
extent that the exercise price thereof is secured by the deposited U.S.
Treasury obligations, or to utilize the proceeds from the sale of such
obligations to make other investments.
If a Fund is able to enter into a closing purchase transaction, the
Fund will realize a profit or loss from such transaction if the cost of such
transaction is less or more than the premium received from the writing of the
option, respectively. 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 put and 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 of 1986, as amended (the "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 the Subadvisors deem to be 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 a put option would
entitle the Fund, in exchange for the premium paid, to sell a security at a
specified price upon exercise of the option during the option period. 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 put options purchased by the
Fund may include, but are not limited to, "protective puts," in which the
security to be sold is identical or substantially identical to a security
already held by the Fund or to a security which the Fund has the right to
purchase. The Fund would ordinarily recognize a gain if the value of the
securities decreased during the option period below the exercise price
sufficiently to cover the premium. The Fund would recognize a loss if the value
of the securities remained above the difference between the exercise price and
the premium.
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The Funds may also purchase call options on securities, which 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. The purchase of a call option would entitle the Fund, in exchange
for the premium paid, to purchase a security at a specified price upon exercise
of the option during the option period. The Fund would ordinarily realize a
gain if the value of the securities increased during the option period above
the exercise price sufficiently to cover the premium. The Fund would have a
loss if the value of the securities remained below the sum of the premium and
the exercise price during the option period. In order to terminate an option
position, the Funds may sell put or call options identical to those previously
purchased, which could result in a net gain or loss depending on whether the
amount received on the sale is more or less than the premium and other
transaction costs paid on the put or call option when it was purchased.
Special Risks Associated With Options On Securities. Exchange markets
in the U.S. government securities options are a relatively new and untested
concept, and it is impossible to predict the amount of trading interest that
may exist in such options. The same types of risk apply to over-the-counter
trading in options. There can be no assurance that viable markets will develop
or continue in the United States or abroad.
A Fund's purpose in selling covered options is to realize greater
income than would be realized on portfolio securities transactions alone. A
Fund may forego the benefits of appreciation on securities sold pursuant to
call options, or pay a higher price for securities acquired pursuant to put
options written by the Fund. 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.
The Fund would ordinarily realize a gain if the value of the
securities increased during the option period above the exercise price
sufficiently to cover the premium. The Fund would have a loss if the value of
the securities remained below the sum of the premium paid and the exercise
price during the option period.
The ability of a Fund to successfully utilize options may depend in part upon
the ability of the Subadvisor to forecast interest rates and other economic
factors correctly.
The hours of trading for options on securities may not conform to the
hours during which the underlying securities are traded. To the extent that the
options markets close before the markets for the underlying securities,
significant price and rate movements can take place in the underlying markets
that cannot be reflected in the options markets.
OPTIONS ON FOREIGN CURRENCIES
Subject to any limitation stated in the Prospectus or this SAI, each
Fund may purchase and write options on foreign currencies. A Fund may use
foreign currency options contracts for various reasons, including: to manage
its exposure to changes in currency exchange rates; as an efficient means of
adjusting its overall exposure to certain currencies; or in an effort to
enhance its return. 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 declines in the value of portfolio
securities, a Fund may purchase put options on the foreign currency. If the
value of the currency does decline, that Fund will have the right to sell such
currency for a fixed amount of dollars which exceeds the market value of such
currency, resulting in a gain that may offset, in whole or in part, the
negative effect of currency depreciation on the value of the Fund's securities
denominated in that currency.
Conversely, if a rise in the dollar value of a currency in which
securities to be acquired are denominated is projected, thereby increasing the
cost of such securities, a Fund may purchase call options on such currency. If
the value of such currency does increase, the purchase of such call options
would enable the Fund to purchase currency for a fixed amount of dollars which
is less than the market value of such currency, resulting in a gain that may
offset, at least partially, the effect of any currency-related increase in the
price of securities the Fund intends to acquire. As in the case of other types
of options transactions, however, the benefit a Fund derives from purchasing
foreign currency options
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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.
If a Fund anticipates a decline in the dollar value of foreign
currency-denominated securities due to declining exchange rates, it could,
instead of purchasing a put option, write a call option on the relevant
currency. If the expected decline occurs, the option will most likely not be
exercised, and the diminution in value of portfolio securities will be offset
by the amount of the premium received by the Fund.
Similarly, instead of purchasing a call option to hedge against an
anticipated increase in the dollar cost of securities to be acquired, a Fund
could write a put option on the relevant currency. If rates move in the manner
projected, the put option will expire unexercised and allow the Fund to offset
such increased cost up to the amount of the premium. As in the case of other
types of options transactions, however, the writing of a foreign currency
option will constitute only a partial hedge up to the amount of the premium,
and only if rates move in the expected direction. If unanticipated exchange
rate fluctuations occur, the option may be exercised and a Fund would be
required to purchase or sell the underlying currency at a loss which may not be
fully offset by the amount of the premium. As a result of writing options on
foreign currencies, a Fund also may be required to forego all or a portion of
the benefits which might otherwise have been obtained from favorable movements
in currency exchange rates.
A call option written on foreign currency by a Fund is "covered" if
that Fund owns the underlying foreign currency subject to the call or
securities denominated in that currency or has an absolute and immediate right
to acquire that foreign currency without additional cash consideration (or for
additional cash consideration held in a segregated account by its custodian)
upon conversion or exchange of other foreign currency held in its portfolio. A
call option is also covered if a Fund holds a call on the same foreign currency
for the same principal amount as the call written where the exercise price of
the call held (a) is equal to or less than the exercise price of the call
written or (b) is greater than the exercise price of the call written if the
amount of the difference is maintained by a Fund in liquid assets in a
segregated account with its custodian.
Options on foreign currencies to be written or purchased by a Fund
will be traded on U.S. and foreign exchanges or over-the-counter.
Exchange-traded options generally settle in cash, whereas options traded
over-the-counter may settle in cash or result in delivery of the underlying
currency upon exercise of the option. As with other kinds of option
transactions, however, the writing of an option on foreign currency will
constitute only a partial hedge up to the amount of the premium received and a
Fund could be required to purchase or sell foreign currencies at
disadvantageous 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.
There can be no assurance that a liquid market will exist when a Fund
seeks to close out an option position. Furthermore, if trading restrictions or
suspensions are imposed on the options markets, a Fund may be unable to close
out a position.
Currency options traded on U.S. or other exchanges may be subject to
position limits which may limit the ability of a Fund to reduce foreign
currency risk using such options. Over-the-counter options differ from 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 exchanged-related options. Foreign currency exchange-traded
options generally settle in cash, whereas options traded over-the counter may
settle in cash or result in delivery of the underlying currency upon exercise
of the option.
FUTURES TRANSACTIONS
Subject to any limitations in the Prospectus or this SAI, 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 or to gain market experience to particular
segments of the market represented by the futures contract. 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 may also enter into such
futures contracts in order to lengthen or shorten the average maturity or
duration of the Fund's portfolio.
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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 may also purchase and write put and call
options on futures contracts of the type into which such Fund is authorized to
enter and may engage in related closing transactions. In the United States, all
such futures on securities, debt index futures, stock index futures, foreign
currency futures and related options will be traded on exchanges that are
regulated by the Commodity Futures Trading Commission ("CFTC"). Subject to
compliance with applicable CFTC rules, the Funds also may enter into futures
contracts traded on foreign futures exchanges as long as trading on the
aforesaid foreign futures exchanges does not subject a Fund to risks that are
materially greater than the risks associated with trading on U.S. exchanges.
A futures contract is an agreement to buy or sell a security or
currency (or to deliver a final cash settlement price in the case of a contract
relating to an index or otherwise not calling for physical delivery at the end
of trading in the contracts), for a set price at a future date. When interest
rates are changing and portfolio values are falling, futures contracts can
offset a decline in the value of a Fund's current portfolio securities. When
interest rates are changing and portfolio values are rising, the purchase of
futures contracts can secure better effective rates or purchase prices of the
Fund than might later be available in the market when the Fund makes
anticipated purchases. 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, including long-term U.S. Treasury
bonds, Treasury notes, GNMA certificates, three-month U.S. Treasury bills,
three-month domestic bank certificates of deposit, a municipal bond index and
various stock indexes.
When a purchase or sale of a futures contract is made by a Fund, the
Fund is required to deposit with its custodian (or broker, if legally
permitted) a specified amount of liquid assets ("initial margin") as a partial
guarantee of its performance under the contract. The margin required for a
futures contract is set by the exchange on which the contract is traded and may
be modified during the term of the contract. The initial margin is in the
nature of a performance bond or good faith deposit on the futures contract
which is returned to the Fund upon termination of the contract assuming all
contractual obligations have been satisfied. Each Fund expects to earn
interest income on its initial margin deposits. A futures contract held by a
Fund is valued daily at the official settlement price of the exchange on which
it is traded. Each day, as the value of the security, currency or index
fluctuates, the Fund pays or receives cash, called "variation margin," equal to
the daily change in value of the futures contract. This process is known as
"marking-to-market." Variation margin does not represent a borrowing or loan by
a Fund but is instead a settlement between the Fund and the broker of the
amount one would owe the other if the futures contract expired. In computing
daily net asset value, each Fund will mark-to-market its open futures
positions.
A Fund is also required to deposit and maintain margin with respect to
put and call options on futures contracts written by it. Such margin deposits
will vary depending on the nature of the underlying futures contract (and the
related initial margin requirements), the current market value of the option,
and other futures positions held by the Fund.
Positions taken in the futures markets are not normally held until
delivery or final cash settlement is required, but are instead liquidated
through offsetting transactions which may result in a gain or a loss. While
futures positions taken by a Fund will usually be liquidated in this manner,
the Fund may instead make or take delivery of underlying securities or
currencies whenever it appears economically advantageous to the Fund to do so.
A clearing organization associated with the exchange on which futures are
traded assumes responsibility for closing-out transactions and 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
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valued at the most recent settlement price, unless such price does not appear
to the Subadvisors to reflect the fair value of the contract, in which case the
positions will be valued by or under the direction of the Directors.
Hedging by use of futures on debt securities seeks to establish more
certainly than would otherwise be possible the effective rate of return on
portfolio securities. A Fund may, for example, take a "short" position in the
futures market by selling contracts for the future delivery of debt securities
held by the Fund (or securities having characteristics similar to those held by
the Fund) in order to hedge against an anticipated rise in interest rates that
would adversely affect the value of the Fund's portfolio securities. When
hedging of this character is successful, any depreciation in the value of
portfolio securities will be substantially offset by appreciation in the value
of the futures position.
On other occasions, a Fund may take a "long" position by purchasing
futures on debt securities. This would be done, for example, when the Fund
intends to purchase particular securities and it has the necessary cash, but
expects the rate of return available in the securities markets at that time to
be less favorable than rates currently available in the futures markets. If the
anticipated rise in the price of the securities should occur (with its
concomitant reduction in yield), the increased cost to the Fund of purchasing
the securities will be offset, at least to some extent, by the rise in the
value of the futures position taken in anticipation of the subsequent
securities purchase. A Fund may also purchase futures contracts as a substitute
for the purchase of longer-term securities to lengthen the average duration of
the Fund's portfolio.
The Fund could accomplish similar results by selling securities with
long maturities and investing in securities with 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 the equity portion of a
Fund's securities portfolio with regard to market (systematic) risk, as
distinguished from stock-specific risk. The Funds may enter into stock index
futures to the extent that they have equity securities in their portfolio.
Similarly, the Funds may enter into futures on debt securities indexes
(including the municipal bond index) to the extent they have debt securities in
their portfolios. By establishing an appropriate "short" position in securities
index futures, a Fund may seek to protect the value of its portfolio against an
overall decline in the market for securities. Alternatively, in anticipation of
a generally rising market, a Fund can seek to avoid losing the benefit of
apparently low current prices by establishing a "long" position in securities
index futures and later liquidating that position as particular securities are
in fact acquired. To the extent that these hedging strategies are successful,
the Fund will be affected to a lesser degree by adverse overall market price
movements, unrelated to the merits of specific portfolio securities, than would
otherwise be the case. A Fund 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 the Subadvisor
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 the Subadvisor 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.
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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 the Subadvisor could be incorrect in its expectation as to the
direction or extent of various exchange rate movements or the time span within
which the movements take place.
Options on Futures. For bona fide hedging and other appropriate risk
management purposes, the Funds 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 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.
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The writing of a call option on a futures contract constitutes a
partial hedge against declining prices of the underlying securities or the
currencies in which such securities are denominated. If the futures price at
expiration is below the exercise price, the Fund will retain the full amount of
the option premium, which provides a partial hedge against any decline that may
have occurred in the Fund's holdings of securities or the currencies in which
such securities are denominated.
The writing of a put option on a futures contract is analogous to the
purchase of a futures contract. For example, if the Fund writes a put option on
a futures contract on debt securities related to securities that the Fund
expects to acquire and the market price of such securities increases, the net
cost to a Fund of the debt securities acquired by it will be reduced by the
amount of the option premium received. Of course, if market prices have
declined, the Fund's purchase price upon exercise may be greater than the price
at which the debt securities might be purchased in the securities market.
While the holder or writer of an option on a futures contract may
normally terminate its position by selling or purchasing an offsetting option
of the same series, a Fund's ability to establish and close out options
positions at fairly established prices will be subject to the maintenance of a
liquid market. The Funds will not purchase or write options on futures
contracts unless the market for such options has sufficient liquidity such that
the risks associated with such options transactions are not at unacceptable
levels.
Limitations on Purchase and Sale of Futures Contracts and Options on
Futures Contracts. A Fund will only enter into futures contracts or related
options which are standardized and traded on a U.S. or foreign exchange or
board of trade, or similar entity, or quoted on an automated quotation system.
In general, the Funds will engage in transactions in futures contracts and
related options only for bona fide hedging and other appropriate risk
management purposes, and not for speculation. The Funds will not enter into
futures contracts for which the aggregate contract amounts exceed 100% of the
Fund's net assets. In addition, with respect to positions in futures and
related options that do not constitute bona fide hedging positions, a Fund will
not enter into a futures contract or futures option contract if, immediately
thereafter, the aggregate initial margin deposits relating to such positions
plus premiums paid by it for open futures option positions, less the amount by
which any such options are "in-the-money," would exceed 5% of the Fund's total
assets. A call option is "in-the-money" if the value of the futures contract
that is the subject of the option exceeds the exercise price. A put option is
"in-the-money" if the exercise price exceeds the value of the futures contract
that is the subject of the option.
When purchasing a futures contract, a Fund will maintain with its
custodian (and mark-to-market on a daily basis) liquid assets that, when added
to the amounts deposited with a futures commission merchant as margin, are
equal to the market value of the futures contract. Alternatively, the Fund may
"cover" its position by purchasing a put option on the same futures contract
with a strike price as high or higher than the price of the contract held by
the Fund.
When selling a futures contract, a Fund will maintain with its
custodian (and mark-to-market on a daily basis) liquid assets that, when added
to the amount deposited with a futures commission merchant as margin, are equal
to the market value of the instruments underlying the contract. Alternatively,
the Fund may "cover" its position by owning the instruments underlying the
contract (or, in the case of an index futures contract, a portfolio with a
volatility substantially similar to that of the index on which the futures
contract is based), or by holding a call option permitting the Fund to purchase
the same futures contract at a price no higher than the price of the contract
written by the Fund (or at a higher price if the difference is maintained in
liquid assets with the Fund's custodian).
When selling a call option on a futures contract, a Fund will maintain
with its custodian (and mark-to-market on a daily basis) liquid assets that,
when added to the amounts deposited with a futures commission merchant as
margin, equal the total market value of the futures contract underlying the
call option. Alternatively, the Fund may cover its position by entering into a
long position in the same futures contract at a price no higher than the strike
price of the call option, by owning the instruments underlying the 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.
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The requirements for qualification as a regulated investment company
also may limit the extent to which a Fund may enter into futures, futures
options or forward contracts. See "Tax Information."
Risks Associated with Futures and Futures Options. There are several
risks associated with the use of futures contracts and futures options as
hedging techniques. There can be no assurance that hedging strategies using
futures will be successful. A purchase or sale of a futures contract may result
in losses in excess of the amount invested in the futures contract, which in
some cases may be unlimited. There can be no guarantee that there will be a
correlation between price movements in the hedging vehicle and in the Fund's
securities being hedged. An incorrect correlation could result in a loss on
both the hedged securities or currencies and the hedging vehicle so that the
portfolio return might have been better had hedging not been 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. It is also possible that, when a
Fund has sold stock index futures to hedge its portfolio against a decline in
the market, the market may advance while the value of the particular securities
held in the Fund's portfolio may decline. If this occurred, the Fund would
incur a loss on the futures contracts and also experience a decline in the
value of its portfolio securities.
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.
In addition to the risk that apply to all options transactions, there
are several special risks relating to options on futures contracts. The ability
to establish and close out positions in such options will be subject to the
development and maintenance of a liquid market in the options. It is not
certain that such a market will develop. Although the Funds generally will
purchase only those options and futures contracts for which there appears to be
an active market, there is no assurance that a liquid market on an exchange
will exist for any particular option or futures contract at any particular
time. In the event no such market exists for particular options, it might not
be possible to effect closing transactions in such options with the result that
a Fund would have to exercise options it has purchased in order to realize any
profit and would be less able to limit its exposure to losses on options it has
written.
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. If the price
of a futures contract changes more than the price of the securities or
currencies, the Fund will experience either a loss or a gain on the futures
contracts which will not be completely offset by changes in the price of the
securities or currencies which are the subject of the hedge. In addition, it is
not possible to hedge fully or perfectly against currency fluctuations
affecting the value of securities denominated in foreign currencies because the
value of such securities is likely to fluctuate as a result of independent
factors not related to currency fluctuations.
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
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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 Asset
Manager 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 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 counter party 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 total assets. The EAFE
Index Fund, Indexed Bond Fund, Indexed Equity Fund and Asset Manager 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 Subadvisor'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 counter party. The Subadvisor will
cause a Fund to enter into swap agreements only with counter parties that would
be eligible for consideration as repurchase agreement counter parties under the
Fund's repurchase agreement guidelines. Certain restrictions imposed on the
Funds by the Internal Revenue Code may limit the Funds' ability to use swap
agreements. The swaps market is a relatively new market and is largely
unregulated. It is possible that developments in the swaps market, including
potential government regulation, could adversely affect a Fund's ability to
terminate existing swap agreements or to realize amounts to be received under
such agreements.
Certain swap agreements are exempt from most provisions of the
Commodity Exchange Act ("CEA") and, therefore, are not regulated as futures or
commodity option transactions under the CEA, pursuant to regulations approved
by the Commodity Futures Trading Commission ("CFTC"). 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;
34
<PAGE> 35
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.
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 possible 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 by the
Fund. If the value of a security sold short against the box increases, the Fund
would suffer a loss when it purchases or delivers to the selling broker the
security sold short. The proceeds of the short sale are retained by the broker
pursuant to applicable margin rules. In addition, the Fund may segregate
assets, equal in value to 50% of the value of the short sale, in a special
account with the Fund's custodian. The segregated assets are pledged to the
broker pursuant to applicable margin rules. If a broker, with which the Fund
has open short sales, were to become bankrupt, a Fund could experience losses
or delays in recovering gains on short sales. The Funds will only enter into
short sales against the box with brokers the Subadvisors believe are
creditworthy. Short sales against the box will be limited to no more than 25%
of a Fund's total assets.
RISKS ASSOCIATED WITH DEBT SECURITIES
To the extent that a Fund invests in debt securities, it will be
subject to certain risks. The value of the debt securities held by a Fund, and
thus the net asset value of the shares of beneficial interest of the Fund,
generally will fluctuate depending on a number of factors, including, among
others, changes in the perceived creditworthiness of the issuers of those
securities, movements in interest rates, the average maturity of the Fund's
investments, changes in the relative values of the currencies in which the
Fund's investments are denominated relative to the U.S. dollar, and the extent
to which the Fund hedges its interest rate, credit and currency exchange rate
risks. Generally, a rise in interest rates will reduce the value of fixed
income securities held by a Fund, and a decline in interest rates will increase
the value of fixed income securities held by a Fund. Longer term debt
securities generally pay higher interest rates than do shorter term debt
securities but also may experience greater price volatility as interest rates
change.
Since shares of the Funds represent an investment in securities with
fluctuating market prices, the value of shares of each Fund will vary as the
aggregate value of the Funds' portfolio securities increases or decreases.
Moreover, the value of lower rated debt securities that a Fund purchases may
fluctuate more than the value of higher rated debt securities. Lower rated debt
securities generally carry greater risk that the issuer will default on the
payment of interest and principal. Lower rated fixed income securities
generally tend to reflect short-term corporate and market developments to a
greater extent than higher rated securities which react primarily to
fluctuations in the general level of interest rates. Changes in the value of
securities subsequent to their acquisition will not affect cash income or
yields to maturity to the Funds but will be reflected in the net asset value of
the Funds' shares.
35
<PAGE> 36
Corporate debt securities may bear fixed, contingent, or variable
rates of interest and may involve equity features, such as conversion or
exchange rights or warrants for the acquisition of stock of the same or a
different issuer, participations based on revenues, sales or profits, or the
purchase of common stock in a unit transaction (where corporate debt securities
and common stock are offered as a unit).
When and if available, debt securities may be purchased at a discount
from face value. From time to time, each Fund may purchase securities not
paying interest or dividends at the time acquired if, in the opinion of the
Subadvisor, such securities have the potential for future income (or capital
appreciation, if any).
HIGH YIELD/HIGH RISK SECURITIES
Securities rated below BBB by S&P or Baa by Moody's (sometimes called
"junk bonds") are not considered "investment grade". There is more price
volatility, more risk of losing your principal interest, a greater possibility
of the issuer going bankrupt, plus additional risks. These securities are
considered speculative.
The International Bond Fund may invest up to 25% of its net assets in
debt securities, including short-term instruments, which are rated below
investment grade (i.e., below BBB by S&P or Baa by Moody's) or, if not rated,
determined to be of equivalent quality by the Subadvisor. The lower the ratings
of such securities, the greater their risks render them like equity securities.
Moody's considers bonds it rates Baa to have speculative elements as well as
investment grade characteristics. The Funds may invest in securities which are
rated D by S&P or, if unrated, are of equivalent quality. Securities rated D
may be in default with respect to payment of principal or interest.
Investors should be willing to accept the risk associated with
investment in high yield/high risk securities. Investment in high yield/high
risk bonds involves special risks in addition to the risks associated with
investments in higher rated debt securities. High yield/high risk bonds may be
regarded as predominantly speculative with respect to the issuer's continuing
ability to meet principal and interest payments. Moreover, such securities may
under certain circumstances be less liquid than higher rated debt instruments.
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 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
36
<PAGE> 37
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. Zero coupon
bonds tend to be more volatile than conventional debt securities.
SPECIAL CONSIDERATIONS FOR EAFE INDEX FUND, INDEXED EQUITY FUND,
ASSET MANAGER FUND AND INDEXED BOND FUND
Standard & Poor's(R), "S&P" 500(R), "S&P(R)", "Standard & Poor's 500",
"500", "S&P MidCap 400 Index" and "S&P SmallCap 600 Index" are trademarks of
The McGraw-Hill Companies, Inc. and have been licensed for use by Monitor
Capital. S&P does not sponsor, endorse, sell or promote the Indexed Equity
Fund or the Asset Manager Fund or represent the advisability of investing in
the Funds.
The Indexed Equity Fund and the Asset Manager Fund are not sponsored,
endorsed, sold or promoted by Standard & Poor's, a division of The McGraw-Hill
Companies, Inc. ("S&P"). S&P makes no representation or warranty, express or
implied, to the owners of the Funds, or any member of the public regarding the
advisability of investing in securities generally or in the Funds particularly
or the ability of the S&P 500 Index, the S&P MidCap 400 Index or the S&P
SmallCap 600 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, the S&P MidCap 400 Index or the S&P SmallCap
600 Index which are determined, composed and calculated by S&P without regard
to Monitor or the Funds. S&P has no obligation to take the needs of Monitor or
the owners of the Funds into consideration in determining, composing or
calculating the S&P 500 Index, the S&P MidCap 400 Index or the S&P SmallCap 600
Index. S&P is not responsible for and has not participated in the
determination of the prices and amount of the Funds or the timing of the
issuance or sale of the Funds or in the determination or calculation of the
equation by which the Funds are to be converted into cash. S&P has no
obligation or liability in connection with the administration, marketing or
trading of the Funds.
S&P does not guarantee the accuracy and/or the completeness of the S&P
500 Index, S&P MidCap 400 Index, S&P SmallCap 600 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 Funds, 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, S&P MidCap 400 Index, S&P SmallCap 600 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.
The inclusion of a security in the MSCI EAFE Index, the S&P 500 Index
or the BIG Index in no way implies an opinion by the index sponsors, Morgan
Stanley, Standard & Poor's or Salomon Smith Barney, as to the attractiveness of
that security as an investment. The MainStay Institutional Funds that are
managed as index funds (EAFE Index Fund, Indexed Equity Fund and Indexed Bond
Fund) are not sponsored by or affiliated with the sponsors of their respective
indexes.
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<PAGE> 38
The Indexed Equity Fund and, in part, the Asset Manager Fund are
managed to parallel the S&P 500 Index. Because of the market-value weighting,
as of January 31, 2000, the 10 largest companies account for approximately 25%
of the Index. As of that date, the six largest weightings in the S&P 500 Index
as a percentage of net assets accounted for 18.66% of the Index.
The Asset Manager Fund also invests in common stocks selected to
replicate the S&P MidCap 400 Index, the S&P SmallCap 600 Index and the Morgan
Stanley REIT Index.
The S&P MidCap 400 Index consists of 400 domestic common stocks chosen
for market size, liquidity, and industry group representation. The S&P MidCap
400 Index is an unmanaged market-value weighted index in which each stock's
weight is proportionate to its market value. As of February 29, 2000, the range
of market capitalization of companies within the S&P MidCap 400 Index was $106
million to $51.3 billion.
The S&P SmallCap 600 Index consists of 600 domestic common stocks
chosen for market size, liquidity, and industry group representation (bid-asked
spread, ownership, share turnover and number of no trade days). The S&P
SmallCap 600 Index is an unmanaged market-value weighted index in which each
stock's weight is proportionate to its market value. As of February 29, 2000,
the range of market capitalization of companies in the S&P SmallCap 600 Index
was $33 million to $7.8 billion.
The Morgan Stanley REIT Index is a capitalization-weighted index of
the most actively traded real estate investment trusts, and is designed to be a
measure of real estate equity performance. The Morgan Stanley REIT Index is
calculated by Morgan Stanley and Co., Inc. and reflects reinvestment of all
applicable dividends, capital gains and interest.
FUNDAMENTAL 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, and the Funds objectives as described in the Prospectus, 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 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 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);
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<PAGE> 39
(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) 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.
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS
In addition to the Company's fundamental investment restrictions, the
Directors of the Company have voluntarily adopted certain policies and
restrictions which are observed in the conduct of the affairs of the Funds.
These represent intentions of the Directors based upon current circumstances.
They differ from fundamental investment policies in that the following
additional investment restrictions may be changed or amended by action of the
Directors without requiring prior notice to or approval of shareholders.
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 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;
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<PAGE> 40
(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 Subadvisors,
pursuant to guidelines approved by the Directors.
Each Subadvisor 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;
(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
Subadvisor 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 Subadvisor 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).
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<PAGE> 41
DIRECTORS AND OFFICERS
The Board of Directors oversees the Funds, the Manager and the
Subadvisors. Information pertaining to the Directors and Officers of the
Company is set forth below. Directors deemed to be "interested persons" of the
Company for purposes of the 1940 Act are indicated by an asterisk.
<TABLE>
<CAPTION>
PRINCIPAL
NAME, POSITION(s) WITH OCCUPATION(s) DURING
ADDRESS AND AGE THE COMPANY PAST 5 YEARS
<S> <C> <C>
Stephen C. Roussin*, 36 Director and President and Chief Operating Officer, New York Life Asset
51 Madison Avenue Chairman Management Operating Company LLC, 1999 to present;
New York, NY President, Chief Executive Officer and Trustee, The
10010 MainStay Funds, 1997-present; Senior Vice President,
New York Life Insurance Company, 1997 to present;
Director, New York Life Trust Company,
1997 to present; Director, New York Life Benefit
Services LLC, 1997 to present; Director, NYLIFE
Securities, Inc., 1997 to present; Director, MainStay
Shareholder Services LLC, 1997 to present; Director,
Eagle Strategies Corp., 1997 to present; Director,
President and Chief Executive Officer, MainStay
Management LLC, 1997 to present; Senior Vice President,
Smith Barney, 1994 to 1997; and Division Sales Manager,
Prudential Securities, 1989 to 1994.
Patrick G. Boyle*, 46 Director Senior Vice President, New York Life Asset Management
51 Madison Avenue Operating Company LLC, 1999 to present; Senior Vice
New York, NY President, Pension Department, New York
10010 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 LLC,
1996 to 1998, and Director, 1991 to present;
Director, New York Life Benefit Services LLC, 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 1998; Director, MBL Life Assurance Co., Inc.,
1997 to present.
Lawrence Glacken, 72 Director Retired, 1987 to present; Vice President, Investment
353 Canterbury Drive Banking, The First Boston Corporation, 1964-1987.
Ramsey, NJ 07446
Robert P. Mulhearn, 52 Director Private Investor, 1987 to
60 Twin Brooks Road present; Managing Director,
</TABLE>
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<PAGE> 42
<TABLE>
<CAPTION>
PRINCIPAL
NAME, POSITION(s) WITH OCCUPATION(s) DURING
ADDRESS AND AGE THE COMPANY PAST 5 YEARS
<S> <C> <C>
Saddle River, NJ 07458 Morgan Stanley, 1979-1987.
Susan B. Kerley, 48 Director President, Global Research Associates, 1990 to
P.O. 9572 present; Manager, Special Investments, Rockefeller &
New Haven, CT 06535 Co., 1988-1990; Director of Research, Rogers, Casey
and Barksdale, 1983-1988; Director, Citifunds, 1991
to present.
Linda M. Livornese, 48 President Vice President, Pension Department, New York Life
51 Madison Avenue Insurance Company, 1990 to present; Pension Vice
New York, NY 10010 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.
Marc J. Brookman, 36 Executive Vice President, New York Life Insurance Company, 1998
51 Madison Avenue Vice President to present; Senior Vice President-Product
New York, NY 10010 Development, MainStay Institutional Funds, Inc. and
Retirement Plans, 1998 to present; National Sales
Director, Vice President, United Asset Management
Retirement Plan Services, 1996 to 1998; Regional
Sales Manager, Vice President, Oppenheimer Capital
Quest for Value, 1991 to 1995.
Jefferson C. Boyce, 42 Senior Vice Senior Vice President, New York Life Insurance
51 Madison Avenue President Company, 1994 to present; Senior Vice President, The
New York, NY 10010 MainStay Funds, 1995 to present; Director, Monitor
Capital Advisors LLC, 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 LLC,
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, LLC, 1994
to present; Director, NYLIFE Depositary Corporation,
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 LLC., 1997 to present; Chief
Administrative Officer, Pension, Mutual Funds,
Structured Finance, Corporate Quality, Human
Resources and Employees' Health Departments, New York
</TABLE>
42
<PAGE> 43
<TABLE>
<CAPTION>
PRINCIPAL
NAME, POSITION(s) WITH OCCUPATION(s) DURING
ADDRESS AND AGE THE COMPANY PAST 5 YEARS
<S> <C> <C>
Life Insurance Company, 1992 to 1994; Vice President,
Pension Department, New York Life Insurance Company,
1989 to 1992.
Richard W. Zuccaro, 50 Tax Vice Vice President, New York Life Insurance Company, 1995
51 Madison Avenue President to present; Vice President -- Tax, New York Life
New York, NY 10010 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 LLC, 1990 to
present; Tax Vice President, NYLIFE Insurance Company
of Arizona, 1990 to present; Tax Vice President,
NYLIFE Realty Inc., 1991 to present; Tax Vice
President, NYLICO Inc., 1991 to present; Tax Vice
President, New York Life Fund Inc., 1991 to present;
Tax Vice President, New York Life International
Investment, Inc., 1991 to present; Tax Vice President
NYLIFE Funding Inc., 1991 to present; Tax Vice
President, NYLCO, 1991 to present; Tax Vice
President, NYLIFE Equity Inc., 1991 to present; Tax
Vice President, MainStay VP Series Fund, Inc., 1991
to present; Tax Vice President, CNP Realty
Investments, Inc., 1991 to present; Tax Vice
President, New York Life Worldwide Holding, Inc.,
1992 to present; Tax Vice President, NYLIFE
Structured Asset Management Company Ltd., 1992 to
present; Tax Vice President, The MainStay Funds, 1991
to present; Tax Vice President, Eagle Strategies
Corp. (registered investment adviser),
1993 to present; Tax Vice President, NYLIFE
Distributors Inc., 1993 to present; Vice President &
Assistant Controller, New York Life Insurance and
Annuity Corp., 1995 to present, and Assistant
Controller, 1991 to 1995; Vice President, NYLCare
Health Plans, Inc., 1995 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 LLC, 1996 to present; Tax Vice
President, NYLINK Insurance Agency Incorporated, 1996
to present; Tax Vice President, MainStay Shareholder
Services LLC, 1997 to present.
John Flanagan, 53 Treasurer Vice President and Treasurer, New York Life
51 Madison Avenue (Principal Asset Management Operating Company LLC, 1999
New York, NY 10010 Financial and to present; Vice President, New York Life
Accounting Insurance Company, 1999 to present; Vice
Officer) President and Chief Financial Officer, The
MainStay Funds, 1999 to present; Director,
Vice President and Chief Financial Officer,
MainStay Management LLC,
</TABLE>
43
<PAGE> 44
<TABLE>
<CAPTION>
PRINCIPAL
NAME, POSITION(s) WITH OCCUPATION(s) DURING
ADDRESS AND AGE THE COMPANY PAST 5 YEARS
<S> <C> <C>
1999 to present; Director, Vice President and
Chief Financial Officer, MainStay Shareholder
Services LLC, 1999 to present; Senior Vice
President and Chief Financial Officer, NYLIFE
Distributors, Inc., 1999 to present;
Treasurer, Strong Funds and Senior Vice
President, Strong Capital Management, Inc.,
1997 to 1998; Partner, predecessor to
PricewaterhouseCoopers LLP, 1994 to 1997.
Joseph McBrien, 51 Secretary Vice President and Secretary, New York Life
51 Madison Avenue Asset Management Operating Company LLC, 1999
New York, NY 10010 to present; Vice President and Associate
General Counsel, New York Life Insurance
Company, 1999 to present; Secretary, MainStay
VP Series Fund, Inc., 1999 to present;
Secretary, The MainStay Funds, 1999 to
present; Secretary, MainStay Management LLC,
1999 to present; Secretary, MainStay
Shareholder Services LLC, 1999 to present;
Secretary, Monitor Capital Advisors LLC, 1999
to present; Vice President and Counsel, State
Street Bank and Trust Company, 1997 to 1999;
Principal, McBrien Consulting, 1996 to 1997;
Senior Vice President and General Counsel,
Lieber & Company, 1986 to 1996; Senior Vice
President and General Counsel, Evergreen
Asset Management Corp., 1986 to 1996.
</TABLE>
* Messrs. Boyle and Roussin are Directors who are "interested persons" of
the Company as that term is defined in the 1940 Act.
As indicated in the above table, certain Directors and Officers also
hold positions with the Manager, Monitor, MacKay Shields LLC, New York Life
Asset Management Operating Company LLC, New York Life Insurance Company ("New
York Life"), NYLIFE Securities, Inc. and/or NYLIFE Distributors, Inc.
The Independent Directors of the Company receive from the Company an
annual retainer of $24,000 and a fee of $1,000 for each Board of Directors
meeting and for each Board committee meeting attended and are reimbursed for
all out-of-pocket expenses related to attendance at such meetings. Directors
who are affiliated with New York Life Insurance Company do not receive
compensation from the Company.
For the fiscal period ended October 31, 1999, the Directors received
the following compensation from the Company and from certain other investment
companies (as indicated) that have the same investment advisers as the Company
or an investment adviser that is an affiliated person of one of the Company's
investment advisers:
<TABLE>
<CAPTION>
TOTAL COMPENSATION
FROM REGISTRANT AND
AGGREGATE COMPENSATION FUND COMPLEX PAID
NAME AND POSITION FROM COMPANY DIRECTORS
<S> <C> <C>
Lawrence Glacken $24,000 $24,000
Director
Robert P. Mulhearn $23,000 $23,000
Director
Susan B. Kerley $23,000 $23,000
Director
</TABLE>
44
<PAGE> 45
As of January 31, 2000, the Directors and Officers of the Company as a
group owned less than 1% of the outstanding shares of any Class of each of the
Funds.
45
<PAGE> 46
THE MANAGER, THE SUBADVISORS AND THE DISTRIBUTOR
MANAGEMENT AGREEMENT
Pursuant to the Management Agreement for the Funds dated November 21,
1997, MainStay Management LLC (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. MainStay Management LLC is a direct subsidiary of NYLIFE LLC,
which is a direct subsidiary of New York Life Insurance Company.
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 the Manager (as the term is defined in the 1940 Act). The Directors,
including the Independent Directors, approved an amendment to the Management
Agreement at an in-person meeting held on September 7, 1999 to reflect the
conversion of MainStay Management from a corporation to a limited liability
company under the laws of the State of Delaware.
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 they have been elected or appointed.
The Management Agreement provides that the Manager shall not be liable
to a Fund for any error or judgment by the Manager or for any loss sustained by
a Fund except in the case of the Manager's 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 "Know
With Whom You're Investing," 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 a Subadvisor;
(b) the fees to be paid to the Subadvisors 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 the
Prospectus, "Know With Whom You're Investing".)
46
<PAGE> 47
Commencing November 21, 1997 through December 31, 1997, for the fiscal
year ended December 31, 1998 and for the ten months ended October 31, 1999, the
amount of the management fee paid by each Fund to the Manager was as follows:
<TABLE>
<CAPTION>
NOVEMBER 21, 1997
THROUGH YEAR ENDED TEN MONTHS ENDED
DECEMBER 31, 1997 DECEMBER 31, 1998 OCTOBER 31, 1999
----------------- ----------------- ----------------
<S> <C> <C> <C>
Asset Manager Fund $ 305,965 $ 3,114,621 $ 2,927,643
EAFE Index 57,337 562,217 561,256
Growth Equity Fund 670,493 6,963,032 7,314,578
Indexed Equity Fund 541,630 6,263,846 6,695,784
International Equity Fund 108,499 1,104,413 1,013,499
Value Equity Fund 941,883 7,963,179 5,585,920
Bond Fund 155,008 1,373,917 1,156,712
Indexed Bond Fund 68,007 744,747 662,306
International Bond Fund 43,865 440,402 393,177
Money Market Fund 142,675 1,386,536 1,470,982
Short-Term Bond Fund 32,585 260,453 264,919
</TABLE>
As of November 21, 1997, the Manager limited certain Funds' expenses.
In connection with the voluntary expense limitations, the Manager assumed the
following expenses for the period November 21, 1997 through December 31, 1997,
for the fiscal year ended December 31, 1998, and for the ten months ended
October 31, 1999:
<TABLE>
<CAPTION>
NOVEMBER 21, 1997
THROUGH YEAR ENDED TEN MONTHS ENDED
DECEMBER 31, 1997 DECEMBER 31, 1998 OCTOBER 31, 1999
----------------- ----------------- ----------------
<S> <C> <C> <C>
EAFE Index Fund $ 42,915 $ 257,925 $ 223,379
Indexed Equity Fund 290,257 * 3,269,934 * 3,292,206 *
International Equity Fund 13,689 36,690 ---
Bond Fund 18,927 192,482 159,149
Indexed Bond Fund 19,676 222,581 164,813
International Bond Fund 14,104 70,444 57,982
Money Market Fund 37,695 383,039 343,743
Short-Term Bond Fund 14,826 127,949 109,252
</TABLE>
* For the ten months ended October 31, 1999, Manager assumed $2,622,628 and
Monitor, the Funds Sub-Advisor, assumed $669,578. For the year ended December
31, 1998, Manager assumed $2,643,549 and Monitor assumed $626,385. For the
period November 21, 1997 through December 31, 1997, Manager assumed $236,104,
Monitor assumed $54,163.
47
<PAGE> 48
As long as expense limitations continue, they may lower the Funds'
expenses and increase their respective yields. 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 each
of the Subadvisors, and 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, the Subadvisors manage the Funds' portfolios, including
the purchase, retention, disposition and loan of securities. As compensation
for service, the Manager, not the Funds, pays the Funds' Subadvisors a monthly
fee calculated on the basis of each Fund's average daily net assets at the
following annual rates:
<TABLE>
<CAPTION>
PERCENTAGE OF AVERAGE
FUND DAILY NET ASSETS
---- ----------------
<S> <C>
Asset Manager Fund 0.15%
EAFE Index Fund 0.15%
Growth Equity Fund 0.25%
Index Equity Fund 0.10%
International Equity Fund 0.35%
Value Equity Fund 0.25%
Bond Fund 0.20%
Indexed Bond Fund 0.10%
International Bond Fund 0.30%
Money Market Fund 0.10%
Short-Term Bond Fund 0.15%
</TABLE>
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 their
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, the Manager, or
any Subadvisor (as the term is defined in the 1940 Act). Effective April 1,
2000, NYLAMOC replaced New York Life as Subadvisor to the Money Market Fund
pursuant to a substitution agreement by and among the Manager, NYLAMOC and New
York Life. The Directors, including the Independent Directors, approved
amendments to the Sub-Advisory Agreements at an in-person meeting held on
September 7, 1999 to reflect the conversion of MainStay Management, MacKay
Shields and Monitor from corporations to limited liability companies under the
laws of the State of Delaware.
The Subadvisors have authorized any of their directors, officers and
employees who have been elected or appointed as Directors or officers of the
Company to serve in the capacities in which they have been elected or
appointed. In connection with the services they render, the Subadvisors bear
the salaries and expenses of all of their personnel.
The Sub-Advisory Agreements provide that the Subadvisors shall not be
liable to a Fund for any error of judgment by a Subadvisor or for any loss
sustained by a Fund except in the case of the Subadvisor'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.
48
<PAGE> 49
For the 10 months ended October 31, 1999, the fiscal year ended
December 31, 1998 and for the period from November 21, 1997 to December 31,
1997, the amount of the sub-advisory fee paid by the Manager to New York Life,
MacKay Shields or Monitor was as follows:
<TABLE>
<CAPTION>
TEN MONTHS ENDED YEAR ENDED 11/21/97 THROUGH
FUND OCTOBER 31, 1999 12/31/98 12/31/97
---- ---------------- -------- --------
<S> <C> <C> <C>
Asset Manager Fund $ 675,610 $ 718,759 $ 70,607
EAFE Index Fund 88,619 88,771 9,053
Growth Equity Fund 2,151,346 2,047,951 197,204
Indexed Equity Fund* 1,339,157* 1,252,770* 108,326*
International Equity Fund 417,323 454,158 44,677
Value Equity Fund 1,642,918 2,342,112 277,024
Bond Fund 308,456 366,373 41,336
Indexed Bond Fund 132,461 148,950 13,601
International Bond Fund 147,441 165,151 16,450
Money Market Fund 294,196 277,307 28,535
Short-Term Bond Fund 66,230 65,113 8,146
</TABLE>
*For the ten months ended October 31, 1999, the fiscal year ended
December 31, 1998 and the period ended December 31, 1997, the Subadvisor for
the Indexed Equity Fund waived or reimbursed fees in the amounts of $669,578,
$626,385 and $54,163, respectively.
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, the amount of the
advisory fee paid by each Fund to New York Life, MacKay Shields or Monitor was
as follows:
<TABLE>
<CAPTION>
FUND
1/1/97 THROUGH 11/20/97
<S> <C>
Asset Manager Fund $ 508,530
EAFE Index Fund 118,622
Growth Equity Fund 1,414,379
Index Equity Fund 719,601
International Equity Fund 406,316
Value Equity Fund 2,008,307
Bond Fund 316,678
Indexed Bond Fund 105,411
International Bond Fund 136,941
Money Market Fund 181,674
Short-Term Bond Fund 69,125
</TABLE>
SUB-ADMINISTRATION AGREEMENT
Prior to April 1, 2000 the Manager had delegated certain of its
administrative responsibilities to New York Life pursuant to a
Sub-Administration Agreement between the Manager and New York Life. Under the
Sub-Administration Agreement, among other things, New York Life responded to
shareholder inquiries and prepared shareholder reports. For these services, the
Manager paid a percentage of its management fee to New York Life, calculated on
the basis of each Fund's average daily net assets at the annual rates set forth
below. For the year ended December 31, 1998, the Manager paid New York Life
$1,109,299, and $383,039 was waived or reimbursed. For the ten months ended
October 31, 1999, the Manager paid New York Life $1,176,785, and $343,743 was
waived or reimbursed. The Directors, including
49
<PAGE> 50
the Independent Directors, approved amendments to the Sub-Administration
Agreement at an in-person meeting held on September 7, 1999 to reflect the
conversion of MainStay Management from a corporation to a limited liability
company under the laws of the State of Delaware.
<TABLE>
<CAPTION>
FUND PERCENTAGE OF AVERAGE
DAILY NET ASSETS*
<S> <C>
Asset Manager 0.40%
Bond Fund 0.45%
EAFE Index Fund 0.70%
Growth Equity Fund 0.50%
Indexed Bond Fund 0.30%
Indexed Equity Fund 0.30%
International Bond Fund 0.40%
International Equity Fund 0.40%
Money Market Fund 0.30%
Short-Term Bond Fund 0.35%
Value Equity 0.50%
</TABLE>
* Expense reimbursement due to voluntary expense limitations will be
borne by the Sub-Administrator (in the case of Indexed Equity,
together with the Manager).
In previous years, prior to a change in management structure, each
Fund paid an administrative fee directly to New York Life as administrator.
After the restructuring, and until April 1, 2000 , the Manager paid the
sub-administration fee to New York Life. For the period January 1, 1999
through October 31, 1999, the fiscal year ended December 31, 1998 and the
period from November 21, 1997 through December 31, 1997, the amount of the
administration fee paid and waived and/or reimbursed for each Fund was as
follows:
<TABLE>
<CAPTION>
1/1/99 THROUGH 10/31/99 YEAR ENDED 12/31/98 1/1/97 THROUGH 11/20/97
----------------------- ------------------- -----------------------
ADMINISTRATION ADMINISTRATION ADMINISTRATION
FEE WAIVED FEE WAIVED FEE WAIVED
ADMINISTRATION AND/OR ADMINISTRATION AND/OR ADMINISTRATION AND/OR
FUND FEE PAID REIMBURSED FEE PAID REIMBURSED FEE PAID REIMBURSED
-------- ---------- -------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C>
Asset Manager Fund $ 2,252,033 $ N/A (1) $ 2,395,862 $ N/A (1) $ 235,357 $ N/A (1)
------------------
EAFE Index Fund 472,637 36,690 473,446 257,925 48,284 42,915
---------------
Growth Equity Fund 5,163,231 N/A (1) 5,621,068 N/A (1) 473,289 N/A (1)
------------------
Indexed Equity Fund 5,356,627 3,292,206 (2) 5,011,077 3,269,934 (3) 433,304 236,104
-------------------
International Equity Fund 596,176 N/A (1) 649,656 36,690 63,822 13,689
-------------------------
Value Equity Fund 3,943,002 N/A (1) 5,621,068 N/A (1) 664,859 N/A (1)
-----------------
Bond Fund 848,255 159,149 1,007,539 192,482 113,673 18,967
---------
Indexed Bond Fund 529,845 164,813 595,798 222,581 54,405 19,676
-----------------
International Bond Fund 245,735 57,982 275,251 70,444 27,415 14,104
-----------------------
Money Market Fund 1,176,788 343,743 1,109,229 383,039 114,140 37,696
-----------------
Short-Term Bond Fund 198,689 109,252 195,341 127,949 24,439 14,826
--------------------
</TABLE>
1 Fund had no expense limitation during period.
2 New York Life assumed $2,622,628.
3 New York Life assumed $2,643,549.
50
<PAGE> 51
Under the previous structure, for the period January 1, 1997 through
November 20, 1997, the fee paid and waived and/or reimbursed was as follows:
<TABLE>
<CAPTION>
1/1/97 THROUGH 11/20/97
-----------------------
ADMINISTRATION
FEE WAIVED
ADMINISTRATION AND/OR
FUND FEE PAID REIMBURSED
---- -------- ----------
<S> <C> <C> <C>
Asset Manager Fund $ 1,695,098 $ N/A (1)
------------------ --------- ---
EAFE Index Fund 632,652 229,592
--------------- ------- ------
Growth Equity Fund 3,394,512 N/A (1)
------------------ --------- ---
Indexed Equity Fund 2,878,403 1,878,195 (2)
------------------- --------- ---------
International Equity Fund 580,451 35,792
------------------------- ------- ------
Value Equity Fund 4,819,937 N/A (1)
----------------- --------- ---
Bond Fund 870,864 154,845
--------- ------- -------
Indexed Bond Fund 421,641 161,693
----------------- ------- -------
International Bond Fund 228,235 60,073
----------------------- ------- ------
Money Market Fund 726,696 194,751
----------------- ------- -------
Short-Term Bond Fund 207,375 96,101
-------------------- ------- ------
</TABLE>
1 Fund had no expense limitation during period.
2 New York Life assumed $1,518,395, Monitor assumed $359,800.
DISTRIBUTION AGREEMENT
NYLIFE Distributors, Inc. serves as the Company's distributor and
principal underwriter (the "Distributor") pursuant to a Distribution Agreement,
dated January 1, 1994. Prior to that time, NYLIFE Securities Inc. ("NYLIFE
Securities"), an affiliated company, had acted as principal underwriter. NYLIFE
Securities sells shares of the Funds pursuant to a dealer agreement with the
Distributor. The Distributor is not obligated to sell any specific amount of
the Company's shares, and receives no compensation from the Company pursuant to
the Distribution Agreement.
The Company anticipates making a continuous offering of its shares,
although it reserves the right to suspend or terminate such offering at any
time. The Distribution Agreement was most recently approved by the Board of
Directors, including a majority of the Directors who are not "interested
persons" (as defined in the 1940 Act) of the Company or the Distributor, nor
have any direct or indirect financial interest in the operation of the
distribution plan or in any related agreement (the "Independent Directors") at
a meeting held on March 2, 1999.
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 the Manager, 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
51
<PAGE> 52
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 "Independent Directors"), cast in person at a meeting called for the
purpose of voting on such amendments, and by a majority of the outstanding
voting securities as defined in the 1940 Act for the Institutional Service
Class of the Fund.
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 Independent
Directors. 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
Independent Directors. The Plan was last approved by the Directors, including
the Independent Directors, at a meeting held March 2, 1999. The Plan was
originally approved by the Directors, including the Independent Directors, at a
meeting held on September 13, 1994 and amended at a meeting held on March 4,
1997.
The Plan provides that the Manager 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
heading "Shareholder Guide," and that information is incorporated herein by
reference.
Certain clients of the Company's Subadvisors 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 Subadvisor 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 one or more of
the Funds 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, 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.
52
<PAGE> 53
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 Subadvisor will seek the best execution of the
Fund's orders. The Subadvisor 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. Consistent with the foregoing primary considerations, the Conduct
Rules of the NASD and such other policies as the Directors may determine, the
Subadvisors may consider sales of shares of the Funds as a factor in the
selection of broker-dealers to execute the Funds' portfolio transactions.
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.
Under each Sub-Advisory Agreement and as permitted by Section 28(e) of
the Securities Exchange Act of 1934 (the "1934 Act"), a Subadvisor may cause a
Fund to pay a broker-dealer (except the Affiliated Broker) which provides
brokerage and research services to the Subadvisor an amount of commission for
effecting a securities transaction for a Fund in excess of the amount other
broker-dealers would have charged for the transaction if the Subadvisor
determines in good faith that the greater commission is reasonable in relation
to the value of the brokerage and research services provided by the executing
broker-dealer viewed in terms of either a particular transaction or the
Subadvisor's overall responsibilities to the Company or to its other clients.
The term "brokerage and research services" includes advice as to the value of
securities, the advisability of investing in, purchasing, or selling
securities, and the availability of securities or of purchasers or sellers of
securities; furnishing analyses and reports concerning issuers, industries,
securities, economic factors and trends, portfolio strategy and the performance
of accounts; and effecting securities transactions and performing functions
incidental thereto such as clearance and settlement.
Although commissions paid on every transaction will, in the judgment
of the Subadvisors, be reasonable in relation to the value of the brokerage
services provided, commissions exceeding those which another broker might
charge may be paid to broker-dealers (except the Affiliated Broker) who were
selected to execute transactions on behalf of the Company and the Subadvisors'
other clients in part for providing advice as to the availability of securities
or of purchasers or sellers of securities and services in effecting securities
transactions and performing functions incidental thereto such as clearance and
settlement.
Broker-dealers may be willing to furnish statistical, research and
other factual information or services ("Research") to the Subadvisors for no
consideration other than brokerage or underwriting commissions. Securities may
be bought or sold through such broker-dealers, but at present, unless otherwise
directed by the Trust, a commission higher than one charged elsewhere will not
be paid to such a firm solely because it provided Research to a Subadvisor.
Research provided by brokers is used for the benefit of all of the Subadvisors'
clients and not solely or necessarily for the benefit of the Company. The
Subadvisors' investment management personnel attempt to evaluate the quality of
Research provided by brokers. Results of this effort are sometimes used by the
Subadvisors as a consideration in the selection of brokers to execute portfolio
transactions.
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<PAGE> 54
In certain instances there may be securities which are suitable for a
fund's portfolio as well as for that of another Fund or one or more of the
other clients of the Subadvisors. Investment decisions for a Fund and for the
Subadvisors' other clients are made with a view to achieving their respective
investment objectives. It may develop that a particular security is bought or
sold for only one client even though it might be held by, or bought or sold
for, other clients. Likewise, a particular security may be bought for one or
more clients when one or more other clients are selling that same security.
Some simultaneous transactions are inevitable when several clients receive
investment advice from the same investment adviser, particularly when the same
security is suitable for the investment objectives of more than one client.
When two or more clients are simultaneously engaged in the purchase or sale of
the same security, the securities are allocated among clients in a manner
believed to be equitable to each. It is recognized that in some cases this
system could have a detrimental effect on the price or volume of the security
in a particular transaction as far as a Fund is concerned. The Company believes
that over time its ability to participate in volume transactions will produce
better executions for the Funds.
The Sub-Advisory fee that the Manager pays on behalf of each Fund to
the Subadvisors will not be reduced as a consequence of the Subadvisors'
receipt of brokerage and research services. To the extent a Fund's portfolio
transactions are used to obtain such services, the brokerage commissions paid
by the Fund will exceed those that might otherwise be paid, by an amount which
cannot be presently determined. Such services would be useful and of value to
the Subadvisors in serving both the Funds and other clients and, conversely,
such services obtained by the placement of brokerage business of other clients
would be useful to the Subadvisors in carrying out their obligations to the
Funds.
For the ten months ended October 31, 1999 and the years ended December
31, 1998, and 1997, each of the following Funds paid brokerage commissions as
follows:
<TABLE>
<CAPTION>
TOTAL BROKERAGE COMMISSIONS PAID TOTAL BROKERAGE COMMISSIONS
PAID TO AFFILIATED PERSONS
TEN MONTHS YEAR YEAR TEN MONTHS YEAR YEAR
ENDED ENDED ENDED ENDED ENDED ENDED
10/31/99 12/31/98 12/31/97 10/31/99 12/31/98 12/31/97
<S> <C> <C> <C> <C> <C> <C>
Asset Manager Fund.......... $ 10,104 $ 161,159 $ 22,593 0(0%)(1) 0(0%)(1) 0(0%)(1)
EAFE Index Fund............. 56,634 72,602 20,593 0(0%)(1) 0(0%)(1) 0(0%)(1)
Growth Equity Fund.......... 491,121 423,326 461,682 0(0%)(1) 0(0%)(1) 0(0%)(1)
Indexed Equity Fund......... 171,747 302,291 120,427 0(0%)(1) 0(0%)(1) 0(0%)(1)
International Equity Fund... 325,822 230,372 407,665 0(0%)(1) 0(0%)(1) 0(0%)(1)
Value Equity Fund........... 1,556,063 1,976,646 1,651,353 0(0%)(1) 0(0%)(1) 0(0%)(1)
Short-Term Bond Fund........ N/A N/A 250 0(0%)(1) 0(0%)(1) 0(0%)(1)
</TABLE>
<TABLE>
<CAPTION>
TOTAL AMOUNT OF TRANSACTION
WHERE COMMISSIONS PAID
TEN MONTHS YEAR YEAR
ENDED ENDED ENDED
10/31/99 12/31/98 12/31/97
<S> <C> <C> <C>
Asset Manager Fund........... $ 10,528,527 $ 176,370,188 $ 19,581,960(0%)(2)
EAFE Index Fund.............. 32,365,794 28,623,991 6,116,892(0%)(2)
Growth Equity Fund........... 440,538,560 349,425,106 329,107,159(0%)(2)
Indexed Equity Fund.......... 207,061,153 315,577,968 114,953,870(0%)(2)
International Equity Fund.... 95,050,660 84,406,014 103,442,741(0%)(N/A)
Value Equity Fund............ 810,608,991 1,275,820,583 1,082,875,352(0%)(2)
Short-Term Bond Fund......... N/A N/A 3,202,719(0%)(2)
</TABLE>
<TABLE>
<CAPTION>
TOTAL BROKERAGE
COMMISSIONS PAID
TEN MONTHS YEAR YEAR
ENDED ENDED ENDED
10/31/99 12/31/98 12/31/97
<S> <C> <C> <C>
Asset Manager Fund........... $ N/A $ N/A $ N/A
EAFE Index Fund.............. N/A N/A N/A
Growth Equity Fund........... 785,891 423,326 461,682
Indexed Equity Fund.......... N/A N/A N/A
International Equity Fund.... 346,449 230,372 407,665
Value Equity Fund............ 2,023,439 1,976,646 1,651,353
Short-Term Bond Fund......... N/A N/A 250
</TABLE>
(1) Percent of total commissions paid.
(2) Percent of total transactions involving the payment of commissions
effected through affiliated persons.
The Bond Fund, Indexed Bond Fund, International Bond Fund and Money
Market Fund paid no brokerage commissions during the ten months ended October
31, 1999 and the years ended December 31, 1998 and 1997.
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<PAGE> 55
As of October 31, 1999, 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 Bear Stearns Cos., Inc. (The) $ 750,754 (2)
Lehman Brothers Holdings Inc. 1,324,017 (2)
Merrill Lynch & Co., Inc. 4,354,709 (2)
Schwab (Charles) Corp. (The) 4,797,723 (2)
Asset manager Fund Bear Stearns Cos., Inc. (The) 73,784 (2)
Lehman Brothers Holdings Inc. 130,722 (2)
Merrill Lynch & Co., Inc. 429,709 (2)
Paine Webber Group Inc. 88,101 (2)
Schwab (Charles) Corp. (The) 470,754 (2)
Growth Equity Fund Merrill Lynch & Co., Inc. 5,099,717 (1)
Value Equity Fund American Express Credit Corp. 7,914,554 (1)
Merrill Lynch & Co., Inc. 7,991,721 (1)
Bond Fund American Express Credit Corp. 6,977,509 (1)
Salomon Smith Barney Inc. 5,042,037 (1)
Donaldson, Lufkin & Jenrette 2,122,800 (3)
Lehman Brothers Holdings, Inc. 460,642 (3)
Salomon Smith Barney Inc. 679,119 (3)
Indexed Bond Fund American Express Credit Corp. 1,990,000 (3)
Morgan Stanley, Dean Witter & Co. 933,750 (3)
Money Market Fund Goldman, Sachs Group Inc. (The) 9,762,800 (1)
Merrill Lynch & Co., Inc. 15,000,000 (1)
Morgan (J.P.) & Co. Inc. 17,786,944 (1)
Morgan Stanley, Dean Witter & Co. 4,004,751 (1)
Salomon Smith Barney Inc. 5,000,000 (1)
Morgan Stanley, Dean Witter & Co. 2,509,157 (3)
</TABLE>
(1) Represents investment in commercial papers.
(2) Represents investment in common stock.
(3) Represents investment in corporate bonds.
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).
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
55
<PAGE> 56
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, 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 closing 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 Subadvisor if the prices are deemed by the Subadvisors 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 approved by the Board of
Directors, which prices reflect broker-dealer-supplied valuations or electronic
data processing techniques and/or matrix pricing if those prices are deemed by
a Fund's Subadvisor to be representative of market values at the close of the
first session of the New York Stock Exchange; (f) by appraising exchange-traded
options and futures contracts at the last posted settlement 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 Subadvisor to be representative of
market values, but excluding money market instruments with a remaining maturity
of 60 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 60 days or less are valued by the amortized cost
method unless such method does not represent fair value. Forward foreign
currency exchange contracts held by the funds are valued at their respective
fair market values determined on the basis of the mean between the last current
bid and asked prices based on dealer or exchange quotations.
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 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 of net asset value does not take place
contemporaneously with the determination of the prices of the portfolio
securities used in such calculation.
Events affecting the values of portfolio securities that occur between
the time their prices are determined and the close of the New York Stock
Exchange generally will not be reflected in the Fund's calculation of net asset
values. However, a Subadvisor, in consultation with the Manager, may, in its
judgment, determine that an adjustment to a Fund's net asset value should be
made because intervening events have caused the Fund's net asset value to be
materially inaccurate.
The proceeds received by each Fund for each issue or sale of its
shares, and all net investment income, realized and unrealized gain and
proceeds thereof, subject only to the rights of creditors, will be specifically
allocated to such Fund and constitute the underlying assets of that Fund. The
underlying assets of each Fund will be segregated on the books of account, and
will be charged with the liabilities in respect to such
56
<PAGE> 57
Fund and with a share of the general liabilities of the Company. Expenses with
respect to any two or more Funds will be allocated in proportion to the net
asset values of the respective funds except where allocation of direct expenses
can otherwise be fairly made in the judgment of the Manager.
TAX INFORMATION
While it is anticipated that many shareholders of the Funds will be
tax-exempt institutions, the following discussion may be of general interest to
these shareholders as well as for those shareholders of the Funds who do not
have tax-exempt status. Although the discussion below refers in certain
instances to distributions and other transactions as being taxable to a
shareholder, tax-exempt shareholders will, of course, not be taxed to the
extent provided by applicable tax exemptions. The discussion herein relating to
taxes is presented for general informational purposes only. Since the tax laws
are complex and tax results can vary depending upon specific circumstances,
investors should consult tax advisers regarding investment in a Fund.
Each Fund intends to qualify annually and elect to be treated as a
regulated investment company under Subchapter M of the Internal Revenue Code of
1986, as amended (the "Code"). If a Fund so qualifies and elects, it generally
will not be subject to Federal income tax on its investment company taxable
income (which includes, among other items, dividends, interest, and the excess,
if any, of net short-term capital gains over net long-term capital losses) and
its net capital gains (net long-term capital gains in excess of net short-term
capital losses) that it distributes to its shareholders.
Each Fund intends to distribute, at least annually, to its
shareholders substantially all of its investment company taxable income and its
net capital gains. In determining amounts of capital gains to be distributed,
any capital loss carryovers from prior years will be applied against capital
gains.
To qualify for treatment as a regulated investment company, a Fund
generally must, among other things: (a) derive in each taxable year at least
90% of its gross income from dividends, interest, payments with respect to
securities loans, gains from the sale or other disposition of securities or
foreign currencies, and other income (including gains from certain options,
futures, and forward contracts) derived with respect to its business of
investing in securities or foreign currencies; (b) diversify its holdings so
that at the end of each quarter of the taxable year, (i) at least 50% of the
market value of a Fund's assets is represented by cash, cash items, U.S.
Government securities, the securities of other regulated investment companies
and other securities, with such other securities of any one issuer limited for
the purposes of this calculation to an amount not greater than 5% of the value
of the Fund's total assets and 10% of the outstanding voting securities of such
issuer, and (ii) not more than 25% of the value of its total assets is invested
in the securities of any one issuer (other than U.S. Government securities or
the securities of other regulated investment companies), or of two or more
issuers which the Fund controls and which are engaged in the same or similar
trades or businesses or related trades or businesses; and (c) distribute in
each taxable year at least 90% of the sum of its investment company taxable
income and its net tax-exempt interest income. If a Fund does not meet all of
these Code requirements, it will be taxed as an ordinary corporation and its
distributions (to the extent of available earnings and profits) will be taxed
to shareholders as ordinary income (except to the extent a shareholder is
exempt from tax).
The Treasury Department is authorized to issue regulations to provide
that foreign currency gains that are not directly related to a Fund's principal
business of investing in securities (or options and futures with respect to
securities) may be excluded from the income which qualifies for purposes of the
90% gross income requirement described above. To date, however, no such
regulations have been issued.
Amounts not distributed on a timely basis in accordance with a
calendar year distribution requirement are subject to a nondeductible 4% excise
tax. To prevent imposition of the excise tax, a Fund must distribute for the
calendar year an amount equal to the sum of (1) at least 98% of its ordinary
taxable income (excluding any capital gains or losses) for the calendar year,
(2) at least 98% of the excess of its capital gains over capital losses
(adjusted for certain ordinary losses) for the one-year period ending October
31 of such year, and (3) all ordinary taxable income and capital gain net
income (adjusted for certain ordinary losses) for previous years that were not
distributed during such years. A distribution will be treated as paid on
December 31 of the calendar year if it is declared by a Fund in October,
November or December of that year to shareholders on a record date in such a
month and paid by the Fund during January of the following calendar year. Such
a distribution will be includable in the gross income of shareholders in the
calendar year in which it is declared, rather than the calendar year in which
it is received. To prevent application of the excise tax, the Funds intend to
make distributions in accordance with the calendar year distribution
requirement.
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<PAGE> 58
If a portion of a Fund's net investment income is derived from
dividends from domestic corporations, then a portion of such distributions may
be eligible for the corporate dividends-received deduction. The
dividends-received deduction is reduced to the extent shares of a Fund are
treated as debt-financed under the Code and is generally eliminated unless such
shares are deemed to have been held for more than 45 days. The 45-day holding
period must occur during the 90-day period beginning 45 days before the date on
which the shares become ex-dividend. In the case of dividends on certain
preferred stock, the holding period requirement is 90 days during a 180-day
period. In addition, the entire dividend (including the deducted portion) is
includable in the corporate shareholder's alternative minimum taxable income.
Finally, if such dividends are large enough to constitute "extraordinary
dividends" under Section 1059 of the Code and the applicable holding period
requirements are not met, the shareholder's basis in its shares could be
reduced by all or a portion of the amount of the dividends that qualifies for
the dividends-received deduction.
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, Asset
Manager 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 a Fund's net capital gains, if any, designated by a
Fund as capital gain dividends, will generally be taxable to shareholders as
long-term capital gains, regardless of how long a shareholder has held the
Fund's shares. Net capital gains from assets held for one year or less will be
taxed as ordinary income. Capital gain distributions 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 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.
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<PAGE> 59
Under the Code, gains or losses attributable to fluctuations in
foreign currency exchange rates which occur between the time a Fund accrues
income or other receivables or accrues expenses or other liabilities
denominated in a foreign currency and the time a Fund actually collects such
receivables or pays such liabilities generally are treated as ordinary income
or ordinary loss. Similarly, on disposition of debt securities denominated in
a foreign currency and on disposition of certain financial contracts and
options, gains or losses attributable to fluctuations in the value of foreign
currency between the date of acquisition of the security or contract and the
date of disposition also are treated as ordinary gain or loss. These gains and
losses, referred to under the Code as "section 988" gains and losses, may
increase or decrease the amount of a Fund's investment company taxable income
to be distributed to its shareholders as ordinary income. For example,
fluctuations in exchange rates may increase the amount of income that a Fund
must distribute in order to qualify for treatment as a regulated investment
company and to prevent application of an excise tax on undistributed income.
Alternatively, fluctuations in exchange rates may decrease or eliminate income
available for distribution. If section 988 losses exceed other investment
company taxable income during a taxable year, a Fund generally would not be
able to make ordinary dividend distributions, or distributions made before the
losses were realized would be recharacterized as return of capital to
shareholders for Federal income tax purposes, rather than as an ordinary
dividend, reducing each shareholder's basis in his Fund shares.
Foreign investing involves the possibility of confiscatory taxation,
foreign taxation of income earned in the foreign nation (including withholding
taxes on interest and dividends) or other foreign taxes imposed with respect to
investments in the foreign nation.
Income received by a Fund from sources within a foreign country may be
subject to withholding and other income or similar taxes imposed by that
country. If more than 50% of the value of a Fund's total assets at the close of
its taxable year consists of securities of foreign corporations, the Fund will
be eligible and may elect to "pass-through" to the Fund's shareholders the
amount of foreign income and similar taxes paid by the Fund. Pursuant to the
Funds' current investment policies and practices, only the EAFE Index Fund and
the International Equity Fund are expected to invest in foreign securities
sufficient in amount to be eligible to permit this election to be made.
Pursuant to this election, a shareholder will be required to include in gross
income (in addition to taxable dividends actually received) his pro rata share
of the foreign income and similar taxes paid by a Fund, and will be entitled
either to claim a deduction (as an itemized deduction) for his pro rata share
of such foreign taxes in computing his taxable income or to use it as a foreign
tax credit against his U.S. Federal income taxes, subject to limitations.
Foreign taxes may not be deducted by a shareholder that is an individual in
computing the alternative minimum tax. Each shareholder will be notified within
60 days after the close of a Fund's taxable year whether the foreign taxes paid
by the Fund will "pass-through" for that year and, if so, such notification
will designate (a) the shareholder's portion of the foreign taxes paid to each
such country and (b) the portion of the dividend which represents income
derived from sources within each such country.
Generally, a credit for foreign taxes is subject to the limitation
that it may not exceed the shareholder's U.S. tax attributable to his total
foreign source taxable income. For this purpose, if a Fund makes the election
described in the preceding paragraph, the source of a Fund's income flows
through to its shareholders. With respect to the Funds, gains from the sale of
securities generally will be treated as derived from U.S. sources and section
988 gains generally will be treated as ordinary income derived from U.S.
sources. The limitation on the foreign tax credit is applied separately to
foreign source passive income (as defined for purposes of the foreign tax
credit), including foreign source passive income received from a Fund. In
addition, the foreign tax credit may offset only 90% of the alternative minimum
tax imposed on corporations and individuals. If a Fund is not eligible to make
the election described above, the foreign income and similar taxes it pays
generally will reduce investment company taxable income and distributions by a
Fund will be treated as United States source income.
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, International Bond Fund, International Equity Fund, Asset Manager
Fund and Indexed Bond Fund are expected to invest in shares of foreign
corporations. In general, a foreign corporation is classified as a PFIC for a
taxable year if at least one-half of its assets constitute investment-type
assets or 75% or more of its gross income is investment-type income. If a Fund
receives a so-called "excess distribution" with respect to PFIC stock, the Fund
itself may be subject to a tax on a portion of the excess distribution, whether
or not the corresponding income is distributed by the Fund to shareholders. In
general, under the PFIC rules, an excess distribution is treated as having been
realized ratably over the period during which a Fund held the PFIC shares. A
Fund itself will be subject to tax on the portion, if any, of an excess
distribution that is so allocated to prior Fund taxable years and an interest
59
<PAGE> 60
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, 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 capital gain
realized by a Fund which is taxed as ordinary income when distributed to
shareholders.
60
<PAGE> 61
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 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).
61
<PAGE> 62
PERFORMANCE INFORMATION
The Company may, from time to time, include the yield and effective
yield of its Money Market Fund, the yield of the other Funds or Classes, and
the total return of all Funds or Classes in advertisements, sales literature,
or reports to shareholders or prospective investors. Due to the deduction of
the shareholder service fee, performance of the Institutional Service Class of
each Fund will be lower than the performance of the Institutional Class of the
Fund.
Each of the Funds began offering Institutional Service Class shares on
January 1, 1995. Thus, the performance figures for Institutional Service Class
shares prior to that date have been calculated based on the historical
performance of the Funds' Institutional Class shares from inception through
December 31, 1994, except for the International Equity and International Bond
Funds, which began offering both classes of shares on January 1, 1995.
Performance data for the International Bond Fund and the International Equity
Fund includes the historical performance of each Fund's predecessor separate
account from its inception up to 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 365/7, with the resulting
yield figure carried to at least the nearest hundredth of one percent.
"Effective yield" for the Money Market Fund assumes that all dividends received
during an annual period have been reinvested. Calculation of "effective yield"
begins with the same "base period return" used in the calculation of yield,
which is then annualized to reflect weekly compounding pursuant to the
following formula:
EFFECTIVE YIELD = [(BASE PERIOD RETURN + 1)(365/7)] - 1
The current and effective seven-day average yields as of October 31,
1999 for the Money Market Fund were 5.15% and 5.28%, respectively, for the
Institutional Class, and were 4.90% and 5.02%, respectively, for the
Institutional Service Class. Had certain expenses not been assumed by the
Manager, these yields would have been 5.07% and 5.20%, respectively, for the
Institutional Class, and 4.82% and 4.94%, 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)(6) - 1]
cd
<TABLE>
<S> <C>
where a = dividends and interest earned during the period,
b = expenses accrued for the period (net of
reimbursements),
c = the average daily number of shares outstanding during
the period that were entitled to receive dividends,and
d = the maximum offering price per share on the last day
of the period.
</TABLE>
For the 30-day period ended October 31, 1999, the yield for the
Short-Term Bond Fund was 4.02% for the Institutional Class, and was 3.77% for
the Institutional Service Class.
Quotations of average annual total return for a Fund will be expressed
in terms of the average annual compounded rate of return of a hypothetical
investment in the Fund or Class over certain periods that will include a period
of one year (or, if less, up to the life of the Fund), calculated pursuant to
the following formula: P(1 + T)(n) = ERV (where P = a hypothetical initial
payment of $1,000, T = the total return for the period, n = the number of
periods, and ERV = the ending redeemable value of a hypothetical $1,000 payment
made at the beginning of the period). Quotations of total return may also be
shown for other periods. All total return figures reflect the deduction of a
proportional share of Fund or Class expenses on an annual basis, reflect fee
waivers or reimbursements in effect for each period and assume that all
dividends and distributions are reinvested when paid.
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<PAGE> 63
The average annual total return of the following Funds for the
one-year and five-year periods ended October 31, 1999 and the period from
inception to October 31, 1999 were as follows:
<TABLE>
<CAPTION>
FIVE YEARS AVERAGE ANNUAL
YEAR ENDED ENDED TOTAL RETURN
FUND 10/31/99 10/31/99 SINCE INCEPTION
<S> <C> <C> <C>
EAFE Index Fund
Institutional Class (1)........................... 22.68% 8.25% 8.62%
Institutional Service Class(2). 22.38% 7.98% 8.46%
Growth Equity Fund
Institutional Class (1)........................... 32.29% 25.65% 22.72%
Institutional Service Class(2). 32.01% 25.33% 22.56%
Indexed Equity Fund
Institutional Class (1)........................... 25.63% 25.68% 19.76%
Institutional Service Class(2). 25.32% 25.40% 19.61%
International Equity Fund*
Institutional Class (3)........................... 22.57% 11.14% 11.56%
Institutional Service Class(3). 22.31% 10.77% 11.30%
Asset Manager Fund (formerly MultiAsset Fund)
Institutional Class (1)........................... 12.13% 18.89% 14.29%
Institutional Service Class(2). 11.73% 18.62% 14.14%
Value Equity Fund
Institutional Class (1)........................... 6.39% 13.16% 15.94%
Institutional Service Class(2). 6.12% 12.92% 15.79%
Bond Fund
Institutional Class (1)........................... 1.05% 7.00% 6.86%
Institutional Service Class(2). 1.27% 6.73% 6.71%
Indexed Bond Fund
Institutional Class (1)........................... 0.78% 7.17% 7.07%
Institutional Service Class(2). 0.93% 6.97% 6.95%
International Bond Fund*
Institutional Class (3)........................... 3.46% 7.81% 8.59%
Institutional Service Class(3). 3.69% 7.57% 8.47%
Short-Term Bond Fund
Institutional Class (1)........................... 2.51% 5.85% 5.91%
Institutional Service Class(2). 2.23% 5.59% 5.77%
</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 LLC, the current Subadvisor 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
63
<PAGE> 64
corresponding Funds. Performance figures for the period prior to
January 1, 1995, have been calculated by measuring the change in value
of a unit in the Separate Account from the time period indicated to
January 1, 1995 using the expense structure of each Separate Account,
which generally was higher than the expense structure of its
corresponding Fund. Neither Separate Account was registered under the
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 Manager and Subadvisor, and other pertinent facts relating to the
management of the Fund by the Subadvisor.
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, Business Week, 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 BIG 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 Smith Barney World
Government Benchmark Bond Index, the Salomon Smith Barney non-U.S. Dollar
World Government Bond Index, the Legman Brothers Municipal Bond Index and the
Legman Brothers Government Corporate Index; (ii) other groups of mutual funds
tracked by Morningstar Inc. or Lipper Inc., 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. Advertisements for a Fund may also include general information
about the performance of unmanaged indexes with investment parameters similar
to the Fund's. 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. In addition to the Institutional Class and the
Institutional Service Class, the Money Market Fund offers another class of
shares, the Sweep Shares. 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.
64
<PAGE> 65
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.
SHARE OWNERSHIP OF THE FUNDS
The following table sets forth the information concerning beneficial
and record ownership as of January 31, 2000, of the Funds' shares by each
person who beneficially or of record owned more than 5% of the voting
securities of any Fund:
<TABLE>
<CAPTION>
PERCENTAGE OF
OUTSTANDING
NAME AND ADDRESS OF SHAREHOLDER FUND SHARES OWNED SHARES
<S> <C> <C> <C>
FRANK G AND FRIEDA K BROTZ Indexed Bond 926,479 6.7%
FAMILY FOUNDATION INC
C/O JEFFREY T MOHR
PO BOX 551
SHEBOYGAN WI 53082-0551
MACKAY SHIELDS LLC Short Term Bond 198,105 5.7%
9 W 57TH ST FL 33
NEW YORK NY 10019-2701
MERRILL LYNCH TRUST CO Indexed Equity 6,515,024 14.3%
TTEE FBO CHRYSLER 401(K) PLAN
C/O PHILIP B KOLB
265 DAVIDSON AVE
SOMERSET NJ 08873-4120
NEW YORK LIFE INS CO EMPLOYEES Bond 1,406,522 7.2%
HEALTH AND LIFE BENEFIT TRUST
C/O GEORGE J TRAPP
51 MADISON AVENUE
NEW YORK NY 10010-1603
NEW YORK LIFE TRUST COMPANY Short Term Bond 43,586 37.4%
C/O WILLIAM ZALESKI Bond 200,551 64.7%
51 MADISON AVE RM #117A Indexed Bond 186,921 58.6%
NEW YORK NY 10010-1603 Asset Manager 1,506,491 74.0%
Value Equity 200,280 39.6%
Growth Equity 370,439 54.7%
Indexed Equity 754,142 42.7%
EAFE 21,514 46.6%
PLASTICS ENGINEERING CO EAFE 880,884 14.1%
C/O JEFFREY T MOHR
PO BOX 758
SHEBOYGAN WI 53082-0758
</TABLE>
65
<PAGE> 66
<TABLE>
<CAPTION>
PERCENTAGE OF
OUTSTANDING
NAME AND ADDRESS OF SHAREHOLDER FUND SHARES OWNED SHARES
<S> <C> <C> <C>
PRIORITY SYSTEMS INC International Equity 5,315 12.3%
C/O ANDREW ORONS
PO BOX 4240
HARRISBURG PA 17111-0240
TRUSTEES OF THE VOGEL Short Term Bond 317,401 9.2%
EMPLOYEES PENSION TRUST
C/O HAROLD PALS TRUSTEE
1110 ALBANY PLACE SOUTH
ORANGE CITY IA 51041-0380
NEW YORK LIFE PROGRESS-SHARING Short Term Bond 586,006 17.0%
C/O LYNNE M COHN Asset Manager 3,888,078 10.5%
51 MADISON AVE RM 513 Growth Equity 10,418,221 33.0%
NEW YORK NY 10010-1603 Indexed Equity 3,054,222 6.7%
ASGHAR SHAIGANY, M.D. Money Market 204,473 11.7%
5632 ANNAPOLIS RD STE 12
BLADENSBURG MD 20710-2213
CHARLES SCHWAB & CO INC EAFE 474,102 7.6%
SPL CSTDY A/C FOR BNFT CUST
C/O STEVEN SEARS
ATTN MUTUAL FUNDS - 101 MONTGOMERY
SAN FRANCISCO CA 94104
CNA TRUST CUST Short Term Bond 214,710 6.2%
FBO EFCO CORP 401K & PSP
1800 NE BROADWAY AVE
DES MOINES IA 50313-2644
DEBORAH A LANDON Short Term Bond 20,744 17.8%
5 OLD ENGLISH RD
SLINGERLANDS NY 12159-3634
DESCO FEDERAL CREDIT UNION Money Market 91,622 5.3%
C/O RICHARD POWELL CEO
PO BOX 1546
PORTSMOUTH OH 45662-1546
FISERV SECURITIES, INC Bond 29,862 9.6%
FAO 40154887
ATTN: MUTUAL FUNDS
ONE COMMERCE SQUARE
</TABLE>
66
<PAGE> 67
<TABLE>
<CAPTION>
PERCENTAGE OF
OUTSTANDING
NAME AND ADDRESS OF SHAREHOLDER FUND SHARES OWNED SHARES
<S> <C> <C> <C>
2005 MARKET STREET SUITE 1200
PHILADELPHIA PA 19103-7084
FISERV SECURITIES, INC Indexed Bond 16,077 5.0%
FAO 40050012
ATTN: MUTUAL FUNDS
ONE COMMERCE SQUARE
2005 MARKET STREET SUITE 1200
PHILADELPHIA PA 19103-7084
FISERV SECURITIES, INC International Bond 838 6.7%
FAO 40035615
ATTN: MUTUAL FUNDS
ONE COMMERCE SQUARE
2005 MARKET STREET SUITE 1200
PHILADELPHIA PA 19103-7084
FISERV SECURITIES, INC International Bond 1,094 8.7%
FAO 40162203
ATTN: MUTUAL FUNDS
ONE COMMERCE SQUARE
2005 MARKET STREET SUITE 1200
PHILADELPHIA PA 19103-7084
FISERV SECURITIES, INC International Bond 1,120 8.9%
FAO 40023882
ATTN: MUTUAL FUNDS
ONE COMMERCE SQUARE
2005 MARKET STREET SUITE 1200
PHILADELPHIA PA 19103-7084
FISERV SECURITIES, INC International Bond 2,042 16.3%
FAO 40021562
ATTN: MUTUAL FUNDS
ONE COMMERCE SQUARE
2005 MARKET STREET SUITE 1200
PHILADELPHIA PA 19103-7084
FISERV SECURITIES, INC International Bond 3,334 26.6%
FAO 40044144 International Equity 3,406 7.9%
ATTN: MUTUAL FUNDS
ONE COMMERCE SQUARE
2005 MARKET STREET SUITE 1200
PHILADELPHIA PA 19103-7084
</TABLE>
67
<PAGE> 68
<TABLE>
<CAPTION>
PERCENTAGE OF
OUTSTANDING
NAME AND ADDRESS OF SHAREHOLDER FUND SHARES OWNED SHARES
<S> <C> <C> <C>
FISERV SECURITIES, INC International Equity 2,177 5.1%
FAO 40059423
ATTN: MUTUAL FUNDS
2005 MARKET STREET SUITE 1200
PHILADELPHIA PA 19103-7084
JAMES TUCKER International Equity 3,021 7.0%
NANCY D MILLER-TUCKER TEN ENT
1121 S. GLENSTONE AVE
SPRINGFIELD, MO 65804 - 0313
JANET CAREY TTEE Short Term Bond 14,386 12.4%
FBO ZACHARY LAKE LANDON
U/W OF HERBERT D LANDON DECEASED
RR 3 BOX 290-4
DALLAS PA 18612-9452
JOAN F THOMPSON Short Term Bond 7,227 6.2%
BRUCE BARRY AND BRIAN THOMPSON TOD
11129 72ND AVE NO
MAPLE GROVE MN 55369-7655
METHODIST HOME ENDOWMENT FUND International Equity 816,297 6.2%
C/O JOSEPH BAILEY
1111 HERRING AVE
WACO TX 76708-3696
MILLERS LP GAS INC Money Market 300,130 17.2%
10122 SMITH CALHOUN RD
PLAIN CITY OH 43064-8960
NEW YORK LIFE Bond 2,640,788 13.6%
SEPARATE ACCOUNTS
C/O CAROL MEYER
PO BOX 422
PARSIPPANY NJ 07054-0422
NEW YORK LIFE INS CO AGENTS Bond 1,338,321 6.9%
HEALTH AND LIFE BENEFIT TRUST
C/O GEORGE J TRAPP
51 MADISON AVENUE
NEW YORK NY 10010-1603
NEW YORK LIFE INSURANCE COMPANY Asset Manager 11,896,456 32.1%
</TABLE>
68
<PAGE> 69
<TABLE>
<CAPTION>
PERCENTAGE OF
OUTSTANDING
NAME AND ADDRESS OF SHAREHOLDER FUND SHARES OWNED SHARES
<S> <C> <C> <C>
C/O RICHARD SCHWARTZ Indexed Equity 4,366,344 9.6%
260 CHERRY HILL ROAD EAFE 1,444,229 23.0%
PARSIPPANY NJ 07054-1187
NEW YORK LIFE TRUST COMPANY Money Market 138,992,343 62.2%
CLIENT ACCOUNTS Short Term Bond 202,854 5.9%
C/O WILLIAM ZALESKI Bond 1,332,633 6.8%
51 MADISON AVE RM #117A Indexed Bond 3,165,345 22.7%
NEW YORK NY 10010-1603 Asset Manager 10,060,281 27.2%
Value Equity 6,772,565 11.8%
Growth Equity 5,676,747 18.0%
Indexed Equity 11,097,604 24.3%
NEW YORK LIFE TRUST COMPANY International Bond 767 6.1%
CUST FOR THE IRA OF
GEORGE S O'NEILL
116 MARK DRIVE
MORRISVILLE PA 19067-4810
NEW YORK LIFE TRUST COMPANY International Equity 2,998 7.0%
CUST FOR THE IRA OF
GENE R FEYEN
2556 BIRCHCREST SE
GRAND RAPIDS MI 49506-5419
NEW YORK LIFE TRUST COMPANY International Equity 3,276 7.6%
CUST FOR THE IRA ROLLOVER OF
EDWARD G MURPHY
585 S GREEN BAY RD
LAKE FOREST IL 60045-3071
NEW YORK LIFE TRUST COMPANY Money Market 91,206 5.2%
CUST FOR THE ROLLOVER IRA OF
WILLIAM G WINCH
11 ARROWHEAD TRAIL
TIJERAS NM 87059-7606
NEW YORK LIFE TRUST COMPANY Money Market 98,666 5.7%
CUST FOR THE ROLLOVER IRA OF
KENNETH LANDAU
13521 HAYNES ST
VAN NUYS CA 91401-1714
NEW YORK LIFE TRUST COMPANY Money Market 152,923 8.8%
CUST FOR THE ROLLOVER IRA OF
</TABLE>
69
<PAGE> 70
<TABLE>
<CAPTION>
PERCENTAGE OF
OUTSTANDING
NAME AND ADDRESS OF SHAREHOLDER FUND SHARES OWNED SHARES
<S> <C> <C> <C>
ROSE L STORIN
6602 78TH ST
MIDDLE VLG NY 11379-2715
NEW YORK LIFE TRUST COMPANY EAFE 3,269 7.1%
CUST FOR THE ROLLOVER IRA OF
DENNIS WEINER
434 RIDGEWOOD AVE
GLENRIDGE NJ 07028-1722
NEW YORK LIFE TRUST COMPANY International Bond 711 5.7%
CUST FOR THE ROLLOVER IRA OF
MARY RODRIGO
3269 GOA WAY
LAVALLETTE NJ 08735-1215
NEW YORK LIFE TRUST COMPANY International Bond 1,252 10.0%
CUST FOR THE ROLLOVER IRA OF
ANDREW L TIMMINS
2 FIRST ST
MORRISTOWN NJ 07960-2705
TRUSTEES OF LONE STAR Short Term Bond 910,179 26.4%
HOURLY RETIREMENT PLAN
DAY & ZIMMERMANN INC
1818 MARKET STREET
PHILADELPHIA PA 19103-3638
TRUSTEES OF THE NEW YORK Bond 6,871,240 35.3%
LIFE INSURANCE CO RETIREMENT Indexed Bond 4,535,982 32.6%
PLAN & PENSION PLAN Value Equity 23,564,127 41.0%
300 INTERPACE PKWY BLDG A Growth Equity 6,120,691 19.4%
PARSIPPANY NJ 07054-1100 Indexed Equity 7,848,727 17.2%
EAFE 1,013,399 16.2%
International Bond 3,950,813 72.4%
International Equity 4,969,413 38.0%
TRUSTEES OF THE NYLIC Bond 2,321,864 11.9%
RETIREMENT PLAN (AGENTS) Indexed Bond 2,431,171 17.5%
300 INTERPACE PKWY BLDG A Value Equity 16,430,557 28.6%
PARSIPPANY NJ 07054-1100 Growth Equity 4,178,078 13.2%
Indexed Equity 7,448,228 16.3%
EAFE 810,719 12.9%
International Bond 1,125,635 20.6%
International Equity 3,999,424 30.6%
</TABLE>
70
<PAGE> 71
<TABLE>
<CAPTION>
PERCENTAGE OF
OUTSTANDING
NAME AND ADDRESS OF SHAREHOLDER FUND SHARES OWNED SHARES
<S> <C> <C> <C>
US BANK NA CUST International Equity 903,026 6.9%
CENEX HARVEST STATES
P O BOX 64010
ST PAUL MN 55164-0010
</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.
NYLIFE Distributors, Inc. is a corporation organized under the laws of
Delaware. NYLIFE Distributors, Inc. is a wholly owned subsidiary of NYLIFE LLC
and an indirect wholly owned subsidiary of New York Life.
CODE OF ETHICS
The Company has adopted a Code of Ethics governing personal trading
activities of all Directors, officers of the Company and persons who, in
connection with their regular functions, play a role in the recommendation of
any purchase or sale of a security by the Company or obtain information
pertaining to such purchase or sale or who have the power to influence the
management or policies of the Company or the Manager or a Subadvisor unless
such power is the result of their position with the Company or Manager or
Subadvisor. 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. Subject to these restrictions,
these persons are permitted to invest in securities, including securities that
may be purchased or held by the Funds. The Company has developed procedures
for administration of the Code of Ethics.
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New
York 10036, has been selected as independent accountants of the Company. The
Fund's Annual Reports, which are incorporated by reference in this SAI, have
been incorporated in reliance on the reports of PricewaterhouseCoopers LLP,
independent accountants, given on the authority of said firm as experts in
auditing and accounting.
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.
TRANSFER AGENT
MainStay Shareholder Services LLC ("MSS") is the Funds' Transfer,
Dividend Disbursing and Shareholder Servicing Agent. MSS, whose address is 260
Cherry Hill Road, Parsippany, NJ 07054, is an indirect wholly owned subsidiary
of New York Life Insurance Company. MSS provides customer service, is
responsible for preparing and sending statements, confirms and checks, and
keeps certain financial and accounting records. MSS is paid a per account fee
and out-of-pocket expenses by the Funds. MSS has entered into an agreement with
Boston Financial Data Services ("BFDS"), whose address is 2 Heritage Drive,
North Quincy, MA 02171. BFDS will perform certain of the services for which MSS
is responsible. In addition, the Fund or MSS may contract with other service
organizations, including affiliates of MSS and broker-dealers and other
financial institutions, which will establish a single omnibus account for their
clients with the Fund. The service organizations will provide shareholder
services to the shareholders within the omnibus accounts and receive service
fees for those services from the Fund.
CUSTODIAN
The Bank of New York, 90 Washington Street, New York, NY 10286, is
custodian of the Funds' investments and has subcustodial agreements for holding
the Funds' foreign investments.
71
<PAGE> 72
REGISTRATION STATEMENT
This Statement of Additional Information and the Prospectus do not
contain all the information included in the Company's registration statement
filed with the SEC under the Securities Act of 1933 with respect to the
securities offered hereby, certain portions of which have been omitted pursuant
to the rules and regulations of the SEC. The registration statement, including
the exhibits filed therewith, may be examined at the offices of the SEC in
Washington, D.C.
Statements contained herein and in the Prospectus as to the contents
of any contract or other documents referred to are not necessarily complete,
and, in each instance, reference is made to the copy of such contract or other
documents filed as an exhibit to the registration statement, each such
statement being qualified in all respects by such reference.
72
<PAGE> 73
APPENDIX A
DESCRIPTION OF SECURITIES RATINGS
MOODY'S INVESTORS SERVICE, INC.
Corporate and Municipal Bond Ratings
Aaa: Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edged." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa: Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high-grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than the Aaa
securities.
A: Bonds which are rated A possess many favorable investment
attributes and are to be considered as upper-medium-grade obligations. Factors
giving security to principal and interest are considered adequate but elements
may be present which suggest a susceptibility to impairment sometime in the
future.
Baa: Bonds which are rated Baa are considered as medium-grade
obligations (i.e., they are neither highly protected nor poorly secured).
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics as
well.
Ba: Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B: Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
Caa: Bonds which are rated Caa are of poor standing. Such issues may
be in default or there may be present elements of danger with respect to
principal or interest.
Ca: Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings.
C: Bonds which are rated C are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Moody's applies numerical modifiers, 1, 2, and 3, in each generic
rating classified from Aa through Caa. The modifier 1 indicates that the issue
ranks in the higher end of its generic rating category; the modifier 2
indicates a midrange ranking; and the modifier 3 indicates that the issue ranks
in the lower end of its generic rating category.
Advance refunded issues that are secured by escrowed funds held in
cash, held in trust, reinvested in direct noncallable United States government
obligations or noncallable obligations unconditionally guaranteed by the U.S.
government are identified with a hatchmark (#) symbol, i.e., #Aaa.
Moody's assigns conditional ratings to bonds for which the security
depends upon the completion of some act or the fulfillment of some condition.
These are bonds secured by: (a) earnings of projects under construction; (b)
earnings of projects unseasoned in operating experience; (C) rentals that begin
when facilities are completed; or (d) payments to which some other limiting
condition attaches. The parenthetical rating denotes probable credit stature
upon completion of construction or elimination of basis of condition, e.g.,
Con.(Baa).
73
<PAGE> 74
Municipal Short-Term Loan Ratings
MIG 1/VMIG 1: This designation denotes best quality. There is present
strong protection by established cash flows, superior liquidity support or
demonstrated broad-based access to the market for refinancing.
MIG 2/VMIG 2: This designation denotes high quality. Margins of
protection are ample although not so large as in the preceding group.
MIG 3/VMIG 3: This designation denotes favorable quality. All security
elements are accounted for but there is lacking the undeniable strength of the
preceding grades. Liquidity and cash flow protection may be narrow and market
access for refinancing is likely to be less well established.
MIG 4/VMIG 4: This designation denotes adequate quality. Protection
commonly regarded as required of an investment security is present and although
not distinctly or predominantly speculative, there is specific risk.
SG: This designation denotes speculative quality. Debt instruments in
this category lack margins of protection.
Corporate Short-Term Debt Ratings
Moody's short-term debt ratings are opinions of the ability of issuers
to repay punctually senior debt obligations which have an original maturity not
exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment ability of rated issuers:
PRIME-1: Issuers rated Prime-1 (or supporting institutions) have a
superior ability for repayment of senior short-term debt obligations. Prime-1
repayment ability will often be evidenced by many of the following
characteristics: leading market positions in well-established industries; high
rates of return on funds employed; conservative capitalization structure with
moderate reliance on debt and ample asset protection; broad margins in earnings
coverage of fixed financial charges and high internal cash generation; and
well-established access to a range of financial markets and assured sources of
alternate liquidity.
PRIME-2: Issuers rated Prime-2 (or supporting institutions) have a
strong ability for repayment of senior short-term debt obligations. This will
normally be evidenced by many of the characteristics cited above but to a
lesser degree. Earnings trends and coverage ratios, while sound, may be more
subject to variation. Capitalization characteristics, while still appropriate,
may be more affected by external conditions. Ample alternate liquidity is
maintained.
PRIME-3: Issuers rated Prime-3 (or supporting institutions) have an
acceptable ability for repayment of senior short-term obligations. The effect
of industry characteristics and market compositions may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and may require relatively high financial
leverage. Adequate alternate liquidity is maintained.
NOT PRIME: Issuers rated Not Prime do not fall within any of the Prime
rating categories.
STANDARD & POOR'S
Corporate and Municipal Long-Term Debt Ratings
Investment Grade
AAA: Debt rated AAA has the highest rating assigned by Standard &
Poor's. The obligor's capacity to meet its financial commitment on the
obligation is extremely strong.
AA: Debt rated AA differs from the highest rated issues only in small
degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong.
A: Debt rated A is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories. However, the obligor's capacity to meet its financial commitment on
the obligation is still strong.
BBB: Debt rated BBB exhibits adequate protection parameters. However,
adverse economic conditions or changing circumstances are more likely to lead
to a weakened capacity of the obligor to meet its financial commitment on the
obligation.
74
<PAGE> 75
SPECULATIVE GRADE
Debt rated BB, B, CCC, CC, and C is regarded as having significant
speculative characteristics with respect to capacity to pay interest and repay
principal. BB indicates the least degree of speculation and C the highest.
While such debt will likely have some quality and protective characteristics,
these may be outweighed by large uncertainties or major exposures to adverse
conditions.
BB: Debt rated BB is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial or economic conditions which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
B: Debt rated B is more vulnerable to nonpayment than obligations
rated BB, but the obligor currently has the capacity to meet its financial
commitment on the obligation. Adverse business, financial or economic
conditions will likely impair the obligor's capacity or willingness to meet its
financial commitment on the obligation.
CCC: Debt rated CCC is currently vulnerable to nonpayment and is
dependent upon favorable business, financial and economic conditions for the
obligor. In the event of adverse business, financial or economic conditions,
the obligor is not likely to have the capacity to meet its financial commitment
on the obligation.
CC: An obligation rated CC is currently highly vulnerable to
nonpayment.
C: The C rating may be used to cover a situation where a bankruptcy
petition has been filed or a similar action has been taken, but debt service
payments are continued.
D: Debt rated D is in payment default. The D rating category is used
when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period. The D rating will also be used upon the
filing of a bankruptcy petition, or the taking of similar action, if debt
service payments are jeopardized.
Plus (+) or Minus (-): The ratings from AA to CCC may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
Debt obligations of issuers outside the United States and its
territories are rated on the same basis as domestic corporate and municipal
issues. The ratings measure the creditworthiness of the obligor but do not take
into account currency exchange and related uncertainties.
SHORT-TERM RATING DEFINITIONS
A-1: A short-term obligation rated 'A-1' is rated in the highest
category by Standard & Poor's. The obligor's capacity to meet its financial
commitment on the obligation is strong. Within this category, certain
obligations are designated with a plus sign(+). This indicates that the
obligor's capacity to meet its financial commitment on these obligations is
extremely strong.
A-2: A short-term obligation rated 'A-2' is somewhat more susceptible
to the adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity to
meet its financial commitment on the obligation is satisfactory.
A-3: A short-term obligation rated 'A-3' exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
B: A short-term obligation rated 'B' is regarded as having significant
speculative characteristics. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major ongoing
uncertainties which could lead to the obligor's inadequate capacity to meet its
financial commitment on the obligation.
C: A short-term obligation rated 'C' is currently vulnerable to
nonpayment and is dependent upon favorable business, financial, and economic
conditions for the obligor to meet its financial commitment on the obligation.
D: A short-term obligation rated 'D' is in payment default. The 'D'
rating category is used when payments on an obligation are not made on the date
due even if the applicable grace period has not expired, unless Standard &
Poor's believes that such payments will be made during such grace period. The
'D' rating also will be used upon the filing of a bankruptcy petition or the
taking of a similar action if payments on an obligation are jeopardized.
75
<PAGE> 76
MAINSTAY INSTITUTIONAL FUNDS INC.
MONEY MARKET FUND SWEEP SHARES
STATEMENT OF ADDITIONAL INFORMATION
DATE: MARCH 1, 2000
AS SUPPLEMENTED APRIL 19, 2000
This Statement of Additional Information supplements the information
contained in the Prospectus for the Money Market Fund Sweep Shares dated March
1, 2000 as amended or supplemented from time to time (the "Prospectus"), and
should be read in conjunction with the Prospectus. The Prospectus is available
without charge by writing to MainStay Institutional Funds Inc., 260 Cherry Hill
Road, Parsippany, New Jersey 07054-1108, or by calling 1-800-695-2126. This
Statement of Additional Information, although not in itself a prospectus, is
incorporated in its entirety by reference in and is made a part of the
Prospectus.
No dealer, salesman or any other person has been authorized to give
any information or to make any representations, other than those contained in
this Statement of Additional Information or in the 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
Fund or NYLIFE Distributors, Inc. (the "Distributor"). This Statement of
Additional Information and the 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.
Shareholder inquiries should be made by writing directly to MainStay
Institutional Funds Inc., 260 Cherry Hill Road, Parsippany, New Jersey
07054-1108, or by calling 1-800-695-2126. In addition, you can make inquiries
through your registered representative.
The Money Market Fund's financial statements, including the Statement
of Assets and Liabilities and the Portfolio of Investments for the ten months
ended October 31, 1999, the Statement of Operations for the ten months ended
October 31, 1999 and the year ended December 31, 1998, the Statement of Changes
in Net Assets for the ten months ended October 31, 1999 and the years ended
December 31, 1998 and 1997, the notes to the Financial Statements, and the
Report of the Independent Accountants, all of which are included in the
Company's 1999 Annual Report to Shareholders, are hereby incorporated by
reference into this Statement of Additional Information.
<PAGE> 77
<TABLE>
<CAPTION>
TABLE OF CONTENTS
<S> <C>
ADDITIONAL INFORMATION ABOUT THE FUND.............................................................................3
BORROWING................................................................................................5
COMMERCIAL PAPER.........................................................................................6
REPURCHASE AGREEMENTS AND REVERSE REPURCHASE AGREEMENTS..................................................6
U.S. GOVERNMENT SECURITIES...............................................................................7
LENDING OF PORTFOLIO SECURITIES..........................................................................7
BANKING INDUSTRY AND SAVINGS AND LOAN INDUSTRY
OBLIGATIONS...........................................................................................8
FLOATING AND VARIABLE RATE SECURITIES....................................................................8
FOREIGN SECURITIES.......................................................................................8
WHEN-ISSUED AND FIRM OR STANDBY COMMITMENT AGREEMENTS....................................................9
MORTGAGE-RELATED AND OTHER ASSET-BACKED SECURITIES.......................................................9
LOAN PARTICIPATION INTERESTS............................................................................16
ZERO COUPON BONDS.......................................................................................18
RISKS ASSOCIATED WITH DEBT SECURITIES...................................................................18
FUNDAMENTAL INVESTMENT RESTRICTIONS..............................................................................19
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS..........................................................................20
DIRECTORS AND OFFICERS...........................................................................................23
COMPENSATION TABLE......................................................................................28
THE MANAGER, THE SUBADVISOR AND THE DISTRIBUTOR..................................................................29
MANAGEMENT AGREEMENT....................................................................................29
SUB-ADVISORY AGREEMENT..................................................................................31
SUB-ADMINISTRATION AGREEMENT............................................................................32
DISTRIBUTION AGREEMENT..................................................................................32
SERVICE FEES............................................................................................33
DISTRIBUTION FEES.......................................................................................33
ADDITIONAL INFORMATION...........................................................................................34
PURCHASES AND REDEMPTIONS........................................................................................35
PORTFOLIO TRANSACTIONS AND BROKERAGE.............................................................................35
NET ASSET VALUE..................................................................................................37
TAX INFORMATION..................................................................................................38
PERFORMANCE INFORMATION..........................................................................................41
OTHER INFORMATION................................................................................................42
CAPITALIZATION..........................................................................................42
BENEFICIAL OWNERSHIP OF SHARES..........................................................................42
CODE OF ETHICS..........................................................................................43
INDEPENDENT ACCOUNTANTS.................................................................................43
LEGAL COUNSEL...........................................................................................43
TRANSFER AGENT..........................................................................................44
CUSTODIAN...............................................................................................44
REGISTRATION STATEMENT..................................................................................44
APPENDIX A DESCRIPTION OF SECURITIES RATINGS.....................................................................44
MOODY'S INVESTORS SERVICE, INC..........................................................................44
STANDARD & POOR'S.......................................................................................47
</TABLE>
-2-
<PAGE> 78
ADDITIONAL INFORMATION ABOUT THE FUND
MainStay Institutional Funds Inc. (the "Company") is an open-end
management investment company (or mutual fund) currently consisting of eleven
separate investment portfolios, one of which is the Money Market Fund (the
"Fund"). This Statement of Additional Information discusses the Money Market
Fund Sweep Shares (the "Sweep Shares"), a class of shares offered by the Fund.
The Prospectus discusses the investment objective of the Fund and the
policies to be employed to achieve that objective. This section contains
supplemental information concerning certain of the securities and other
instruments in which the Fund may invest, the investment policies and portfolio
strategies the Fund may utilize, and certain risks involved with those
investments, policies and strategies.
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 Rule 2a-7 under the Investment Company
Act of 1940 (the "1940 Act"), 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 Fund's Subadvisor, New York Life Asset Management
Operating Company LLC (the "Subadvisor" or "NYLAMOC"), 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 Subadvisor; (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
-3-
<PAGE> 79
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 Guarantee is substituted with another Demand Feature or
Guarantee; (5) if it is a security issued by a money market fund registered
with the Securities and Exchange Commission ("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 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, 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 "First Tier" securities of any one
issuer and except that this limitation shall not apply to U.S. government
securities or securities subject to certain Guarantees. The Fund may invest up
to 5% of its total assets in securities that were "Second Tier" when acquired.
Immediately after the acquisition of any Demand Feature or Guarantee, the Fund,
with respect to 75% of its total assets, shall not have invested more than 10%
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 5% 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 "Second Tier" securities of any one issuer, 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 Subadvisor, 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 Subadvisor 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.
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The Directors have also established procedures designed to stabilize,
to the extent reasonably possible, the Fund's price per share as computed for
the purpose of sales and redemptions at $1.00. Such procedures include review
of the Fund's portfolio by the Directors, at such intervals as they deem
appropriate, to determine whether the Fund's net asset value calculated by
using available market quotations or market equivalents (the determination of
value by reference to interest rate levels, quotations of comparable securities
and other factors) deviates from $1.00 per share based on amortized cost.
The extent of deviation between the Fund's net asset value based upon
available market quotations or market equivalents and $1.00 per share based on
amortized cost will be periodically examined by the Directors. If such
deviation exceeds 1/2 of 1%, the Directors will promptly consider what action,
if any, will be initiated. In the event the Directors determine that a
deviation exists which may result in material dilution or other unfair results
to investors or existing shareholders, they will take such corrective action as
they regard to be necessary and appropriate, 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. The Fund is a diversified fund as defined
under the 1940 Act.
BORROWING
The 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 1940 Act requires the 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, the 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 the Fund's borrowings, the 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 the 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
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by appreciation of the securities purchased. The 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
The Fund may invest in commercial paper. The 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 Subadvisor 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.
REPURCHASE AGREEMENTS AND REVERSE REPURCHASE AGREEMENTS
The Fund may enter into domestic or foreign repurchase agreements with
certain sellers determined to be creditworthy by the Manager or Subadvisor. A
repurchase agreement, which provides a means for the 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 a custodian
appointed by the Fund. The Fund attempts to assure that the value of the
purchased securities, including any accrued interest, will at all times exceed
the value of the repurchase agreement. 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 Subadvisor seeks 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. The Fund will not invest more than 10% of its net
assets (taken at current market value) in repurchase agreements maturing in
more than seven days.
The Fund may enter into reverse repurchase agreements with banks or
broker-dealers, which involve the sale of a security by the Fund and its
agreement to repurchase the instrument at a specified time and price. The Fund
will maintain a segregated account consisting of liquid
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assets to cover its obligations under reverse repurchase agreements. The 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 reverse repurchase
agreements by the Fund creates leverage which increases the 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.
U.S. 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.
LENDING OF PORTFOLIO SECURITIES
In accordance with guidelines adopted by the Board of Directors, the
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 the market value of the securities loaned. The Fund
would have the right to call a loan and obtain the securities loaned at any
time generally on less than five days' notice. For the duration of a loan, the
Fund would continue to receive the equivalent of the interest or dividends paid
by the issuer on the securities loaned and would also receive compensation from
the investment of the collateral. The Fund would not, however, have the right
to vote any securities having voting rights during the existence of the loan,
but the Fund would call the loan in anticipation of an important vote to be
taken among holders of the securities or of the giving or withholding of their
consent on a material matter affecting the investment. The Company, on behalf
of the Fund, has entered into an agency agreement with Merrill Lynch Portfolio
Services, Inc. which acts as the Fund's 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 Subadvisor.
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 or breach its agreement with a Fund. However,
the loans would be made only to firms deemed by a Subadvisor to be creditworthy
and approved by the Board, and when, in the judgment of the Subadvisor, the
consideration which can be earned currently from securities loans of this type
justifies the attendant risk. If the Subadvisor determines to make securities
loans, it is intended that the value of the securities loaned will not exceed
33% of the value of the total assets of the
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Fund. Under the guidelines adopted by the Board of Directors, the Fund is
prohibited from lending more than 5% of the Fund's total assets to any one
counterparty.
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. The Fund may not invest in time deposits
maturing in more than seven days which are subject to withdrawal penalties. The
Fund will limit its investment in time deposits for which there is a penalty
for early withdrawal to 10% of its net assets.
The 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 the Fund with a certain degree of protection
against rises in interest rates, the Fund will participate in any declines in
interest rates as well.
The interest rate on a leveraged inverse floating rate debt instrument
("inverse floater") resets in the opposite direction from the market rate of
interest to which the inverse floater is indexed. An inverse floater may be
considered to be leveraged to the extent that its interest rate varies by a
magnitude that exceeds the magnitude of the change in the index rate of
interest. The higher degree of leverage inherent in inverse floaters is
associated with greater volatility in their market values. Accordingly, the
duration of an inverse floater may exceed its stated final maturity. Certain
inverse floaters may be determined to be illiquid securities for purposes of
the Fund's limitation on investments in such securities.
FOREIGN SECURITIES
The Fund may purchase U.S. dollar-denominated securities of foreign
issuers. Foreign investing involves the possibility of expropriation,
nationalization, confiscatory taxation, foreign
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taxation of income earned in the foreign nation (including withholding taxes on
interest and dividends) or other foreign taxes imposed with respect to
investments in the foreign nation, foreign exchange controls (which may include
suspension of the ability to transfer currency from a given country), default
in foreign government securities, political or social instability or diplomatic
developments which could affect investments in securities of issuers in those
nations. In addition, in many countries there is less publicly available
information about issuers than is available in reports about companies in the
United States. Foreign companies are not generally subject to uniform
accounting and auditing and financial reporting standards, and auditing
practices and requirements may not be comparable to those applicable to U.S.
companies. In many foreign countries, there is less government supervision and
regulation of business and industry practices, stock exchanges, brokers and
listed companies than in the United States. Foreign securities transactions may
be subject to higher brokerage and custodial costs than domestic securities
transactions. In addition, the foreign securities markets of many of the
countries in which the Fund may invest may also be smaller, less liquid and
subject to greater price volatility than those in the United States.
WHEN-ISSUED AND FIRM OR STANDBY COMMITMENT AGREEMENTS
The 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 (60 days for municipal bonds and notes).
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 the Fund
are held in cash pending the settlement of a purchase of securities, the Fund
would earn no income; however, it is the Company's intention that the 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 the 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 the Fund's net asset value or income will be exposed to additional risk by
the purchase of securities on a when-issued or firm commitment basis. The Fund
will establish a segregated account in which it will maintain liquid assets at
least equal in value to any commitments to purchase securities on a
when-issued, firm, or standby commitment basis. Such segregated securities
either will mature or, if necessary, be sold on or before the settlement date.
MORTGAGE-RELATED AND OTHER ASSET-BACKED SECURITIES
Mortgage-related and asset-back securities, which include
mortgage-backed securities, are securities that derive their value from
underlying pools of loans that may include interests in
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pools of lower-rate debt securities, consumer loans or mortgages, or complex
instruments such as collateralized mortgage obligations and stripped
mortgage-backed securities. The value of these securities may be significantly
affected by changes in interest rates, the market's perception of issuers and
the creditworthiness of the parties involved. The ability of a Fund to
successfully utilize these instruments may depend in part upon the ability of
the Fund's Subadvisor to forecast interest rates and other economic factors
correctly. Some securities may have a structure that makes their reaction to
interest rate changes and other factors difficult to predict, making their
value highly volatile. These securities may also be subject to prepayment risk
and if the security has been purchased at a premium the amount of the premium
would be lost in the event of prepayment. 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.
The Fund will invest only in mortgage-related (or other asset-backed)
securities that meet the requirements of Rule 2a-7 under the 1940 Act. In
addition, if any such security is determined to be illiquid, the Fund will
limit its investments in these and other illiquid instruments to not more than
10% of its net assets.
Mortgage Pass-Through Securities. Mortgage pass-through securities,
which are securities representing 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 ("GNMA")) are described as
"modified pass-through." These securities entitle the holder to receive all
interest and principal payments owed on the mortgage pool, net of certain fees,
at the scheduled payment dates regardless of whether or not the mortgagor
actually makes the payment. Some mortgage pass-through certificates may include
securities backed by adjustable-rate mortgages which bear interest at a rate
that will be adjusted periodically.
The principal governmental guarantor of mortgage-related securities is
GNMA. GNMA is a wholly owned U.S. government corporation within the U.S.
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 ("FHA")-insured or Veterans
Administration-guaranteed mortgages.
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 the Fund to a lower rate of return upon reinvestment of principal. Also,
if a security subject to prepayment has been purchased at a premium, in the
event of prepayment, the value of the premium would be lost.
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Payment of principal and interest on some mortgage pass-through
securities (but not the market value of the securities themselves) may be
guaranteed by the full faith and credit of the U.S. government (in the case of
securities guaranteed by GNMA); or guaranteed by agencies or instrumentalities
of the U.S. government (in the case of securities guaranteed by the Federal
National Mortgage Association ("FNMA") or the Federal Home Loan Mortgage
Corporation ("FHLMC"), which are supported only by the discretionary authority
of the U.S. government to purchase the agency's obligations).
Government-related guarantors (i.e., not backed by the full faith and
credit of the U.S. government) include the FNMA and the 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
and acts as a government instrumentality under authority granted by Congress.
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. FNMA is authorized to borrow from the U.S. Treasury to
meet its obligations.
FHLMC was created by Congress in 1970 for the purpose of increasing
the availability of mortgage credit for residential housing. It is a government
sponsored corporation and acts as a government instrumentality under authority
granted by Congress. FHLMC was formerly owned by the twelve Federal Home Loan
Banks and is now owned entirely by private stockholders. 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.
If either fixed or variable rate pass-through securities issued by the
U.S. government or its agencies or instrumentalities are developed in the
future, the Fund reserves the right to invest in them.
Commercial banks, savings and loan institutions, private mortgage
insurance companies, mortgage bankers and other secondary market issuers also
create pass-through pools of conventional residential mortgage loans. Such
issuers may, in addition, be the originators and/or servicers of the underlying
mortgage loans as well as the guarantors of the mortgage-related securities.
Pools created by such non-governmental issuers generally offer a higher rate of
interest than government and government-related pools because there are no
direct or indirect government or agency guarantees of payments in the former
pools. However, timely payment of interest and principal of these pools may be
supported by various forms of insurance or guarantees, including individual
loan, title, pool and hazard insurance and letters of credit. The insurance and
guarantees are issued by governmental entities, private insurers and the
mortgage poolers. Such insurance and guarantees and the creditworthiness of the
issuers thereof will be considered in determining whether a mortgage-related
security meets the 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. The Fund may buy
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mortgage-related securities without insurance or guarantees if, through an
examination of the loan experience and practices of the originator/servicers
and poolers, the Fund's Subadvisor determines that the securities meet the
Fund's quality standards. Although the market for such securities is becoming
increasingly liquid, securities issued by certain private organizations may not
be readily marketable. The Fund will not purchase mortgage-related securities
or any other assets which in the opinion of the Subadvisor are illiquid if, as
a result, more than 10% of the value of the Fund's net assets will be illiquid.
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 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 Fund 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 the Fund's net assets would be invested in any one
CMO, more than 10% of the Fund's net assets would be invested in CMOs and other
investment company securities in the aggregate, or the 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 FHA prepayment experience applied to the mortgage
collateral pool. All sinking fund
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payments in the CMOs are allocated to the retirement of the individual classes
of bonds in the order of their stated maturities. Payment of principal on the
mortgage loans in the collateral pool in excess of the amount of FHLMC's
minimum sinking fund obligation for any payment date are paid to the holders of
the CMOs as additional sinking fund payments. Because of the "pass-through"
nature of all principal payments received on the collateral pool in excess of
FHLMC's minimum sinking fund requirement, the rate at which principal of the
CMOs is actually repaid is likely to be such that each class of bonds will be
retired in advance of its scheduled maturity date.
If collection of principal (including prepayments) on the mortgage
loans during any semiannual payment period is not sufficient to meet FHLMC's
minimum sinking fund obligation on the next sinking fund payment date, FHLMC
agrees to make up the deficiency from its general funds.
Criteria for the mortgage loans in the pool backing the CMOs are
identical to those of FHLMC PCS. FHLMC has the right to substitute collateral
in the event of delinquencies and/or defaults.
Other Mortgage-Related Securities. Other mortgage-related securities
include securities other than those described above that directly or indirectly
represent a participation in, or are secured by and payable from, mortgage
loans on real property, including CMO residuals or stripped mortgaged-backed
securities, and may be structured in classes with rights to receive varying
proportions of principal and interest. Other mortgage-related securities may be
equity or debt 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, partnerships, trusts and special purpose
entities of the foregoing.
The Subadvisor expects 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, the Subadvisor 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.
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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 the Fund 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. The Fund limits its investment in CMO residuals to less than 5% of
its net assets.
CMOs may offer a higher yield than U.S. government securities, but
they may also be subject to greater price fluctuation and credit risk. In
addition, CMOs typically will be issued in a variety of classes or series,
which have different maturities and are retired in sequence. Privately issued
CMOs are not government securities nor are they supported in any way by any
governmental agency or instrumentality. In the event of a default by an issuer
of a CMO, there is no assurance that the collateral securing such CMO will be
sufficient to pay principal and interest. It is possible that there will be
limited opportunities for trading CMOs in the over-the-counter market, the
depth and liquidity of which will vary from time to time.
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
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<PAGE> 90
adverse effect on the Fund's yield to maturity from these securities. If the
underlying mortgage assets experience greater than anticipated prepayments of
principal, the Fund may fail to fully recoup its initial investment in these
securities even if the security is in one of the highest rating categories.
Although SMBS are purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers, these
securities were only recently developed. As a result, established trading
markets have not yet developed and, accordingly, these securities may be deemed
"illiquid" and subject to the Fund's limitations on investment in illiquid
securities.
Risks Associated with Mortgage-Related Securities. As is the case with
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-related securities in which the Fund may invest may be
particularly sensitive to changes in prevailing interest rates, and, like the
other investments of the Fund, the ability of the Fund to successfully utilize
these instruments may depend in part upon the ability of the Subadvisor to
forecast interest rates and other economic factors correctly. If the Subadvisor
incorrectly forecasts such factors and has taken a position in mortgage-backed
securities that is or becomes contrary to prevailing market trends, the Fund
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 the 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 the Fund may not receive all or
part of its principal because the issuer or credit enhancer has defaulted on
its obligations. Obligations issued by U.S. government-related entities are
guaranteed as to the payment of principal and interest, but are not backed by
the full faith and credit of the U.S. government. The performance of private
label mortgage-backed securities, issued by private institutions, is based on
the financial health of those institutions.
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<PAGE> 91
Other Asset-Backed Securities. The Subadvisor expects that other
asset-backed securities (unrelated to mortgage loans) will be offered to
investors in the future. Several types of asset-backed securities have already
been offered to investors, including Certificates for Automobile Receivables
("CARSSM"). CARSSM represent undivided fractional interests in a trust
("trust") whose assets consist of a pool of motor vehicle retail installment
sales contracts and security interests in the vehicles securing the contracts.
Payments of principal and interest on CARSSM are passed-through monthly to
certificate holders, and are guaranteed up to certain amounts and for a certain
time period by a letter of credit issued by a financial institution
unaffiliated with the trustee or originator of the trust. An investor's return
on CARSSM may be affected by early prepayment of principal on the underlying
vehicle sales contracts. If the letter of credit is exhausted, the trust may be
prevented from realizing the full amount due on a sales contract because of
state law requirements and restrictions relating to foreclosure sales of
vehicles and the obtaining of deficiency judgments following such sales or
because of depreciation, damage or loss of a vehicle, the application of
Federal and state bankruptcy and insolvency laws, or other factors. As a
result, certificate holders may experience delays in payments or losses if the
letter of credit is exhausted.
Consistent with the Fund's investment objective and policies and the
requirements of Rule 2a-7, the Fund 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-related securities.
LOAN PARTICIPATION INTERESTS
The Fund may invest in participation interests in loans. The Fund's
investment in loan participation interests may take the form of participation
interests in, assignments of 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, the 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, the 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. The
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. The Fund will not act as an agent bank, a guarantor or 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.
The Fund generally will rely on the agent bank or an intermediate Participant
to collect its portion of the
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<PAGE> 92
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 the 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
the Fund were determined by an appropriate regulatory authority or court to be
subject to the claims of the agent bank's general or secured creditors, the
Fund might incur certain costs and delays in realizing payment on a corporate
loan, or suffer a loss of principal and/or interest. In situations involving
intermediate Participants similar risks may arise.
When the Fund acts as co-lender in connection with a Participation
Interest or when the 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 the Fund's
Subadvisor 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 the Fund disposing of such securities at a substantial
discount from face value or holding such security until maturity. When the 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 Fund considers Participation Interests not subject to
puts to be illiquid.
The principal credit risk associated with acquiring Participation
Interests from a co-lender or another Participant is the credit risk associated
with the underlying corporate borrower. A Fund may incur additional credit
risk, however, when it is in the position of participant rather
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<PAGE> 93
than co-lender because the Fund must assume the risk of insolvency of the
co-lender from which the Participation Interest was acquired and that of any
person interpositioned between the Fund and the co-lender.
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 the Fund must accrue and distribute every year even
though the Fund receives no payment on the investment in that year.
RISKS ASSOCIATED WITH DEBT SECURITIES
To the extent that the Fund invests in debt securities, it will be
subject to certain risks. The value of the debt securities held by the Fund,
and thus the net asset value of the shares of beneficial interest of the Fund,
generally will fluctuate depending on a number of factors, including, among
others, changes in the perceived creditworthiness of the issuers of those
securities, movements in interest rates, the average maturity of the Fund's
investments, changes in the relative values of the currencies in which the
Fund's investments are denominated relative to the U.S. dollar, and the extent
to which the Fund hedges its interest rate, credit and currency exchange rate
risks. Generally, a rise in interest rates will reduce the value of fixed
income securities held by the Fund, and a decline in interest rates will
increase the value of fixed income securities held by a Fund. Longer term debt
securities generally pay higher interest rates than do shorter term debt
securities but also may experience greater price volatility as interest rates
change.
Since shares of the Fund represent an investment in securities with
fluctuating market prices, the value of shares of the Fund will vary as the
aggregate value of the Fund's portfolio securities increases or decreases.
Moreover, the value of lower rated debt securities that the Fund purchases may
fluctuate more than the value of higher rated debt securities. Lower rated debt
securities generally carry greater risk that the issuer will default on the
payment of interest and principal. Lower rated fixed income securities
generally tend to reflect short-term corporate and market developments to a
greater extent than higher rated securities which react primarily to
fluctuations in the general level of interest rates. Changes in the value of
securities subsequent to their acquisition will not affect cash income or
yields to maturity to the Funds but will be reflected in the net asset value of
the Fund's shares.
Corporate debt securities may bear fixed, contingent, or variable
rates of interest and may involve equity features, such as conversion or
exchange rights or warrants for the acquisition of
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<PAGE> 94
stock of the same or a different issuer, participations based on revenues,
sales or profits, or the purchase of common stock in a unit transaction (where
corporate debt securities and common stock are offered as a unit).
When and if available, debt securities may be purchased at a discount
from face value. From time to time, each Fund may purchase securities not
paying interest or dividends at the time acquired if, in the opinion of the
Subadvisor, such securities have the potential for future income (or capital
appreciation, if any).
FUNDAMENTAL INVESTMENT RESTRICTIONS
The Fund's investment restrictions set forth below are fundamental
policies of the Fund; i.e., they may not be changed without a majority vote of
the outstanding shares of the Fund, as defined in the 1940 Act. Except for
those investment policies of the Fund specifically identified as fundamental in
the Prospectus and this Statement of Additional Information and the Fund's
objective as described in the Prospectus, 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 in the Prospectus, apply to the 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 will not be considered a violation.
THE FUND 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
Fund elects to be so classified and the foregoing limitation shall no longer
apply with respect to the Fund;
(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;
(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;
(4) borrow money or issue senior securities, except that the 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;
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<PAGE> 95
(5) lend any funds or other assets, except that the 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) 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) the 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) the
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.
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS
In addition to the Company's fundamental investment restrictions, the
Directors of the Company have voluntarily adopted certain policies and
restrictions which are observed in the conduct of the affairs of the Fund.
These represent intentions of the Directors based upon current circumstances.
They differ from fundamental investment policies in that the following
additional investment restrictions may be changed or amended by action of the
Directors without requiring prior notice to or approval of shareholders.
Unless otherwise indicated, all percentage limitations apply to the
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 will not be considered a violation.
UNDER THESE RESTRICTIONS, THE FUND MAY NOT:
(1) 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 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
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<PAGE> 96
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;
(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) the 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) the 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 Subadvisor,
pursuant to guidelines approved by the Directors.
The Subadvisor takes into account a number of factors in determining
whether a Rule 144A security being considered for purchase by the 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;
(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, the Subadvisor 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
NRSROs; or
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<PAGE> 97
(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 Subadvisor 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).
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<PAGE> 98
DIRECTORS AND OFFICERS
The Board of Directors oversees the Fund, the Manager and the
Subadvisor. Information pertaining to the Directors and Officers of the Company
is set forth below. Directors deemed to be "interested persons" of the Company
for purposes of the 1940 Act are indicated by an asterisk.
<TABLE>
<CAPTION>
NAME, POSITION(S) WITH PRINCIPAL OCCUPATION(S)
ADDRESS AND AGE THE COMPANY DURING PAST 5 YEARS
--------------- ----------- -------------------
<S> <C> <C>
Stephen C. Roussin,* 36 Director and President and Chief Operating Officer, New York Life
51 Madison Avenue Chairman Asset Management Operating Company LLC, 1999 to present;
New York, NY 10010 President, Chief Executive Officer and Trustee, The
Mainstay Funds, 1997 to present; Director, New York Life
Trust Company, 1997 to present; Director, New York Life
Benefit Services LLC, 1997 to present; Director, NYLIFE
Securities, Inc., 1997 to present; Director, MainStay
Shareholder Services LLC, 1997 to present; Director,
Eagle Strategies Corp., 1997 to present; Director,
President and Chief Executive Officer, MainStay
Management LLC, 1997 to present; Senior Vice President,
Smith Barney, 1994 to 1997; and Division Sales Manager,
Prudential Securities, 1989 to 1994.
</TABLE>
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<PAGE> 99
<TABLE>
<S> <C> <C>
Patrick G. Boyle,* 46 Director Senior Vice President, New York Life Asset Management
51 Madison Avenue Operating Company LLC, 1999 to present; Senior Vice
New York, NY 10010 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 LLC, 1996 to 1998, and Director, 1991
to present; Director, New York Life Benefit Services
LLC, 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 1998, Director,
MBL Life Assurance Co. Inc., 1997 to present.
Lawrence Glacken, 72 Director Retired, 1987 to present; Vice President, Investment
353 Canterbury Drive Banking, The First Boston Corporation, 1964-1987.
Ramsey, NJ 07446
Robert P. Mulhearn, 52 Director Private Investor, 1987 to present; Managing Director,
60 Twin Brooks Road Morgan Stanley, 1979-1987.
Saddle River, NJ 07458
Susan B. Kerley, 48 Director President, Global Research Associates, 1990 to present;
P.O. 9572 Manager, Special Investments, Rockefeller & Co.,
New Haven, CT 06535 1988-1990; Director of Research, Rogers, Casey and
Barksdale, 1983-1988; Director, Citifunds, 1991 to
present.
</TABLE>
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<PAGE> 100
<TABLE>
<S> <C> <C>
Linda M. Livornese, 48 President Vice President, Pension Department, New York Life
51 Madison Avenue Insurance Company, 1990 to present; Pension Vice
New York, NY 10010 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.
Marc J. Brookman, 36 Executive Vice Vice President, New York Life Insurance Company, 1998 to
51 Madison Avenue President present; Senior Vice President-Product Development,
New York, NY 10010 MainStay Institutional Funds Inc. and Retirement Plans
1998 to present; National Sales Director, Vice President,
United Asset Management Retirement Plan Services, 1996 to
1998; Regional Sales Manager, Vice President, Oppenheimer
Capital Quest for Value, 1991 to 1995.
</TABLE>
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<PAGE> 101
<TABLE>
<S> <C> <C>
Jefferson C. Boyce, 42 Senior Vice Senior Vice President, New York Life Insurance Company,
President 1994 to present; Director, Monitor Capital Advisors
LLC, 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 LLC,
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 LLC, 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.
</TABLE>
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<PAGE> 102
<TABLE>
<S> <C> <C>
Richard W. Zuccaro, 50 Tax Vice Vice President, New York Life Insurance Company, 1995
51 Madison Avenue President to present; Vice President -- Tax, New York Life
New York, NY 10010 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 LLC, 1990 to
present; Tax Vice President, NYLIFE Insurance Company
of Arizona, 1990 to present; Tax Vice President, NYLIFE
Realty Inc., 1991 to present; Tax Vice President,
NYLICO Inc., 1991 to present; Tax Vice President, New
York Life Fund Inc., 1991 to present; Tax Vice
President, New York Life International Investment,
Inc., 1991 to present; Tax Vice President NYLIFE
Funding Inc., 1991 to present; Tax Vice President,
NYLCO, 1991 to present; Tax Vice President, NYLIFE
Equity Inc., 1991 to present; Tax Vice President,
MainStay VP Series Fund, Inc., 1991 to present; Tax
Vice President, CNP Realty Investments, Inc., 1991 to
present; Tax Vice President, New York Life Worldwide
Holding, Inc., 1992 to present; Tax Vice President,
NYLIFE Structured Asset Management Company Ltd., 1992
to present; Tax Vice President, The MainStay Funds,
1991 to present; Tax Vice President, Eagle Strategies
Corp. (registered investment adviser), 1993 to present;
Tax Vice President, NYLIFE Distributors, Inc., 1993 to
present; Vice President & Assistant Controller, New
York Life Insurance and Annuity Corp., 1995 to present,
and Assistant Controller, 1991 to 1995; Vice President,
NYLCare Health Plans, Inc., 1995 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 LLC, 1996 to present; Tax Vice
President, NYLINK Insurance Agency Incorporated, 1996
to present; Tax Vice President, MainStay Shareholder
Services LLC, 1997 to present.
</TABLE>
-27-
<PAGE> 103
<TABLE>
<S> <C> <C>
John Flanagan, 53 Treasurer Vice President and Treasurer, New York Life Asset
51 Madison Avenue (Principal Management Operating Company LLC, 1999 to present; Vice
New York, NY 10010 Financial and President, New York Life Insurance Company 1999 to
Accounting present; Vice President and Chief Financial Officer,
Officer) The MainStay Funds, 1999 to present; Director, Vice
President and Chief Financial Officer, MainStay
Management LLC, 1999 to present; Director, Vice
President and Chief Financial Officer, MainStay
Shareholder Services LLC, 1999 to present; Senior Vice
President and Chief Financial Officer, NYLIFE
Distributors, Inc., 1999 to present, Treasurer, Strong
Funds and Senior Vice President, Strong Capital
Management, Inc. from 1997 to 1998; Partner,
predecessor to PricewaterhouseCoopers LLP, from 1994 to
1997.
Joseph McBrien, 51 Secretary Vice President and Secretary, New York Life Asset
51 Madison Avenue Management Operating Company LLC, 1999 to present; Vice
New York, NY 10010 President and Associate General Counsel, New York Life
Insurance Company, 1999 to present; Secretary, MainStay
VP Series Fund, Inc., 1999 to present; Secretary, The
MainStay Funds, 1999 to present; Secretary, MainStay
Management LLC, 1999 to present; Secretary, MainStay
Shareholder Services LLC, 1999 to present; Secretary,
Monitor Capital Advisors LLC, 1999 to present; Vice
President and Counsel, State Street Bank and Trust
Company, 1997 to 1999; Principal, McBrien Consulting,
1996 to 1997; Senior Vice President and General
Counsel, Lieber & Company 1986 to 1996; Senior Vice
President and General Counsel, Evergreen Asset
Management Corp., 1986 to 1996.
</TABLE>
* Messrs. Boyle and Roussin are Directors who are "interested persons"
of the Company as that term is defined in the 1940 Act.
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<PAGE> 104
COMPENSATION TABLE
As indicated in the above table, certain Directors and Officers also
hold positions with Monitor, MainStay Management LLC, MacKay Shields LLC, New
York Life Asset Management Operating Company LLC, New York Life Insurance
Company ("New York Life"), NYLIFE Securities Inc. and/or NYLIFE Distributors,
Inc.
The Independent Directors of the Company receive from the Company an
annual retainer of $24,000 and a fee of $1,000 for each Board of Directors
meeting and for each Board committee meeting attended and are reimbursed for
all out-of-pocket expenses related to attendance at such meetings. Directors
who are affiliated with New York Life Insurance Company do not receive
compensation from the Company.
For the fiscal period ended October 31, 1999, the Directors received
the following compensation from the Company and from certain other investment
companies (as indicated) that have the same investment advisers as the Company
or an investment adviser that is an affiliated person of one of the Company's
investment advisers:
<TABLE>
<CAPTION>
TOTAL COMPENSATION FROM
AGGREGATE COMPENSATION REGISTRANT AND FUND
NAME AND POSITION FROM COMPANY(1) COMPLEX PAID DIRECTORS
----------------- ---------------------- -----------------------
<S> <C> <C>
Lawrence Glacken $24,000 $24,000
Director
Robert P. Mulhearn $23,000 $23,000
Director
Susan B. Kerley $23,000 $23,000
Director
</TABLE>
As of January 31, 2000, the Directors and Officers of the Company as a
group owned less than 1% of the outstanding shares of any class of the Fund.
THE MANAGER, THE SUBADVISOR AND THE DISTRIBUTOR
MANAGEMENT AGREEMENT
Pursuant to the Management Agreement for the Fund dated November 21,
1997, MainStay Management LLC (the "Manager"), subject to the supervision of
the Directors of the Company and in conformity with the stated policies of the
Fund, administers the Fund's business affairs and investment advisory
responsibilities.
The Manager is a direct subsidiary of NYLIFE LLC, which is a direct
subsidiary of New York Life Insurance Company.
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 the Fund approved the Management
Agreement. The Management Agreement
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<PAGE> 105
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 the Fund (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 Directors, including the Independent Directors, approved
amendments to the Management Agreement, the Sub-Advisory Agreement and the
Sub-Administration Agreement at an in-person meeting held on September 7, 1999,
to reflect the conversion of MainStay Management from a corporation to a
limited liability company under the laws of the State of Delaware.
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 they have been elected or appointed.
The Management Agreement provides that the Manager shall not be liable
to the Fund for any error or judgment by the Manager or for any loss sustained
by the 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 the
Fund, and except as indicated in the Prospectus under the heading "Know With
Whom You're Investing," 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 Subadvisor;
(b) the fees to be paid to the Subadvisor pursuant to the Sub-Advisory
Agreement; and
(c) all expenses incurred by the Manager in connection with
administering the ordinary course of the Fund's business, other than those
assumed by the Company.
For its services, the Fund pays the Manager a monthly fee. (See the
Prospectus, "Know With Whom You're Investing.")
Commencing November 21, 1997 through December 31, 1997, the Fund paid
the Manager management fees of $142,675. For the year ended December 31, 1998,
the Fund paid the Manager management fees of $1,386,536. For the ten months
ended October 31, 1999, the Fund paid the Manager Management fees of
$1,470,982.
The Manager has agreed to limit certain Fund expenses as discussed in
the Prospectus. In connection with a voluntary expense limitation, the Manager
assumed expenses in the amount of $37,695 for the period November 21, 1997
through December 31, 1997, $383,039 for the year ended December 31, 1998, and
$343,743 for the ten months ended October 31, 1999.
-30-
<PAGE> 106
As long as the expense limitation continues, it may lower the Fund's
expenses and increase its yield. The voluntary expense limitation may be
terminated or revised at any time, at which time the Fund's expenses may
increase and its yield may be reduced, depending on the total assets of the
Fund.
SUB-ADVISORY AGREEMENT
Pursuant to the Sub-Advisory Agreement between the Manager and the
Subadvisor on behalf of the Fund, the Subadvisor, subject to the supervision of
the Directors of the Company and the Manager in conformity with the stated
policies of the Fund and the Company, manages the Fund's portfolio, including
the purchase, retention, disposition and loan of securities. As compensation
for services, the Manager, not the Fund, pays the Fund's Subadvisor a monthly
fee calculated on the basis of the Fund's average daily net assets during the
preceding month at an annual rate of 0.10%.
The Directors, including the Independent Directors, approved the
Sub-Advisory Agreement at an in-person meeting held September 9, 1997. On
November 17, 1997, the shareholders of the Fund approved the Sub-Advisory
Agreement with New York Life. The Sub-Advisory 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 the Fund (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, the Manager, or the Subadvisor (as the term is defined
in the 1940 Act). Effective April 1, 2000, New York Life Asset Management
Operating Company LLC ("NYLAMOC") replaced New York Life as Subadvisor to the
Fund pursuant to a substitution agreement by and among the Manager, NYLAMOC and
New York Life.
The Subadvisor has authorized any of its directors, officers and
employees who have been elected or appointed as Directors or officers of the
Company to serve in the capacities in which they have been elected or
appointed. In connection with the services it renders, the Subadvisor bears the
salaries and expenses of all of their personnel.
The Sub-Advisory Agreement provides that the Subadvisor shall not be
liable to the Fund for any error of judgment by the Subadvisor or for any loss
sustained by the Fund except in the case of the Subadvisor's willful
misfeasance, bad faith, gross negligence or reckless disregard of duty. The
Sub-Advisory Agreement also provides that it 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.
For the ten months ended October 31, 1999, the amount of Sub-Advisory
fees payable by the Manager to New York Life was $294,196 and for the fiscal
year ended December 31, 1998 and for the period from November 21, 1997 to
December 31, 1997, the amount of the sub-advisory fees paid by the Manager to
New York Life were $277,307 and $28,535, respectively.
In previous years, prior to a change in management structure, the Fund
paid an advisory fee directly to New York Life. For the period January 1, 1997
through November 20, 1997 and
-31-
<PAGE> 107
fiscal year ended December 31, 1996, the advisory fees paid by the Fund to New
York Life were $181,674, and $100,230, respectively.
SUB-ADMINISTRATION AGREEMENT
Prior to April 1, 2000 the Manager had delegated certain of its
administrative responsibilities to New York Life Insurance Company pursuant to
a Sub-Administration Agreement between the Manager and New York Life. Under the
Sub-Administration Agreement, among other things, New York Life Insurance
Company responded to shareholder inquiries and prepared shareholder reports.
For these services, the Manager paid a percentage of its management fees to New
York Life Insurance Company. For the year ended December 31, 1998, the Manager
paid New York Life $1,109,299 and $383,039 was waived or reimbursed, in
connection with the Fund. For the ten months ended October 31, 1999, the
Manager paid New York Life $1,176,785 and $343,743 was waived or reimbursed.
In previous years, prior to a change in management structure, the Fund
paid an administrative fee directly to New York Life as administrator. For the
period January 1, 1997 through November 20, 1997, the amount of the
administration fee paid by the Fund to New York Life was $726,696. Also prior
to the above-referenced change in management structure and in connection with
the voluntary expense limitation, New York Life, as administrator, assumed
expenses for the Fund for the period January 1, 1997 through November 20, 1997
in the amount of $194,751.
DISTRIBUTION AGREEMENT
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 Fund pursuant to a dealer agreement with the
Distributor. The Distributor is not obligated to sell any specific amount of
the Fund's shares, and receives no compensation from the Company pursuant to
the Distribution Agreement.
The Company anticipates making a continuous offering of the Fund's
shares, although it reserves the right to suspend or terminate such offering at
any time. The Distribution Agreement was most recently approved by the Board of
Directors, including a majority of the Directors who are not "interested
persons" (as defined in the 1940 Act) of the Company or the Distributor nor
have any direct or indirect financial interest in the operation of the
distribution plan or in any related agreement (the "Independent Directors") at
a meeting held on March 2, 1999. The Distribution Agreement is subject to
annual approval by the Board of Directors. The Distribution Agreement is
terminable with respect to the 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 the 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.
-32-
<PAGE> 108
SERVICE FEES
The Company has adopted a Shareholder Services Plan with respect to
the Sweep Shares. Under the terms of the Plan, the Company is permitted to pay,
out of the Sweep Shares assets of the Fund, a fee in the amount of 0.25% on an
annualized basis of the average daily net assets attributable to the Sweep
Shares, to the Manager, 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, the 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 Sweep Shares. 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 Sweep Shares 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 "Independent
Directors"), cast in person at a meeting called for the purpose of voting on
such amendment, and by a majority (as defined in the 1940 Act) of the
outstanding voting securities of the Sweep Shares.
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 Independent
Directors. The Plan was approved by the Directors, including the Independent
Directors, at a meeting held on September 1, 1998. 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 Independent Directors. The Plan was
last approved by the Directors, including the Independent Directors, at a
meeting held March 2, 1999. The Plan provides that the Manager 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.
DISTRIBUTION FEES
The Company has adopted a Rule 12b-1 Plan of Distribution ("12b-1
Plan") with respect to the Sweep Shares. Under the terms of the 12b-1 Plan, the
Company is permitted to pay, out of the Sweep Shares assets of the Fund, a fee
at the annual rate of 0.25% of the average daily net assets attributable to the
Sweep Shares, to the Distributor, NYLIFE Securities, Inc. or any other
broker-dealer or other financial institution, for account sweep and other
distribution-related services to the Sweep Shares and for services to
shareholders of the Sweep Shares. The amounts payable under the 12b-1 Plan are
used to support the distribution of Sweep Shares, including the establishment
and operation of account sweep services and any other activities or expenses
primarily intended to result in the sale of Sweep Shares.
The 12b-1 Plan provides that it may not be amended to materially
increase the costs which holders of Sweep Shares may bear under the Plan
without the approval of a majority of
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<PAGE> 109
both (i) the Directors of the Company and (ii) the Independent Directors, cast
in person at a meeting called for the purpose of voting on such amendment, and
by a majority (as defined in the 1940 Act) of the outstanding voting securities
of the Sweep Shares.
The 12b-1 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
Independent Directors. The 12b-1 Plan was approved by the Directors, including
the Independent Directors, at a meeting held on September 1, 1998.
The 12b-1 Plan provides that it shall continue in effect so long as
such continuance is specifically approved at least annually by the Directors
and the Independent Directors. The 12b-1 Plan was last approved by the
Directors, including the Independent Directors, at a meeting held on March 2,
1999. The Plan provides that NYLIFE Distributors, Inc. and/or NYLIFE
Securities, Inc. shall provide to the Directors, and the Board shall review at
least quarterly, a written report of the amounts expended under the 12b-1 Plan
and the purposes for which such expenditures were made.
For the fiscal period from November 24, 1998 through December 31,
1998, the Fund's Sweep Shares paid $106.78 pursuant to the Sweep Shares Rule
12b-1 Plan. For the ten months ended October 31, 1999, the Fund's Sweep Shares
paid $258,999 pursuant to the Sweep Shares Rule 12b-1 Plan.
ADDITIONAL INFORMATION
Shareholders maintaining Fund accounts through brokerage firms and
other institutions should be aware that such institutions necessarily set
deadlines for receipt of transaction orders from their clients that are earlier
than the transaction times of the Fund itself so that the institutions may
properly process such orders prior to their transmittal to MainStay Shareholder
Services LLC. Should an investor place a transaction order with such an
institution after its deadline, the institution may not effect the order with
the Fund until the next business day. Accordingly, an investor should
familiarize himself or herself with the deadlines set by his or her
institution. A brokerage firm acting on behalf of a customer in connection with
transactions in Fund shares is subject to the same legal obligations imposed on
it generally in connection with transactions in securities for a customer,
including the obligation to act promptly and accurately.
Orders for the purchase of Fund shares become effective at the next
transaction time after Federal funds or bank wire monies become available to
MainStay Shareholder Services LLC for a shareholder's investment. Federal funds
are a bank's deposits in a Federal Reserve Bank. These funds can be transferred
by Federal Reserve wire from the account of one member bank to that of another
member bank on the same day and are considered to be immediately available
funds; similar immediate availability is accorded monies received at MainStay
Shareholder Services LLC by bank wire. Money transmitted by a check drawn on a
member of the Federal Reserve System is converted to Federal funds in one
business day following receipt. Checks drawn on banks which are not members of
the Federal Reserve System may take longer. All payments (including checks from
individual investors) must be in United States dollars.
-34-
<PAGE> 110
PURCHASES AND REDEMPTIONS
Purchases and redemptions are discussed in the Prospectus under the
heading "Shareholder Guide" and that information is incorporated herein by
reference.
The Company determines the net asset value per share of the 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 Fund not
reasonably practicable.
For shares of the Fund redeemed within any 90-day period, the 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, 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 in kind, should such a distribution occur.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Purchases and sales of securities on a securities exchange are
effected by brokers, and the Fund pays 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 the Fund, the Subadvisor will seek the best execution of the Fund's
orders. The Subadvisor 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. Consistent with the foregoing primary considerations, the Conduct
Rules of the NASD and such other policies as the
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<PAGE> 111
Directors may determine, the Subadvisor may consider sales of shares of the
Funds as a factor in the selection of broker-dealers to execute the Funds'
portfolio transactions.
Under each Sub-Advisory Agreement and as permitted by Section 28(e) of
the Securities Exchange Act of 1934 (the "1934 Act"), a Subadvisor may cause a
Fund to pay a broker-dealer (except the Affiliated Broker) which provides
brokerage and research services to the Subadvisor an amount of commission for
effecting a securities transaction for a Fund in excess of the amount other
broker-dealers would have charged for the transaction if the Subadvisor
determines in good faith that the greater commission is reasonable in relation
to the value of the brokerage and research services provided by the executing
broker-dealer viewed in terms of either a particular transaction or the
Subadvisor's overall responsibilities to the Company or to its other clients.
The term "brokerage and research services" includes advice as to the value of
securities, the advisability of investing in, purchasing, or selling
securities, and the availability of securities or of purchasers or sellers of
securities; furnishing analyses and reports concerning issuers, industries,
securities, economic factors and trends, portfolio strategy and the performance
of accounts; and effecting securities transactions and performing functions
incidental thereto such as clearance and settlement.
Although commissions paid on every transaction will, in the judgment
of the Subadvisors, be reasonable in relation to the value of the brokerage
services provided, commissions exceeding those which another broker might
charge may be paid to broker-dealers (except the Affiliated Broker) who were
selected to execute transactions on behalf of the Company and the Subadvisors'
other clients in part for providing advice as to the availability of securities
or of purchasers or sellers of securities and services in effecting securities
transactions and performing functions incidental thereto such as clearance and
settlement.
Broker-dealers may be willing to furnish statistical, research and
other factual information or services ("Research") to the Subadvisors for no
consideration other than brokerage or underwriting commissions. Securities may
be bought or sold through such broker-dealers, but at present, unless otherwise
directed by the Trust, a commission higher than one charged elsewhere will not
be paid to such a firm solely because it provided Research to a Subadvisor.
Research provided by brokers is used for the benefit of all of the Subadvisors'
clients and not solely or necessarily for the benefit of the Trust. The
Subadvisors' investment management personnel attempt to evaluate the quality of
Research provided by brokers. Results of this effort are sometimes used by the
Subadvisors as a consideration in the selection of brokers to execute portfolio
transactions.
In certain instances there may be securities which are suitable for a
fund's portfolio as well as for that of another Fund or one or more of the
other clients of the Subadvisors. Investment decisions for a Fund and for the
Subadvisors' other clients are made with a view to achieving their respective
investment objectives. It may develop that a particular security is bought or
sold for only one client even though it might be held by, or bought or sold
for, other clients. Likewise, a particular security may be bought for one or
more clients when one or more other clients are selling that same security.
Some simultaneous transactions are inevitable when several clients receive
investment advice from the same investment adviser, particularly when the same
security is suitable for the investment objectives of more than one client.
When two or more clients are simultaneously engaged in the purchase or sale of
the same security, the
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<PAGE> 112
securities are allocated among clients in a manner believed to be equitable to
each. It is recognized that in some cases this system could have a detrimental
effect on the price or volume of the security in a particular transaction as
far as a Fund is concerned. The Trust believes that over time its ability to
participate in volume transactions will produce better executions for the
Funds.
The Sub-Advisory fee that the Manager pays on behalf of each Fund to
the Subadvisors will not be reduced as a consequence of the Subadvisors'
receipt of brokerage and research services. To the extent a Fund's portfolio
transactions are used to obtain such services, the brokerage commissions paid
by the Fund will exceed those that might otherwise be paid, by an amount which
cannot be presently determined. Such services would be useful and of value to
the Subadvisors in serving both the Funds and other clients and, conversely,
such services obtained by the placement of brokerage business of other clients
would be useful to the Subadvisors in carrying out their obligations to the
Funds.
For the fiscal period ended October 31, 1999 and the year ended
December 31, 1998, the Fund paid no brokerage commissions on portfolio
transactions for the Sweep Shares.
As of October 31, 1999, the Fund held commercial paper of the
following issuers with whose broker-dealer subsidiaries or affiliates the Fund
regularly conducts business:
<TABLE>
<CAPTION>
BROKER-DEALER MARKET VALUE
<S> <C>
Goldman Sachs Group Inc. (The) $9,962,800
Merrill Lynch & Co. Inc. $15,000,000
Morgan (J.P.) & Co. Inc. $17,786,944
Salomon Smith Barney Holdings Inc. $5,000,000
</TABLE>
NET ASSET VALUE
The Company determines the net asset value per share of each class of
the Fund on each day the New York Stock Exchange is open for trading. Net asset
value per share is calculated as of noon (New York City time) for the Sweep
Shares of the Fund, by dividing the amortized cost 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 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 the Fund may differ somewhat than that
obtained in a similar investment company which uses available market quotations
to value all of its portfolio securities.
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<PAGE> 113
TAX INFORMATION
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 the Fund.
The 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 the 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.
To qualify for treatment as a regulated investment company, the Fund
generally must, among other things: (a) derive in each taxable year at least
90% of its gross income from dividends, interest, payments with respect to
securities loans, gains from the sale or other disposition of securities or
foreign currencies, and other income (including gains from certain options,
futures, and forward contracts) derived with respect to its business of
investing in securities or foreign currencies; (b) diversify its holdings so
that at the end of each quarter of the taxable year, (i) at least 50% of the
market value of the 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 the 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).
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, the 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 the Fund in October,
November or December of that year to shareholders on a record date in such a
month and paid by the Fund during January of the following calendar year. Such
a distribution will be includable in the gross income of shareholders in the
calendar year in which it is declared, rather than the calendar year in which
it is received.
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If a portion of a Fund's net investment income is derived from
dividends from domestic corporations, then a portion of such distributions may
be eligible for the corporate dividends-received deduction. The
dividends-received deduction is reduced to the extent shares of a Fund are
treated as debt-financed under the Code and is generally eliminated unless such
shares are deemed to have been held for more than 45 days. The 45-day holding
period must occur during the 90-day period beginning 45 days before the date on
which the shares become ex-dividend. In the case of dividends on certain
preferred stock, the holding period requirement is 90 days during a 180-day
period. In addition, the entire dividend (including the deducted portion) is
includable in the corporate shareholder's alternative minimum taxable income.
Finally, if such dividends are large enough to constitute "extraordinary
dividends" under Section 1059 of the Code and the applicable holding period
requirements are not met, the shareholder's basis in its shares could be
reduced by all or a portion of the amount of the dividends that qualifies for
the dividends-received deduction.
The 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.
Dividends paid to shareholders out of the Fund's "net investment
company taxable income" will be taxable to shareholders as ordinary dividend
income, and to the extent attributable to dividends received from U.S.
corporations, may be eligible for the dividends received deduction in the hands
of shareholders. Distributions of the Fund's net capital gains, if any,
designated by the Fund as capital gain dividends, will generally be taxable to
shareholders as long-term capital gains, regardless of how long a shareholder
has held the Fund's shares. Net capital gains from assets held for one year or
less will be taxed as ordinary income. 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.
The Fund's distributions with respect to a given taxable year may
exceed its current and accumulated earnings and profits available for
distribution. In that event, distributions in excess of such earnings and
profits would be characterized as a return of capital to shareholders for
Federal income tax purposes, thus reducing each shareholder's cost basis in his
Fund shares. Distributions in excess of a shareholder's cost basis in his
shares would be treated as a gain realized from a sale of such shares.
Upon the taxable disposition (including a sale or redemption) of
shares of the 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 the 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
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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 the
Fund on the reinvestment date.
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.
Some of the debt securities that may be acquired by the 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 Fund, original issue
discount on a taxable debt security earned in a given year generally is treated
for Federal income tax purposes as interest and, therefore, such income would
be subject to the distribution requirements of the Code.
Some of the debt securities may be purchased by the 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 the
Fund at a constant rate over the time remaining to the debt security's maturity
or, at the election of the Fund, at a constant yield to maturity which takes
into account the semi-annual compounding of interest.
If the Fund holds zero coupon 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.
The 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 Fund also
may be subject to state and local taxes and their treatment
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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 Fund 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 and total return of the Fund in advertisements, sales literature, or
reports to shareholders or prospective investors.
Current yield for the Fund will be based on the change in the value of
a hypothetical investment (exclusive of capital charges) over a particular
seven-day period, less a pro rata share of Fund expenses accrued over that
period (the "base period"), and stated as a percentage of the investment at the
start of the base period (the "base period return"). The base period return is
then annualized by multiplying by 365/7, with the resulting yield figure
carried to at least the nearest hundredth of one percent. "Effective yield" for
the 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)(365/7)] - 1
The current and effective seven-day average yields as of October 31,
1999 for the Money Market Fund's Sweep Shares were 4.65% and 4.76%. Had certain
expenses not been assumed by the Manager, these yields would have been 4.57%
and 4.67%.
In addition, advertising for the 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 the 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
the 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 the Fund may
discuss the investment philosophy, personnel and assets under management of the
Fund's Manager and Subadvisor, and other pertinent facts relating to the
management of the Fund by the Subadvisor.
From time to time the Fund 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.
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In addition, performance information for the 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 Smith Barney 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 Smith Barney World Government Benchmark Bond Index,
the Salomon Brothers non-U.S. Dollar World Government Bond Index, the Lehman
Brothers Municipal Bond Index and the Lehman Brothers Government Corporate
Index; (ii) other groups of mutual funds tracked by Morningstar Inc. or Lipper
Inc., 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 Fund. Advertisements for a Fund may also
include general information about the performances of unmanaged indexes with
investment parameters similar to the Fund's. 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 Fund may include general
information about the services and products offered by the Fund, 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 Fund is a separate portfolio 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. In addition to the Sweep Shares, the Fund offers two other
classes of shares, the Institutional Class and the Institutional Service Class.
The Company also offers ten other portfolios, each of which has two classes of
shares. The Board of Directors may establish additional portfolios (with
different investment objectives and fundamental policies), and classes thereof,
at any time in the future. Establishment and offering of additional portfolios
or classes will not alter the rights of the Company's shareholders. When
issued, shares are fully paid, non-assessable, redeemable, and freely
transferable.
BENEFICIAL OWNERSHIP OF SHARES
The following table sets forth the information concerning beneficial
and record ownership as of January 31, 2000, of the Fund's shares by each
person who beneficially or of record owned more than 5% of the Money Market
Sweep Shares:
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<TABLE>
<CAPTION>
NAMES AND ADDRESS PERCENTAGE OF
OF SHAREHOLDER OUTSTANDING SHARES
----------------- ------------------
<S> <C>
FISERV Securities, Inc. 100%
Attn: Cash Sweeps Department
One Commerce Square
2005 Market Street
Philadelphia, PA 19103-7042
</TABLE>
CODE OF ETHICS
The Company has adopted a Code of Ethics governing personal trading
activities of all Directors, officers of the Company and persons who, in
connection with their regular functions, play a role in the recommendation of
any purchase or sale of a security by the Company or obtain information
pertaining to such purchase or sale or who have the power to influence the
management or policies of the Company or the Manager or a Subadvisor unless
such power is the result of their position with the Company or Manager or
Subadvisor. 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. Subject to these restrictions,
these persons are permitted to invest in securities, including securities that
may be purchased or held by the Funds. The Company has developed procedures for
administration of the Code of Ethics.
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New
York 10036, has been selected as independent accountants of the Company. The
Funds' Annual Reports, which are incorporated by reference in this SAI, have
been incorporated in reliance on the reports of PricewaterhouseCoopers LLP,
independent accountant, given on the authority of said firm as experts in
auditing and accounting.
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.
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TRANSFER AGENT
MainStay Shareholder Services LLC ("MSS") is the Fund's Transfer,
Dividend Disbursing and Shareholder Servicing Agent. MSS, whose address is 260
Cherry Hill Road, Parsippany, NJ 07054, is an indirect wholly owned subsidiary
of New York Life Insurance Company. MSS provides customer service, is
responsible for preparing and sending statements, confirms and checks, and
keeps certain financial and accounting records. MSS is paid a per account fee
and out-of-pocket expenses by the Funds. MSS is paid a per account fee and
out-of-pocket expenses by the Funds. MSS has entered into an agreement with
Boston Financial Data Services ("BFDS"), whose address is 2 Heritage Drive,
North Quincy, MA 02171. BFDS will perform certain of the services for which MSS
is responsible. In addition, the Fund or MSS may contract with other service
organizations, including affiliates of MSS and broker-dealers and other
financial institutions, which will establish a single omnibus account for their
clients with the Fund. The service organizations will provide shareholder
services to the shareholders within the omnibus accounts and receive service
fees for those services from the Fund.
CUSTODIAN
The Bank of New York, 90 Washington Street, New York, NY 10286, is
custodian of the Funds' investments and has subcustodial agreements for holding
the Funds' foreign investments.
REGISTRATION STATEMENT
This Statement of Additional Information and the Prospectus do not
contain all the information included in the Company's registration statement
filed with the SEC under the Securities Act of 1933 with respect to the
securities offered hereby, certain portions of which have been omitted pursuant
to the rules and regulations of the SEC. The registration statement, including
the exhibits filed therewith, may be examined at the offices of the SEC in
Washington, D.C.
Statements contained herein and in the Prospectus as to the contents
of any contract or other documents referred to are not necessarily complete,
and, in each instance, reference is made to the copy of such contract or other
documents filed as an exhibit to the registration statement, each such
statement being qualified in all respects by such reference.
APPENDIX A DESCRIPTION OF SECURITIES RATINGS
MOODY'S INVESTORS SERVICE, INC.
Corporate and Municipal Bond Ratings
Aaa: Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edged." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
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Aa: Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high-grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than the Aaa
securities.
A: Bonds which are rated A possess many favorable investment
attributes and are to be considered as upper-medium-grade obligations. Factors
giving security to principal and interest are considered adequate but elements
may be present which suggest a susceptibility to impairment sometime in the
future.
Baa: Bonds which are rated Baa are considered as medium-grade
obligations (i.e., they are neither highly protected nor poorly secured).
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics as
well.
Ba: Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B: Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
Caa: Bonds which are rated Caa are of poor standing. Such issues may
be in default or there may be present elements of danger with respect to
principal or interest.
Ca: Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings.
C: Bonds which are rated C are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Moody's applies numerical modifiers, 1, 2, and 3, in each generic
rating classified from Aa through Caa. The modifier 1 indicates that the issue
ranks in the higher end of its generic rating category; the modifier 2
indicates a midrange ranking; and the modifier 3 indicates that the issue ranks
in the lower end of its generic rating category.
Advance refunded issues that are secured by escrowed funds held in
cash, held in trust, reinvested in direct noncallable United States government
obligations or noncallable obligations unconditionally guaranteed by the U.S.
government are identified with a hatchmark (#) symbol, i.e., #Aaa.
Moody's assigns conditional ratings to bonds for which the security
depends upon the completion of some act or the fulfillment of some condition.
These are bonds secured by: (a) earnings of projects under construction; (b)
earnings of projects unseasoned in operating
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experience; (c) rentals that begin when facilities are completed; or (d)
payments to which some other limiting condition attaches. The parenthetical
rating denotes probable credit stature upon completion of construction or
elimination of basis of condition, e.g., Con.(Baa).
MUNICIPAL SHORT-TERM LOAN RATINGS
MIG 1/VMIG 1: This designation denotes best quality. There is present
strong protection by established cash flows, superior liquidity support or
demonstrated broad-based access to the market for refinancing.
MIG 2/VMIG 2: This designation denotes high quality. Margins of
protection are ample although not so large as in the preceding group.
MIG 3/VMIG 3: This designation denotes favorable quality. All security
elements are accounted for but there is lacking the undeniable strength of the
preceding grades. Liquidity and cash flow protection may be narrow and market
access for refinancing is likely to be less well established.
MIG 4/VMIG 4: This designation denotes adequate quality. Protection
commonly regarded as required of an investment security is present and although
not distinctly or predominantly speculative, there is specific risk.
SG: This designation denotes speculative quality. Debt instruments in
this category lack margins of protection.
Corporate Short-Term Debt Ratings
Moody's short-term debt ratings are opinions of the ability of issuers
to repay punctually senior debt obligations which have an original maturity not
exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment ability of rated issuers:
PRIME-1: Issuers rated Prime-1 (or supporting institutions) have a
superior ability for repayment of senior short-term debt obligations. Prime-1
repayment ability will often be evidenced by many of the following
characteristics: leading market positions in well-established industries; high
rates of return on funds employed; conservative capitalization structure with
moderate reliance on debt and ample asset protection; broad margins in earnings
coverage of fixed financial charges and high internal cash generation; and
well-established access to a range of financial markets and assured sources of
alternate liquidity.
PRIME-2: Issuers rated Prime-2 (or supporting institutions) have a
strong ability for repayment of senior short-term debt obligations. This will
normally be evidenced by many of the characteristics cited above but to a
lesser degree. Earnings trends and coverage ratios, while sound, may be more
subject to variation. Capitalization characteristics, while still appropriate,
may be more affected by external conditions. Ample alternate liquidity is
maintained.
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PRIME-3: Issuers rated Prime-3 (or supporting institutions) have an
acceptable ability for repayment of senior short-term obligations. The effect
of industry characteristics and market compositions may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and may require relatively high financial
leverage. Adequate alternate liquidity is maintained.
NOT PRIME: Issuers rated Not Prime do not fall within any of the Prime
rating categories.
STANDARD & POOR'S
Corporate and Municipal Long-Term Debt Ratings
Investment Grade
AAA: Debt rated AAA has the highest rating assigned by Standard &
Poor's. The obligor's capacity to meet its financial commitment on the
obligation is extremely strong.
AA: Debt rated AA differs from the highest rated issues only in small
degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong.
A: Debt rated A is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories. However, the obligor's capacity to meet its financial commitment on
the obligation is still strong.
BBB: Debt rated BBB exhibits adequate protection parameters. However,
adverse economic conditions or changing circumstances are more likely to lead
to a weakened capacity of the obligor to meet its financial commitment on the
obligation.
SPECULATIVE GRADE
Debt rated BB, B, CCC, CC, and C is regarded as having significant
speculative characteristics with respect to capacity to pay interest and repay
principal. BB indicates the least degree of speculation and C the highest.
While such debt will likely have some quality and protective characteristics,
these may be outweighed by large uncertainties or major exposures to adverse
conditions.
BB: Debt rated BB is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial or economic conditions which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
B: Debt rated B is more vulnerable to nonpayment than obligations
rated BB, but the obligor currently has the capacity to meet its financial
commitment on the obligation. Adverse business, financial or economic
conditions will likely impair the obligor's capacity or willingness to meet its
financial commitment on the obligation.
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CCC: Debt rated CCC is currently vulnerable to nonpayment and is
dependent upon favorable business, financial and economic conditions for the
obligor. In the event of adverse business, financial or economic conditions,
the obligor is not likely to have the capacity to meet its financial commitment
on the obligation.
CC: An obligation rated CC is currently highly vulnerable to
nonpayment.
C: The C rating may be used to cover a situation where a bankruptcy
petition has been filed or a similar action has been taken, but debt service
payments are continued.
D: Debt rated D is in payment default. The D rating category is used
when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period. The D rating will also be used upon the
filing of a bankruptcy petition, or the taking of similar action, if debt
service payments are jeopardized.
Plus (+) or Minus (-): The ratings from AA to CCC may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
Debt obligations of issuers outside the United States and its
territories are rated on the same basis as domestic corporate and municipal
issues. The ratings measure the creditworthiness of the obligor but do not take
into account currency exchange and related uncertainties.
Short-Term Rating Definitions
A-1: A short-term obligation rated 'A-1' is rated in the highest
category by Standard & Poor's. The obligor's capacity to meet its financial
commitment on the obligation is strong. Within this category, certain
obligations are designated with a plus sign(+). This indicates that the
obligor's capacity to meet its financial commitment on these obligations is
extremely strong.
A-2: A short-term obligation rated 'A-2' is somewhat more susceptible
to the adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity to
meet its financial commitment on the obligation is satisfactory.
A-3: A short-term obligation rated 'A-3' exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
B: A short-term obligation rated 'B' is regarded as having significant
speculative characteristics. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major ongoing
uncertainties which could lead to the obligor's inadequate capacity to meet its
financial commitment on the obligation.
C: A short-term obligation rated 'C' is currently vulnerable to
nonpayment and is dependent upon favorable business, financial, and economic
conditions for the obligor to meet its financial commitment on the obligation.
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D: A short-term obligation rated 'D' is in payment default. The 'D'
rating category is used when payments on an obligation are not made on the date
due even if the applicable grace period has not expired, unless Standard &
Poor's believes that such payments will be made during such grace period. The
'D' rating also will be used upon the filing of a bankruptcy petition or the
taking of a similar action if payments on an obligation are jeopardized.
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