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PAINEWEBBER BALANCED FUND
PAINEWEBBER TACTICAL ALLOCATION FUND
CLASS Y SHARES
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019
STATEMENT OF ADDITIONAL INFORMATION
The two funds named above (each a "Fund" and, collectively, "Funds") are
diversified series of professionally managed, open-end management investment
companies organized as a Maryland corporation and a Massachusetts business
trust, respectively. PaineWebber Balanced Fund ("Balanced Fund"), a series of
PaineWebber Master Series, Inc. ("Corporation"), seeks high total return with
low volatility; it invests primarily in a combination of equity securities,
investment grade debt securities and money market instruments. PaineWebber
Tactical Allocation Fund ("Tactical Allocation Fund"), a series of PaineWebber
Investment Trust ("Trust"), seeks total return, consisting of long-term
capital appreciation and current income, by utilizing a disciplined investment
strategy that actively allocates the Fund's assets between equity securities
and U.S. Treasury notes or U.S. Treasury bills.
The investment adviser, administrator and distributor for each Fund is
Mitchell Hutchins Asset Management Inc. ("Mitchell Hutchins"), a wholly owned
subsidiary of PaineWebber Incorporated ("PaineWebber"). As distributor for the
Funds, Mitchell Hutchins has appointed PaineWebber to serve as the exclusive
dealer for the sale of Fund shares.
This Statement of Additional Information is not a prospectus and relates
only to the Fund's Class Y shares. It should be read only in conjunction with
the Funds' current Prospectus for those shares, dated January 1, 1997. A copy
of the Prospectus may be obtained by calling any PaineWebber investment
executive or correspondent firm or by calling toll-free 1-800-647-1568. This
Statement of Additional Information is dated January 1, 1997.
INVESTMENT POLICIES AND RESTRICTIONS
The following supplements the information contained in the Prospectus
concerning the Funds' investment policies and limitations. Except as otherwise
indicated in the Prospectus or the Statement of Additional Information, there
are no policy limitations on a Fund's ability to use the investments or
techniques discussed in these documents.
YIELD FACTORS AND RATINGS. Standard & Poor's, a division of The McGraw-Hill
Companies, Inc. ("S&P"), Moody's Investors Service, Inc. ("Moody's") and other
nationally recognized statistical rating organizations ("NRSROs") are private
services that provide ratings of the credit quality of debt obligations. A
description of the range of ratings assigned to debt obligations by Moody's
and S&P is included in the Appendix to this Statement of Additional
Information. Balanced Fund may use these ratings in determining whether to
purchase, sell or hold a security. These ratings represent the NRSROs'
opinions as to the quality of the debt obligations that they undertake to
rate. It should be emphasized, however, that ratings are general and are not
absolute standards of quality. Consequently, debt obligations with the same
maturity, interest rate and rating may have different market prices.
Subsequent to its purchase by Balanced Fund, an issue of debt obligations may
cease to be rated or its rating may be reduced below the minimum rating
required for purchase by the Fund. Mitchell Hutchins will consider such an
event in determining whether the Fund should continue to hold the obligation
but is not required to dispose of it.
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In addition to ratings assigned to individual bond issues, Mitchell Hutchins
will analyze interest rate trends and developments that may affect individual
issuers, including factors such as liquidity, profitability and asset quality.
The yields on bonds and other debt securities in which Balanced Fund invests
are dependent on a variety of factors, including general money market
conditions, general conditions in the bond market, the financial condition of
the issuer, the size of the offering, the maturity of the obligation and its
rating. There is a wide variation in the quality of bonds, both within a
particular classification and between classifications. An issuer's obligations
under its bonds are subject to the provisions of bankruptcy, insolvency and
other laws affecting the rights and remedies of bond holders or other
creditors of an issuer; litigation or other conditions may also adversely
affect the power or ability of issuers to meet their obligations for the
payment of interest and principal on their bonds.
Balanced Fund may invest in convertible debt securities rated Ba or lower by
Moody's, BB or lower by S&P, comparably rated by another NRSRO or determined
by Mitchell Hutchins to be of comparable quality. These securities are below
investment grade, are deemed by those agencies to be predominantly speculative
with respect to the issuer's capacity to pay interest and repay principal and
may involve major risk exposure to adverse conditions. Lower rated debt
securities generally offer a higher current yield than that available for
investment grade issues, but they involve higher risks, in that they are
especially subject to adverse changes in general economic conditions and in
the industries in which the issuers are engaged, to changes in the financial
condition of the issuers and to price fluctuations in response to changes in
interest rates. During periods of economic downturn or rising interest rates,
highly leveraged issuers may experience financial stress which could adversely
affect their ability to make payments of interest and principal and increase
the possibility of default. In addition, such issuers may not have more
traditional methods of financing available to them and may be unable to repay
debt at maturity by refinancing. The risk of loss due to default by such
issuers is significantly greater because such securities frequently are
unsecured and subordinated to the prior payment of senior indebtedness.
The market for lower rated debt securities has expanded rapidly in recent
years, and its growth generally paralleled a long economic expansion. In the
past, the prices of many lower rated debt securities declined substantially,
reflecting an expectation that many issuers of such securities might
experience financial difficulties. As a result, the yields on lower rated debt
securities rose dramatically. However, such higher yields did not reflect the
value of the income stream that holders of such securities expected, but
rather the risk that holders of such securities could lose a substantial
portion of their value as a result of the issuers' financial restructuring or
defaults. There can be no assurance that such declines will not recur. The
market for lower rated debt issues generally is thinner and less active than
that for higher quality securities, which may limit a Fund's ability to sell
such securities at fair value in response to changes in the economy or
financial markets. Adverse publicity and investor perceptions, whether or not
based on fundamental analysis, may also decrease the values and liquidity of
lower rated securities, especially in a thinly traded market.
ASSET-BACKED SECURITIES. Asset-backed securities have structural
characteristics similar to mortgage-backed securities, as discussed in more
detail below. However, the underlying assets are not first lien mortgage loans
or interests therein, but include assets such as motor vehicle installment
sale contracts, other installment sale contracts, home equity loans, leases of
various types of real and personal property and receivables from revolving
credit (credit card) agreements. Such assets are securitized through the use
of trusts or special purpose corporations. Payments or distributions of
principal and interest may be guaranteed up to a certain amount and for a
certain time period by a letter of credit or pool insurance policy issued by a
financial institution unaffiliated with the issuer, or other credit
enhancements may be present.
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MORTGAGE-BACKED SECURITIES. Mortgage-backed securities represent direct or
indirect participations in, or are secured by and payable from, mortgage loans
secured by real property and include single- and multi-class pass-through
securities and collateralized mortgage obligations. Multi-class pass-through
securities and collateralized mortgage obligations are collectively referred
to herein as CMOs. The U.S. government mortgage-backed securities in which
Balanced Fund may invest include mortgage-backed securities issued or
guaranteed as to the payment of principal and interest (but not as to market
value) by the Government National Mortgage Association ("Ginnie Mae"), the
Federal National Mortgage Association ("Fannie Mae"), or the Federal Home Loan
Mortgage Corporation ("Freddie Mac"). Other mortgage-backed securities are
issued by private issuers, generally originators of and investors in mortgage
loans, including savings associations, mortgage bankers, commercial banks,
investment bankers and special purpose entities (collectively "Private
Mortgage Lenders"). Payments of principal and interest (but not the market
value) of such private mortgage-backed securities may be supported by pools of
mortgage loans or other mortgage-backed securities that are guaranteed,
directly or indirectly, by the U.S. government or one of its agencies or
instrumentalities, or they may be issued without any government guarantee of
the underlying mortgage assets but with some form of non-government credit
enhancement. New types of mortgage-backed securities are developed and
marketed from time to time and, consistent with its investment limitations,
Balanced Fund expects to invest in those new types of mortgage-backed
securities that Mitchell Hutchins believes may assist the Fund in achieving
its investment objective. Similarly, Balanced Fund may invest in mortgage-
backed securities issued by new or existing governmental or private issuers
other than those identified herein.
GINNIE MAE CERTIFICATES. Ginnie Mae guarantees certain mortgage pass-through
certificates ("Ginnie Mae certificates") that are issued by Private Mortgage
Lenders and that represent ownership interests in individual pools of
residential mortgage loans. These securities are designed to provide monthly
payments of interest and principal to the investor. Timely payment of interest
and principal is backed by the full faith and credit of the U.S. government.
Each mortgagor's monthly payments to his lending institution on his
residential mortgage are "passed through" to certificateholders such as
Balanced Fund. Mortgage pools consist of whole mortgage loans or
participations in loans. The terms and characteristics of the mortgage
instruments are generally uniform within a pool but may vary among pools.
Lending institutions that originate mortgages for the pools are subject to
certain standards, including credit and other underwriting criteria for
individual mortgages included in the pools.
FANNIE MAE CERTIFICATES. Fannie Mae facilitates a national secondary market
in residential mortgage loans insured or guaranteed by U.S. government
agencies and in privately insured or uninsured residential mortgage loans
(sometimes referred to as "conventional mortgage loans" or "conventional
loans") through its mortgage purchase and mortgage-backed securities sales
activities. Fannie Mae issues guaranteed mortgage pass-through certificates
("Fannie Mae certificates"), which represent pro rata shares of all interests
and principal payments made and owed on the underlying pools. Fannie Mae
guarantees timely payment of interest and principal on Fannie Mae
certificates. The Fannie Mae guarantee is not backed by the full faith and
credit of the U.S. government.
FREDDIE MAC CERTIFICATES. Freddie Mac also facilitates a national secondary
market for conventional residential and U.S. government-insured mortgage loans
through its mortgage purchase and mortgage-backed securities sales activities.
Freddie Mac issues two types of mortgage pass-through securities: mortgage
participation certificates ("PCs") and guaranteed mortgage certificates
("GMCs"). Each PC represents a pro rata share of all interest and principal
payments made and owed on the underlying pool. Freddie Mac generally
guarantees timely monthly payment of interest on PCs and the ultimate payment
of principal, but it also has a PC program under which it guarantees timely
payment of both principal and interest. GMCs also
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represent a pro rata interest in a pool of mortgages. These instruments,
however, pay interest semi-annually and return principal once a year in
guaranteed minimum payments. The Freddie Mac guarantee is not backed by the
full faith and credit of the U.S. government.
PRIVATE, RTC AND SIMILAR MORTGAGE-BACKED SECURITIES. Mortgage-backed
securities issued by Private Mortgage Lenders are structured similarly to CMOs
issued or guaranteed by Ginnie Mae, Fannie Mae and Freddie Mac. Such mortgage-
backed securities may be supported by pools of U.S. government or agency
insured or guaranteed mortgage loans or by other mortgage-backed securities
issued by a government agency or instrumentality, but they generally are
supported by pools of conventional (i.e., non-government guaranteed or
insured) mortgage loans. Since such mortgage-backed securities normally are
not guaranteed by an entity having the credit standing of Ginnie Mae, Fannie
Mae and Freddie Mac, they normally are structured with one or more types of
credit enhancement. See "--Types of Credit Enhancement." These credit
enhancements do not protect investors from changes in market value.
The Resolution Trust Corporation ("RTC"), which was organized by the U.S.
government in connection with the savings and loan crisis, held assets of
failed savings associations as either a conservator or receiver for such
associations, or it acquired such assets in its corporate capacity. These
assets included, among other things, single family and multi-family mortgage
loans, as well as commercial mortgage loans. In order to dispose of such
assets in an orderly manner, RTC established a vehicle registered with the
Securities and Exchange Commission ("SEC") through which it sold mortgage-
backed securities. RTC mortgage-backed securities represent pro rata interests
in pools of mortgage loans that RTC held or had acquired, as described above,
and are supported by one or more of the types of private credit enhancements
used by Private Mortgage Lenders.
COLLATERALIZED MORTGAGE OBLIGATIONS AND MULTI-CLASS MORTGAGE PASS-
THROUGHS. CMOs are debt obligations that are collateralized by mortgage loans
or mortgage pass-through securities (such collateral collectively being called
"Mortgage Assets"). CMOs may be issued by Private Mortgage Lenders or by
government entities such as Fannie Mae or Freddie Mac. Multi-class mortgage
pass-through securities are interests in trusts that are comprised of mortgage
assets and that have multiple classes similar to those in CMOs. Unless the
context indicates otherwise, references herein to CMOs include multi-class
mortgage pass-through securities. Payments of principal of and interest on the
mortgage assets (and in the case of CMOs, any reinvestment income thereon)
provide the funds to pay debt service on the CMOs or to make schedule
distributions on the multi-class mortgage pass-through securities.
In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMO, also referred to as a "tranche," is issued at a specific
fixed or floating coupon rate and has a stated maturity or final distribution
date. Principal prepayments on the mortgage assets may cause CMOs to be
retired substantially earlier than their stated maturities or final
distribution dates. Interest is paid or accrued on all classes of a CMO (other
than any principal-only class) on a monthly, quarterly or semi-annual basis.
The principal and interest on the mortgage assets may be allocated among the
several classes of a CMO in many ways. In one structure, payments of
principal, including any principal prepayments, on the mortgage assets are
applied to the classes of a CMO in the order of their respective stated
maturities or final distribution dates so that no payment of principal will be
made on any class of the CMO until all other classes having an earlier stated
maturity or final distribution date have been paid in full. In some CMO
structures, all or a portion of the interest attributable to one or more of
the CMO classes may be added to the principal amounts attributable to such
classes, rather than passed through to certificateholders on a current basis,
until other classes of the CMO are paid in full.
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Parallel pay CMOs are structured to provide payments of principal on each
payment date to more than one class. These simultaneous payments are taken
into account in calculating the stated maturity date or final distribution
date of each class, which, as with other CMO structures, must be retired by
its stated maturity date or final distribution date but may be retired
earlier.
ARM AND FLOATING RATE MORTGAGE-BACKED SECURITIES. ARM mortgage-backed
securities are mortgage-backed securities that represent a right to receive
interest payments at a rate that is adjusted to reflect the interest earned on
a pool of mortgage loans bearing variable or adjustable rates of interest
(such mortgage loans are referred to as "ARMs"). Floating rate mortgage-backed
securities are classes of mortgage-backed securities that have been structured
to represent the right to receive interest payments at rates that fluctuate in
accordance with an index but that generally are supported by pools comprised
of fixed-rate mortgage loans. Because the interest rates on ARM and floating
rate mortgage-backed securities are reset in response to changes in a
specified market index, the values of such securities tend to be less
sensitive to interest rate fluctuations than the values of fixed-rate
securities.
TYPES OF CREDIT ENHANCEMENT. To lessen the effect of failures by obligors on
mortgage assets to make payments, mortgage-backed securities may contain
elements of credit enhancement. Such credit enhancement falls into two
categories: (1) liquidity protection and (2) protection against losses
resulting after default by an obligor on the underlying assets and collection
of all amounts recoverable directly from the obligor and through liquidation
of the collateral. Liquidity protection refers to the provision of advances,
generally by the entity administering the pool of assets (usually the bank,
savings association or mortgage banker that transferred the underlying loans
to the issuer of the security), to ensure that the receipt of payments on the
underlying pool occurs in a timely fashion. Protection against losses
resulting after default and liquidation ensures ultimate payment of the
obligations on at least a portion of the assets in the pool. Such protection
may be provided through guarantees, insurance policies or letters of credit
obtained by the issuer or sponsor, from third parties, through various means
of structuring the transaction or through a combination of such approaches.
Balanced Fund will not pay any additional fees for such credit enhancement,
although the existence of credit enhancement may increase the price of a
security. Credit enhancements do not provide protection against changes in the
market value of the security.
Examples of credit enhancement arising out of the structure of the
transaction include "senior-subordinated securities" (multiple class
securities with one or more classes subordinate to other classes as to the
payment of principal thereof and interest thereon, with the result that
defaults on the underlying assets are borne first by the holders of the
subordinated class), creation of "spread accounts" or "reserve funds" (where
cash or investments, sometimes funded from a portion of the payments on the
underlying assets, are held in reserve against future losses) and "over-
collateralization" (where the scheduled payments on, or the principal amount
of, the underlying assets exceed that required to make payment of the
securities and pay any servicing or other fees). The degree of credit
enhancement provided for each issue generally is based on historical
information regarding the level of credit risk associated with the underlying
assets. Delinquency or loss in excess of that anticipated could adversely
affect the return on an investment in such a security.
ADDITIONAL INFORMATION ON ARM AND FLOATING RATE MORTGAGE-BACKED SECURITIES.
Because the interest rates on ARM and floating rate mortgage-backed securities
are reset in response to changes in a specified market index, the values of
such securities tend to be less sensitive to interest rate fluctuations than
the values of fixed-rate securities. As a result, during periods of rising
interest rates, ARMs generally do not decrease in value as much as fixed rate
securities. Conversely, during periods of declining rates, ARMs generally do
not increase in value as much as fixed rate securities. ARM mortgage-backed
securities represent a right to receive interest payments at a rate that is
adjusted to reflect the interest earned on a pool of ARMs.
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ARMs generally provide that the borrower's mortgage interest rate may not be
adjusted above a specified lifetime maximum rate or, in some cases, below a
minimum lifetime rate. In addition, certain ARMs provide for limitations on
the maximum amount by which the mortgage interest rate may adjust for any
single adjustment period. ARMs also may provide for limitations on changes in
the maximum amount by which the borrower's monthly payment may adjust for any
single adjustment period. In the event that a monthly payment is not
sufficient to pay the interest accruing on the ARM, any such excess interest
is added to the mortgage loan ("negative amortization"), which is repaid
through future monthly payments. If the monthly payment exceeds the sum of the
interest accrued at the applicable mortgage interest rate and the principal
payment that would have been necessary to amortize the outstanding principal
balance over the remaining term of the loan, the excess reduces the principal
balance of the ARM. Borrowers under ARMs experiencing negative amortization
may take longer to build up their equity in the underlying property and may be
more likely to default.
The rates of interest payable on certain ARMs, and therefore on certain ARM
mortgage-backed securities, are based on indices, such as the one-year
constant maturity Treasury rate, that reflect changes in market interest
rates. Others are based on indices, such as the 11th District Federal Home
Loan Bank Cost of Funds Index ("COFI"), that tend to lag behind changes in
market interest rates. The values of ARM mortgage-backed securities supported
by ARMs that adjust based on lagging indices tend to be somewhat more
sensitive to interest rate fluctuations than those reflecting current interest
rate levels, although the values of such ARM mortgage-backed securities still
tend to be less sensitive to interest rate fluctuations than fixed-rate
securities.
Floating rate mortgage-backed securities are classes of mortgage-backed
securities that have been structured to represent the right to receive
interest payments at rates that fluctuate in accordance with an index but that
generally are supported by pools comprised of fixed-rate mortgage loans. As
with ARM mortgage-backed securities, interest rate adjustments on floating
rate mortgage-backed securities may be based on indices that lag behind market
interest rates. Interest rates on floating rate mortgage-backed securities
generally are adjusted monthly. Floating rate mortgage-backed securities are
subject to lifetime interest rate caps, but they generally are not subject to
limitations on monthly or other periodic changes in interest rates or monthly
payments.
SPECIAL CHARACTERISTICS OF MORTGAGE- AND ASSET-BACKED SECURITIES. The yield
characteristics of mortgage- and asset-backed securities differ from those of
traditional debt securities. Among the major differences are that interest and
principal payments are made more frequently, usually monthly, and that
principal may be prepaid at any time because the underlying mortgage loans or
other obligations generally may be prepaid at any time. Prepayments on a pool
of mortgage loans are influenced by a variety of economic, geographic, social
and other factors, including changes in mortgagors' housing needs, job
transfers, unemployment, mortgagors' net equity in the mortgaged properties
and servicing decisions. Generally, however, prepayments on fixed-rate
mortgage loans will increase during a period of falling interest rates and
decrease during a period of rising interest rates. Similar factors apply to
prepayments on asset-backed securities, but the receivables underlying asset-
backed securities generally are of a shorter maturity and thus are less likely
to experience substantial prepayments. Such securities, however, often provide
that for a specified time period the issuers will replace receivables in the
pool that are repaid with comparable obligations. If the issuer is unable to
do so, repayment of principal on the asset-backed securities may commence at
an earlier date. Mortgage- and asset-backed securities may decrease in value
as a result of increases in interest rates and may benefit less than other
fixed-income securities from declining interest rates because of the risk of
prepayment.
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ARMs also may be subject to a greater rate of prepayments in a declining
interest rate environment. For example, during a period of declining interest
rates, prepayments on ARMs could increase because the availability of fixed
rate mortgage loans at competitive interest rates may encourage mortgagors to
"lock-in" at a lower interest rate. Conversely, during a period of rising
interest rates, prepayments on ARMs might decrease. The rate of prepayments
with respect to ARMs has fluctuated in recent years.
The rate of interest on mortgage-backed securities is lower than the
interest rates paid on the mortgages included in the underlying pool due to
the annual fees paid to the servicer of the mortgage pool for passing through
monthly payments to certificateholders and to any guarantor, and due to any
yield retained by the issuer. Actual yield to the holder may vary from the
coupon rate, even if adjustable, if the mortgage-backed securities are
purchased or traded in the secondary market at a premium or discount. In
addition, there is normally some delay between the time the issuer receives
mortgage payments from the servicer and the time the issuer makes the payments
on the mortgage-backed securities, and this delay reduces the effective yield
to the holder of such securities.
Yields on pass-through securities are typically quoted by investment dealers
and vendors based on the maturity of the underlying instruments and the
associated average life assumption. The average life of pass-through pools
varies with the maturities of the underlying mortgage loans. A pool's term may
be shortened by unscheduled or early payments of principal on the underlying
mortgages. Because prepayment rates of individual pools vary widely, it is not
possible to predict accurately the average life of a particular pool. In the
past, a common industry practice has been to assume that prepayments on pools
of fixed rate 30-year mortgages would result in a 12-year average life for the
pool. At present, mortgage pools, particularly those with loans with other
maturities or different characteristics, are priced on an assumption of
average life determined for each pool. In periods of declining interest rates,
the rate of prepayment tends to increase, thereby shortening the actual
average life of a pool of mortgage-backed securities. Conversely, in periods
of rising interest rates, the rate of prepayment tends to decrease, thereby
lengthening the actual average life of the pool. However, these effects may
not be present, or may differ in degree, if the mortgage loans in the pools
have adjustable interest rates or other special payment terms, such as a
prepayment charge. Actual prepayment experience may cause the yield of
mortgage-backed securities to differ from the assumed average life yield.
Reinvestments of prepayments may occur at lower interest rates than the
original investment, thus adversely affecting the yield of Balanced Fund.
ILLIQUID SECURITIES. Each Fund may invest up to 10% of its net assets in
illiquid securities. The term "illiquid securities" for this purpose means
securities that cannot be disposed of within seven days in the ordinary course
of business at approximately the amount at which the Fund has valued the
securities. Illiquid securities are considered to include, among other things,
purchased over-the-counter ("OTC") options, repurchase agreements with
maturities in excess of seven days and securities whose disposition is
restricted under the federal securities laws (other than those Mitchell
Hutchins has determined to be liquid under procedures approved by the
Corporation's board of directors or the Trust's board of trustees (each
sometimes referred to as a "board"). The assets used as cover for OTC options
written by a Fund will be considered illiquid unless the OTC options are sold
to qualified dealers who agree that the Fund may repurchase any OTC option it
writes at a maximum price to be calculated by a formula set forth in the
option agreement. The cover for an OTC option written subject to this
procedure would be considered illiquid only to the extent that the maximum
repurchase price under the formula exceeds the intrinsic value of the option.
Under current SEC guidelines, interest-only ("IO") and principal-only ("PO")
classes of mortgage-backed securities, in which Balanced Fund may invest, are
considered illiquid. However, IO and PO classes of fixed-rate mortgage-backed
securities issued by the U.S. government or one of its agencies or
instrumentalities will not be considered
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illiquid if Mitchell Hutchins has determined that they are liquid pursuant to
guidelines established by Balanced Fund's board. Certain illiquid restricted
securities may be sold only in privately negotiated transactions or in public
offerings with respect to which a registration statement is in effect under
the Securities Act of 1933 ("1933 Act"). Where registration is required, a
Fund may be obligated to pay all or part of the registration expenses and a
considerable period may elapse between the time of the decision to sell and
the time the Fund may be permitted to sell a security under an effective
registration statement. If, during such a period, adverse market conditions
were to develop, the Fund might obtain a less favorable price than prevailed
when it decided to sell.
Not all restricted securities are illiquid. In recent years a large
institutional market has developed for certain securities that are not
registered under the 1933 Act, including private placements, repurchase
agreements, commercial paper, foreign securities and corporate bonds and
notes. These instruments are often restricted securities because the
securities are sold in transactions not requiring registration. Institutional
investors generally will not seek to sell these instruments to the general
public, but instead will often depend either on an efficient institutional
market in which such unregistered securities can be readily resold or on an
issuer's ability to honor a demand for repayment. Therefore, the fact that
there are contractual or legal restrictions on resale to the general public or
certain institutions is not dispositive of the liquidity of such investments.
Rule 144A under the 1933 Act establishes a "safe harbor" from the
registration requirements of the 1933 Act for resales of certain securities to
qualified institutional buyers. Institutional markets for restricted
securities that might develop as a result of Rule 144A could provide both
readily ascertainable values for restricted securities and the ability to
liquidate an investment to satisfy share redemption orders. Such markets might
include automated systems for the trading, clearance and settlement of
unregistered securities of domestic and foreign issuers, such as the PORTAL
System sponsored by the National Association of Securities Dealers, Inc. An
insufficient number of qualified institutional buyers interested in purchasing
Rule 144A-eligible restricted securities held by a Fund, however, could affect
adversely the marketability of such portfolio securities, and the Fund might
be unable to dispose of such securities promptly or at favorable prices.
Each board has delegated the function of making day-to-day determinations of
liquidity to Mitchell Hutchins, pursuant to guidelines approved by the board.
Mitchell Hutchins takes into account a number of factors in reaching liquidity
decisions, including (1) the frequency of trades for the security, (2) the
number of dealers that make quotes for the security, (3) the number of dealers
that have undertaken to make a market in the security, (4) the number of other
potential purchasers and (5) the nature of the security and how trading is
effected (e.g., the time needed to sell the security, how offers are solicited
and the mechanics of transfer). Mitchell Hutchins monitors the liquidity of
restricted securities in each Fund's portfolio and reports periodically on
such decisions to the boards.
REPURCHASE AGREEMENTS. Repurchase agreements are transactions in which a
Fund purchases securities from a bank or recognized securities dealer and
simultaneously commits to resell the securities to the bank or dealer at an
agreed-upon date and price reflecting a market rate of interest unrelated to
the coupon rate or maturity of the purchased securities. Each Fund maintains
custody of the underlying securities prior to their repurchase; thus, the
obligation of the bank or dealer to pay the repurchase price on the date
agreed to is, in effect, secured by such securities. If the value of such
securities is less than the repurchase price, plus any agreed-upon additional
amount, the other party to the agreement must provide additional collateral so
that at all times the collateral is at least equal to the repurchase price,
plus any agreed-upon additional amount. The difference between the total
amount to be received upon repurchase of the securities and the price that was
paid by a Fund upon their acquisition is accrued as interest and included in
the Fund's net investment income.
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Repurchase agreements carry certain risks not associated with direct
investments in securities, including possible declines in the market value of
the underlying securities and delays and costs to the Fund if the other party
to a repurchase agreement becomes insolvent. Each Fund intends to enter into
repurchase agreements only with banks and dealers in transactions believed by
Mitchell Hutchins to present minimal credit risks in accordance with
guidelines established by each Fund's board. Mitchell Hutchins reviews and
monitors the creditworthiness of those institutions under the board's general
supervision.
REVERSE REPURCHASE AGREEMENTS. Balanced Fund may enter into reverse
repurchase agreements with banks and securities dealers up to an aggregate
value of not more than 5% of its net assets. Such agreements involve the sale
of securities held by the Fund subject to its agreement to repurchase the
securities at an agreed-upon date and price reflecting a market rate of
interest. Such agreements are considered to be borrowings and may be entered
into only for temporary or emergency purposes. While a reverse repurchase
agreement is outstanding, the Fund's custodian segregates assets to cover the
Fund's obligations under the reverse repurchase agreement. See "Investment
Policies and Restrictions--Segregated Accounts."
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. A security purchased on a when-
issued or delayed delivery basis is recorded as an asset on the commitment
date and is subject to changes in market value, generally based upon changes
in the level of interest rates. Thus, fluctuation in the value of the security
from the time of the commitment date will affect a Fund's net asset value.
When a Fund commits to purchase securities on a when-issued or delayed
delivery basis, its custodian segregates assets to cover the amount of the
commitment. See "Investment Policies and Restrictions--Segregated Accounts."
Each Fund purchases when-issued securities only with the intention of taking
delivery, but may sell the right to acquire the security prior to delivery if
Mitchell Hutchins deems it advantageous to do so, which may result in a gain
or loss to the Fund.
SECTION 4(2) PAPER. Commercial paper issues in which Balanced Fund may
invest include securities issued by major corporations without registration
under the 1933 Act in reliance on the exemption from such registration
afforded by Section 3(a)(3) thereof and commercial paper issued in reliance on
the so-called "private placement" exemption from registration afforded by
Section 4(2) of the 1933 Act ("Section 4(2) paper"). Section 4(2) paper is
restricted as to disposition under the federal securities laws in that any
resale must similarly be made in an exempt transaction. Section 4(2) paper is
normally resold to other institutional investors through or with the
assistance of investment dealers who make a market in Section 4(2) paper, thus
providing liquidity. The Fund's 10% limitation on investments in illiquid
securities includes Section 4(2) paper, other than Section 4(2) paper that
Mitchell Hutchins has determined to be liquid pursuant to guidelines
established by the Fund's board. The board has delegated to Mitchell Hutchins
the function of making day-to-day determinations of liquidity with respect to
Section 4(2) paper, pursuant to guidelines approved by the board that require
Mitchell Hutchins to take into account the same factors described under
"Illiquid Securities" above for other restricted securities and require
Mitchell Hutchins to perform the same monitoring and reporting functions.
SPECIAL CONSIDERATIONS RELATING TO FOREIGN SECURITIES. To the extent each
Fund holds U.S. dollar-denominated securities of foreign issuers, such
securities may not be registered with the SEC, nor are the issuers thereof
subject to its reporting requirements. Accordingly, there may be less publicly
available information concerning foreign issuers of securities held by a Fund
than is available concerning U.S. companies. Foreign companies are not
generally subject to uniform accounting, auditing and financial reporting
standards or to other regulatory requirements comparable to those applicable
to U.S. companies.
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Each Fund invests in securities of foreign issuers only if such securities
are traded in the U.S. securities markets directly or through American
Depository Receipts ("ADRs"). Generally, ADRs, in registered form, are
denominated in U.S. dollars and are designed for use in the U.S. securities
markets. ADRs are receipts typically issued by a U.S. bank or trust company
evidencing ownership of the underlying securities. For purposes of the Fund's
investment policies, ADRs are deemed to have the same classification as the
underlying securities they represent. Thus, an ADR evidencing ownership of
common stock will be treated as common stock.
Investment income on certain foreign securities in which the Funds may
invest may be subject to foreign withholding or other taxes that could reduce
the return on these securities. Tax treaties between the United States and
foreign countries, however, may reduce or eliminate the amount of foreign
taxes to which a Fund would be subject.
CONVERTIBLE SECURITIES. Balanced Fund is permitted to invest in convertible
securities. A convertible security is a bond, debenture, note, preferred stock
or other security that may be converted into or exchanged for a prescribed
amount of common stock of the same or a different issuer within a particular
period of time at a specified price or formula. A convertible security
entitles the holder to receive interest paid or accrued on debt or the
dividend paid on preferred stock until the convertible security matures or is
redeemed, converted or exchanged. Before conversion, convertible securities
have characteristics similar to non-convertible debt securities in that they
ordinarily provide a stable stream of income with generally higher yields than
those of common stocks of the same or similar issuers. Convertible securities
rank senior to common stock in a corporation's capital structure but are
usually subordinated to comparable non-convertible securities. While no
securities investment is without some risk, investments in convertible
securities generally entail less risk than the issuer's common stock, although
the extent to which such risk is reduced depends in large measure upon the
degree to which the convertible security sells above its value as a fixed
income security. Convertible securities have unique investment characteristics
in that they generally (1) have higher yields than common stocks, but lower
yields than comparable non-convertible securities, (2) are less subject to
fluctuation in value than the underlying stock because they have fixed income
characteristics and (3) provide the potential for capital appreciation if the
market price of the underlying common stock increases.
The value of a convertible security is a function of its "investment value"
(determined by its yield comparison with the yields of other securities of
comparable maturity and quality that do not have a conversion privilege) and
its "conversion value" (the security's worth, at market value, if converted
into the underlying common stock). The investment value of a convertible
security is influenced by changes in interest rates, with investment value
declining as interest rates increase and increasing as interest rates decline.
The credit standing of the issuer and other factors also may have an effect on
the convertible security's investment value. The conversion value of a
convertible security is determined by the market price of the underlying
common stock. If the conversion value is low relative to the investment value,
the price of the convertible security is governed principally by its
investment value and generally the conversion value decreases as the
convertible security approaches maturity. To the extent the market price of
the underlying common stock approaches or exceeds the conversion price, the
price of the convertible security will be increasingly influenced by its
conversion value. In addition, a convertible security generally will sell at a
premium over its conversion value determined by the extent to which investors
place value on the right to acquire the underlying common stock while holding
a fixed income security.
A convertible security may be subject to redemption at the option of the
issuer at a price established in the convertible security's governing
instrument. If a convertible security held by Balanced Fund is called for
redemption, the Fund will be required to permit the issuer to redeem the
security, convert it into underlying common stock or sell it to a third party.
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SEGREGATED ACCOUNTS. When a Fund enters into certain transactions that
involve obligations to make future payments to third parties, including the
purchase of securities on a when-issued or delayed delivery basis or reverse
repurchase agreements, it will maintain with an approved custodian in a
segregated account cash or liquid securities, marked to market daily, in an
amount at least equal to the Fund's obligation or commitment under such
transactions. As described under "Hedging and Related Strategies," segregated
accounts may also be required in connection with certain transactions
involving options, futures contracts or certain interest rate protection
transactions.
SHORT SALES "AGAINST THE BOX." Each Fund may engage in short sales of
securities it owns or has the right to acquire at no added cost through
conversion or exchange of other securities it owns (short sales "against the
box") to defer realization of gains or losses for tax or other purposes. To
make delivery to the purchaser in a short sale, the executing broker borrows
the securities being sold short on behalf of the Fund, and the Fund is
obligated to replace the securities borrowed at a date in the future. When the
Fund sells short, it establishes a margin account with the broker effecting
the short sale and deposits collateral with the broker. In addition, the Fund
maintains with its custodian, in a segregated account, the securities that
could be used to cover the short sale. The Fund incurs transaction costs,
including interest expense, in connection with opening, maintaining and
closing short sales against the box. Neither Fund currently expects to have
obligations under short sales that at any time during the coming year exceed
5% of its net assets.
A Fund might make a short sale "against the box" in order to hedge against
market risks when Mitchell Hutchins believes that the price of a security may
decline, thereby causing a decline in the value of a security owned by the
Fund or a security convertible into or exchangeable for a security owned by
the Fund, or when Mitchell Hutchins wants to sell a security that the Fund
owns at a current price, but also wishes to defer recognition of gain or loss
for federal income tax purposes. In such case, any loss in the Fund's long
position after the short sale should be reduced by a gain in the short
position. Conversely, any gain in the long position should be reduced by a
loss in the short position. The extent to which gains or losses in the long
position are reduced will depend upon the amount of the securities sold short
relative to the amount of the securities the Fund owns, either directly or
indirectly, and in the case where the Fund owns convertible securities,
changes in the investment values or conversion premiums of such securities.
LENDING OF PORTFOLIO SECURITIES. Each Fund is authorized to lend up to 33
1/3% of the total value of its portfolio securities to broker-dealers or
institutional investors that Mitchell Hutchins deems qualified, but only when
the borrower maintains acceptable collateral with the Fund's custodian, marked
to market daily, in an amount at least equal to the market value of the
securities loaned, plus accrued interest and dividends. Acceptable collateral
is limited to cash, U.S. government securities and irrevocable letters of
credit that meet certain guidelines established by Mitchell Hutchins. In
determining whether to lend securities to a particular broker-dealer or
institutional investor, Mitchell Hutchins will consider, and during the period
of the loan will monitor, all relevant facts and circumstances, including the
creditworthiness of the borrower. Each Fund will retain authority to terminate
any loan at any time. A Fund may pay reasonable administrative and custodial
fees in connection with a loan and may pay a negotiated portion of the
interest earned on the cash or money market instruments held as collateral to
the borrower or placing broker. A Fund will receive reasonable interest on the
loan or a flat fee from the borrower and amounts equivalent to any dividends,
interest or other distributions on the securities loaned. A Fund will regain
record ownership of loaned securities to exercise beneficial rights, such as
voting and subscription rights and rights to dividends, interest or other
distributions, when regaining such rights is considered to be in the Fund's
interest.
INVESTMENT LIMITATIONS OF THE FUNDS
FUNDAMENTAL LIMITATIONS. The following investment limitations cannot be
changed for a Fund without the affirmative vote of the lesser of (1) more than
50% of the outstanding shares of the Fund or (2)
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67% or more of the shares present at a shareholders' meeting if more than 50%
of the outstanding shares are represented at the meeting in person or by
proxy. If a percentage restriction is adhered to at the time of an investment
or transaction, later changes in percentage resulting from a change in values
of portfolio securities or the amount of total assets will not be considered a
violation of any of the following limitations.
Each Fund will not:
(1) purchase securities of any one issuer if, as a result, more than 5%
of the Fund's total assets would be invested in securities of that issuer
or the Fund would own or hold more than 10% of the outstanding voting
securities of that issuer, except that up to 25% of the Fund's total assets
may be invested without regard to this limitation, and except that this
limitation does not apply to securities issued or guaranteed by the U.S.
government, its agencies and instrumentalities or to securities issued by
other investment companies.
The following interpretation applies to, but is not a part of, this
fundamental restriction: Mortgage- and asset-backed securities will not be
considered to have been issued by the same issuer by reason of the
securities having the same sponsor, and mortgage- and asset-backed
securities issued by a finance or other special purpose subsidiary that are
not guaranteed by the parent company will be considered to be issued by a
separate issuer from the parent company.
(2) purchase any security if, as a result of that purchase, 25% or more
of the Fund's total assets would be invested in securities of issuers
having their principal business activities in the same industry, except
that this limitation does not apply to securities issued or guaranteed by
the U.S. government, its agencies or instrumentalities or to municipal
securities.
(3) issue senior securities or borrow money, except as permitted under
the Investment Company Act of 1940 ("1940 Act") and then not in excess of
33 1/3% of the Fund's total assets (including the amount of the senior
securities issued but reduced by any liabilities not constituting senior
securities) at the time of the issuance or borrowing, except that the Fund
may borrow up to an additional 5% of its total assets (not including the
amount borrowed) for temporary or emergency purposes.
(4) make loans, except through loans of portfolio securities or through
repurchase agreements, provided that for purposes of this restriction, the
acquisition of bonds, debentures, other debt securities
or instruments, or participations or other interests therein and
investments in government obligations, commercial paper, certificates of
deposit, bankers' acceptances or similar instruments will not be considered
the making of a loan.
(5) engage in the business of underwriting securities of other issuers,
except to the extent that the Fund might be considered an underwriter under
the federal securities laws in connection with its disposition of portfolio
securities.
(6) purchase or sell real estate, except that investments in securities
of issuers that invest in real estate and investments in mortgage-backed
securities, mortgage participations or other instruments supported by
interests in real estate are not subject to this limitation, and except
that the Fund may exercise rights under agreements relating to such
securities, including the right to enforce security interests and to hold
real estate acquired by reason of such enforcement until that real estate
can be liquidated in an orderly manner.
(7) purchase or sell physical commodities unless acquired as a result of
owning securities or other instruments, but the Fund may purchase, sell or
enter into financial options and futures, forward and spot currency
contracts, swap transactions and other financial contracts or derivative
instruments.
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NON-FUNDAMENTAL LIMITATIONS. The following investment restrictions may be
changed by the vote of a Fund's board without shareholder approval:
Each Fund may not:
(1) invest more than 10% of its net assets in illiquid securities, a term
that means securities that cannot be disposed of within seven days in the
ordinary course of business at approximately the amount at which the Fund
has valued the securities and includes, among other things, repurchase
agreements maturing in more than seven days;
(2) purchase securities on margin, except for short-term credit necessary
for clearance of portfolio transactions and except that the Fund may make
margin deposits in connection with its use of financial options and
futures, forward and spot currency contracts, swap transactions and other
financial contracts or derivative instruments;
(3) engage in short sales of securities or maintain a short position,
except that the Fund may (a) sell short "against the box" and (b) maintain
short positions in connection with its use of financial options and
futures, forward and spot currency contracts, swap transactions and other
financial contracts or derivative instruments;
(4) purchase securities of other investment companies, except to the
extent permitted by the 1940 Act and except that this limitation does not
apply to securities received or acquired as dividends, through offers of
exchange, or as a result of reorganization, consolidation or merger;
(5) purchase portfolio securities while borrowings in excess of 5% of its
total assets are outstanding.
HEDGING AND RELATED STRATEGIES
As discussed in the Prospectus, Mitchell Hutchins may use a variety of
financial instruments ("Strategic Instruments"), including certain options,
futures contracts (sometimes referred to as "futures") and options on futures
contracts, to attempt to hedge the Funds' portfolios and to enhance income or
return. A Fund may enter into transactions involving one or more types of
Strategic Instruments under which the full value of its portfolio is at risk,
and Tactical Allocation Fund, in particular, may use Strategic Investments to
this extent in reallocating its exposure to different asset classes when the
Tactical Allocation Model's recommended asset allocation mix changes. Under
other circumstances, however, a Fund's use of these instruments will place at
risk a much smaller portion of its assets. Balanced Fund may also enter into
certain interest rate protection transactions. Balanced Fund may use all of
the instruments identified below. Tactical Allocation Fund is limited to stock
index options and futures, futures on five-year U.S. Treasury notes and
options on these permitted futures contracts.
OPTIONS ON EQUITY AND DEBT SECURITIES--A call option is a short-term
contract pursuant to which the purchaser of the option, in return for a
premium, has the right to buy the security underlying the option at a
specified price at any time during the term of the option. The writer of
the call option, who receives the premium, has the obligation, upon
exercise of the option during the option term, to deliver the underlying
security against payment of the exercise price. A put option is a similar
contract that gives its purchaser, in return for a premium, the right to
sell the underlying security at a specified price during the option term.
The writer of the put option, who receives the premium, has the obligation,
upon exercise of the option during the option term, to buy the underlying
security at the exercise price.
OPTIONS ON INDEXES--An index assigns relative values to the securities
included in the index and fluctuates with changes in the market values of
these securities. Index options operate in the same way as
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more traditional options, except that the exercise of an index option is
effected with cash payment and does not involve delivery of securities.
Thus, upon exercise of an index option, the purchaser will realize, and the
writer will pay, an amount based on the difference between the exercise
price and the closing price of the index.
INDEX FUTURES CONTRACT--An index futures contract is a bilateral
agreement pursuant to which one party agrees to accept, and the other party
agrees to make, delivery of an amount of cash equal to a specified dollar
amount times the difference between the index value at the close of trading
of the contract and the price at which the futures contract is originally
struck. No physical delivery of the securities comprising the index is
made. Generally, contracts are closed out prior to the expiration date of
the contract.
INTEREST RATE FUTURES CONTRACTS--Interest rate futures contracts are
bilateral agreements pursuant to which one party agrees to make, and the
other party agrees to accept, delivery of a specified type of debt security
at a specified future time and at a specified price. Although such futures
contracts by their terms call for actual delivery or acceptance of debt
securities, in most cases the contracts are closed out before the
settlement date without the making or taking of delivery.
OPTIONS ON FUTURES CONTRACTS--Options on futures contracts are similar to
options on securities, except that an option on a futures contract gives
the purchaser the right, in return for the premium, to assume a position in
a futures contract (a long position if the option is a call and a short
position if the option is a put), rather than to purchase or sell a
security, at a specified price at any time during the option term. Upon
exercise of the option, the delivery of the futures position to the holder
of the option will be accompanied by delivery of the accumulated balance
that represents the amount by which the market price of the futures
contract exceeds, in the case of a call, or is less than, in the case of a
put, the exercise price of the option on the future. The writer of an
option, upon exercise, will assume a short position in the case of a call
and a long position in the case of a put.
GENERAL DESCRIPTION OF HEDGING STRATEGIES. Hedging strategies can be broadly
categorized as "short hedges" and "long hedges." A short hedge is a purchase
or sale of a Strategic Instrument intended partially or fully to offset
potential declines in the value of one or more investments held in a Fund's
portfolio. Thus, in a short hedge a Fund takes a position in a Strategic
Instrument whose price is expected to move in the opposite direction of the
price of the investment being hedged. For example, a Fund might purchase a put
option on a security to hedge against a potential decline in the value of that
security. If the price of the security declined below the exercise price of
the put, the Fund could exercise that put and thus limit its loss below the
exercise price to the premium paid plus transaction costs. In the alternative,
because the value of the put option can be expected to increase as the value
of the underlying security declines, the Fund might be able to close out the
put option and realize a gain to offset the decline in the value of the
security.
Conversely, a long hedge is a purchase or sale of a Strategic Instrument
intended partially or fully to offset potential increases in the acquisition
cost of one or more investments that a Fund intends to acquire. Thus, in a
long hedge a Fund takes a position in a Strategic Instrument whose price is
expected to move in the same direction as the price of the prospective
investment being hedged. For example, a Fund might purchase a call option on a
security it intends to purchase in order to hedge against an increase in the
cost of the security. If the price of the security increased above the
exercise price of the call, the Fund could exercise the call and thus limit
its acquisition cost to the exercise price plus the premium paid and
transaction costs. Alternatively, the Fund might be able to offset the price
increase by closing out an appreciated call option and realizing a gain.
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Each Fund may purchase and write (sell) covered straddles on securities or
indices of securities. A long straddle is a combination of a call and a put
option purchased on the same security or on the same futures contract, where
the exercise price of the put is less than or equal to the exercise price of
the call. The Fund might enter into a long straddle when Mitchell Hutchins
believes it likely that interest rates will be more volatile during the term
of the option than the option pricing implies. A short straddle is a
combination of a call and a put written on the same security where the
exercise price of the put is less than or equal to the exercise price of the
call. A Fund might enter into a short straddle when Mitchell Hutchins believes
it unlikely that interest rates will be as volatile during the term of the
option as the option pricing implies.
Strategic Instruments on securities generally are used to hedge against
price movements in one or more particular securities positions that a Fund
owns or intends to acquire. Strategic Instruments on stock indices or debt
securities, in contrast, may be used to hedge either individual securities or
broad equity market sectors. Strategic Instruments on debt securities may be
used to hedge either individual securities or broad fixed income market
sectors.
Income strategies include the writing of covered options to obtain the
related option premiums. Return strategies include the use of Strategic
Instruments to increase or reduce a Fund's exposure to an asset class without
buying or selling the underlying instruments.
The use of Strategic Instruments is subject to applicable regulations of the
SEC, the several options and futures exchanges upon which they are traded and
the Commodity Futures Trading Commission ("CFTC"). In addition, the Funds'
ability to use Strategic Instruments will be limited by tax considerations.
See "Taxes."
In addition to the products, strategies and risks described below and in the
Prospectus, Mitchell Hutchins expects to discover additional opportunities in
connection with options, futures contracts and other hedging, income and
return strategies. These new opportunities may become available as Mitchell
Hutchins develops new techniques, as regulatory authorities broaden the range
of permitted transactions and as new options, futures contracts or other
techniques are developed. Mitchell Hutchins may utilize these opportunities to
the extent that they are consistent with a Fund's investment objective and
permitted by a Fund's investment limitations and applicable regulatory
authorities. The Funds' Prospectus or Statement of Additional Information will
be supplemented to the extent that new products or techniques involve
materially different risks than those described below or in the Prospectus.
SPECIAL RISKS OF HEDGING AND RELATED STRATEGIES. The use of Strategic
Instruments involves special considerations and risks, as described below.
Risks pertaining to particular Strategic Instruments are described in the
sections that follow:
(1) Successful use of most Strategic Instruments depends upon Mitchell
Hutchins' ability to predict movements of the overall securities and interest
rate markets, which requires different skills than predicting changes in the
prices of individual securities. While Mitchell Hutchins is experienced in the
use of Strategic Instruments, there can be no assurance that any particular
strategy adopted will succeed.
(2) There might be imperfect correlation, or even no correlation, between
price movements of a Strategic Instrument and price movements of the
investments being hedged. For example, if the value of a Strategic Instrument
used in a short hedge increased by less than the decline in value of the
hedged investment, the hedge would not be fully successful. Such a lack of
correlation might occur due to factors unrelated to the value of the
investments being hedged, such as speculative or other pressures on the
markets in which Strategic Instruments are traded. The effectiveness of hedges
using Strategic Investments in indices will depend on the degree of
correlation between price movements in the index and price movements in the
securities being hedged.
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(3) Hedging strategies, if successful, can reduce risk of loss by wholly or
partially offsetting the negative effect of unfavorable price movements in the
investments being hedged. However, hedging strategies can also reduce
opportunity for gain by offsetting the positive effect of favorable price
movements in the hedged investments. For example, if a Fund entered into a
short hedge because Mitchell Hutchins projected a decline in the price of a
security in the Fund's portfolio, and the price of that security increased
instead, the gain from that increase might be wholly or partially offset by a
decline in the price of the Strategic Instrument. Moreover, if the price of
the Strategic Instrument declined by more than the increase in the price of
the security, the Fund could suffer a loss. In either such case, the Fund
would have been in a better position had it not hedged at all.
(4) As described below, each Fund might be required to maintain assets as
"cover," maintain segregated accounts or make margin payments when it takes
positions in Strategic Instruments involving obligations to third parties
(i.e., Strategic Instruments other than purchased options). If a Fund were
unable to close out its positions in such Strategic Instruments, it might be
required to continue to maintain such assets or accounts or make such payments
until the position expired or matured. These requirements might impair a
Fund's ability to sell a portfolio security or make an investment at a time
when it would otherwise be favorable to do so, or require that the Fund sell a
portfolio security at a disadvantageous time. A Fund's ability to close out a
position in a Strategic Instrument prior to expiration or maturity depends on
the existence of a liquid secondary market or, in the absence of such a
market, the ability and willingness of a contra party to enter into a
transaction closing out the position. Therefore, there is no assurance that
any position in a Strategic Instrument can be closed out at a time and price
that is favorable to a Fund.
COVER FOR HEDGING AND RELATED STRATEGIES. Transactions using Strategic
Instruments, other than purchased options, expose the Funds to an obligation
to another party. A Fund will not enter into any such transactions unless it
owns either (1) an offsetting ("covered") position in securities or other
options on futures contracts or (2) cash, receivables and liquid securities,
with a value sufficient at all times to cover its potential obligations to the
extent not covered as provided in (1) above. The Funds will comply with SEC
guidelines regarding cover for hedging transactions and will, if the
guidelines so require, set aside cash or liquid securities in a segregated
account with its custodian in the prescribed amount.
Assets used as cover or held in a segregated account cannot be sold while
the position in the corresponding Strategic Instrument is open, unless they
are replaced with similar assets. As a result, the commitment of a large
portion of a Fund's assets to cover or segregated accounts could impede
portfolio management or the Fund's ability to meet redemption requests or
other current obligations.
OPTIONS. The Funds may purchase put and call options, and write (sell)
covered put and call options, on specific securities. The purchase of options
can serve to enhance return by increasing or reducing a Fund's exposure to an
asset class without purchasing or selling the underlying securities. The
purchase of call options serves as a long hedge, and the purchase of put
options serves as a short hedge. Writing covered put or call options can
enable a Fund to enhance income by reason of the premiums paid by the
purchasers of such options. In addition, writing covered put options serves as
a limited long hedge, because increases in the value of the hedged investment
would be offset to the extent of the premium received for writing the option.
However, if the market price of the security underlying a covered put option
declines to less than the exercise price of the option, minus the premium
received, the Fund would expect to suffer a loss. Writing covered call options
serves as a limited short hedge, because declines in the value of the hedged
investment would be offset to the extent of the premium received for writing
the option. However, if the security appreciates to a price higher than the
exercise price of the call option, it can be expected that the option will be
exercised and
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the Fund will be obligated to sell the security at less than its market value.
The securities or other assets used as cover for OTC options written by the
Funds would be considered illiquid to the extent described above under
"Investment Policies and Restrictions--Illiquid Securities."
The value of an option position will reflect, among other things, the
current market value of the underlying investment, the time remaining until
expiration, the relationship of the exercise price to the market price of the
underlying investment, the historical price volatility of the underlying
investment and general market conditions. Options normally have expiration
dates of up to nine months. Generally, OTC options on debt securities are
European-style options. This means that the option is only exercisable
immediately prior to its expiration. This is in contrast to American-style
options, which are exercisable at any time prior to the expiration date of the
option. Options that expire unexercised have no value.
The Funds may effectively terminate their rights or obligations under an
option by entering into a closing transaction. For example, the Fund may
terminate its obligation under a call or put option that it had written by
purchasing an identical call or put option; this is known as a closing
purchase transaction. Conversely, a Fund may terminate a position in a put or
call option it had purchased by writing an identical put or call option; this
is known as a closing sale transaction. Closing transactions permit the Funds
to realize profits or limit losses on an option position prior to its exercise
or expiration.
The Funds may purchase or write both exchange-traded and OTC options.
Exchange markets for options on debt securities exist but are relatively new,
and these instruments are primarily traded on the OTC market. Exchange-traded
options in the United States are issued by a clearing organization affiliated
with the exchange on which the option is listed which, in effect, guarantees
completion of every exchange-traded option transaction. In contrast, OTC
options are contracts between a Fund and its contra party (usually a
securities dealer or a bank) with no clearing organization guarantee. Thus,
when a Fund purchases or writes an OTC option, it relies on the contra party
to make or take delivery of the underlying investment upon exercise of the
option. Failure by the contra party to do so would result in the loss of any
premium paid by the Fund as well as the loss of any expected benefit of the
transaction. The Funds will enter into OTC option transactions only with
contra parties that have a net worth of at least $20 million.
The Funds' ability to establish and close out positions in exchange-traded
options depends on the existence of a liquid market. Each Fund intends to
purchase or write only those exchange-traded options for which there appears
to be a liquid secondary market. However, there can be no assurance that such
market will exist at any particular time. Closing transactions can be made for
OTC options only by negotiating directly with the contra party, or by a
transaction in the secondary market if any such market exists. Although the
Funds will enter into OTC options only with contra parties that are expected
to be capable of entering into closing transactions with the Fund, there is no
assurance that a Fund will in fact be able to close out an OTC option position
at a favorable price prior to expiration. In the event of insolvency of the
contra party, a Fund might be unable to close out an OTC option position at
any time prior to its expiration.
If a Fund were unable to effect a closing transaction for an option it had
purchased, it would have to exercise the option to realize any profit. The
inability to enter into a closing purchase transaction for a covered call
option written by a Fund could cause material losses because the Fund would be
unable to sell the investment used as cover for the written option until the
option expires or is exercised.
The Funds may purchase and write put and call options on common stock
indices or indices of debt securities in much the same manner as the more
traditional options discussed above, except the index options may serve as a
hedge against overall fluctuations in the equity or debt securities market (or
market sectors) rather than anticipated increases or decreases in the value of
a particular security.
17
<PAGE>
GUIDELINES FOR OPTIONS. The Funds' use of options is governed by the
following guidelines, which can be changed by each board without shareholder
vote:
1. Each Fund may purchase a put or call option, including any straddles or
spreads, only if the value of its premium, when aggregated with the premiums
on all other options purchased by the Fund, does not exceed 5% of the Fund's
total assets.
2. The aggregate value of securities underlying put options written by each
Fund, determined as of the date the put options are written, will not exceed
50% of the Fund's net assets.
3. The aggregate premiums paid on all options (including options on
securities, stock indices and indices of debt securities and options on
futures contracts) purchased by each Fund that are held at any time will not
exceed 20% of the Fund's net assets.
FUTURES. The Funds may purchase and sell interest rate futures contracts,
stock index futures contracts or debt securities index futures contracts. The
Funds also may purchase put and call options, and write covered put and call
options, on the futures contracts they are allowed to purchase and sell. The
purchase of futures or call options thereon can serve as a long hedge, and the
sale of futures or the purchase of put options thereon can serve as a short
hedge. Writing covered call options on futures contracts can serve as a
limited short hedge, and writing covered put options on futures contracts can
serve as a limited long hedge, using a strategy similar to that used for
writing covered call options on securities or indices. In addition, Balanced
Fund may purchase or sell futures contracts or options thereon to enhance
return by increasing or reducing the Fund's exposure to an asset class without
purchasing or selling the underlying securities.
Futures strategies also can be used to manage the average duration of a
Fund's portfolio. If Mitchell Hutchins wishes to shorten the average duration
of a Fund, the Fund may sell an interest rate futures contract or a call
option thereon, or purchase a put option on that futures contract. If Mitchell
Hutchins wishes to lengthen the average duration of a Fund, the Fund may buy
an interest rate futures contract or a call option thereon or sell a put
option thereon.
The Funds may also write put options on interest rate futures contracts
while at the same time purchasing call options on the same futures contracts
in order synthetically to create a long futures contract position. Such
options would have the same strike prices and expiration dates. A Fund will
engage in this strategy only when it is more advantageous to the Fund than is
purchasing the futures contract.
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract, a Fund is required to deposit in a segregated
account with its custodian, in the name of the futures broker through whom the
transaction was effected, "initial margin" consisting of cash, obligations of
the United States or obligations that are fully guaranteed as to principal and
interest by the United States, in an amount generally equal to 10% or less of
the contract value. Margin must also be deposited when writing a call option
on a futures contract, in accordance with applicable exchange rules. Unlike
margin in securities transactions, initial margin on futures contracts does
not represent a borrowing, but rather is in the nature of a performance bond
or good-faith deposit that is returned to the Fund at the termination of the
transaction if all contractual obligations have been satisfied. Under certain
circumstances, such as periods of high volatility, a Fund may be required by
an exchange to increase the level of its initial margin payment, and initial
margin requirements might be increased generally in the future by regulatory
action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve
18
<PAGE>
borrowing, but rather represents a daily settlement of a Fund's obligations to
or from a futures broker. When a Fund purchases an option on a future, the
premium paid plus transaction costs is all that is at risk. In contrast, when
a Fund purchases or sells a futures contract or writes a put or call option
thereon, it is subject to daily variation margin calls that could be
substantial in the event of adverse price movements. If a Fund has
insufficient cash to meet daily variation margin requirements, it might need
to sell securities at a time when such sales are disadvantageous.
Holders and writers of futures positions and options on futures can enter
into offsetting closing transactions, similar to closing transactions on
options, by selling or purchasing, respectively, an instrument identical to
the instrument held or written. Positions in futures and options on futures
may be closed only on an exchange or board of trade that provides a secondary
market. Each Fund intends to enter into futures transactions only on exchanges
or boards of trade where there appears to be a liquid, secondary market.
However, there can be no assurance that such a market will exist for a
particular contract at a particular time.
Under certain circumstances, futures exchanges may establish daily limits on
the amount that the price of a future or related option can vary from the
previous day's settlement price; once that limit is reached, no trades may be
made that day at a price beyond the limit. Daily price limits do not limit
potential losses because prices could move to the daily limit for several
consecutive days with little or no trading, thereby preventing liquidation of
unfavorable positions.
If a Fund were unable to liquidate a futures or options position due to the
absence of a liquid secondary market or the imposition of price limits, it
could incur substantial losses. The Fund would continue to be subject to
market risk with respect to the position. In addition, except in the case of
purchased options, the Fund would continue to be required to make daily
variation margin payments and might be required to maintain the position being
hedged by the future or option or to maintain cash or securities in a
segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or related options might not
correlate perfectly with movements in the prices of the investments being
hedged. For example, all participants in the futures and related options
markets are subject to daily variation margin calls and might be compelled to
liquidate futures or related options positions whose prices are moving
unfavorably to avoid being subject to further calls. These liquidations could
increase price volatility of the instruments and distort the normal price
relationship between the futures or options and the investments being hedged.
Also, because initial margin deposit requirements in the futures market are
less onerous than margin requirements in the securities markets, there might
be increased participation by speculators in the futures markets. This
participation also might cause temporary price distortions. In addition,
activities of large traders in both the futures and securities markets
involving arbitrage, "program trading" and other investment strategies might
result in temporary price distortions.
GUIDELINES FOR FUTURES AND RELATED OPTIONS. The Funds' use of futures and
related options is governed by the following guidelines, which can be changed
by each board without shareholder vote:
1. To the extent a Fund enters into futures contracts and options on futures
positions traded on a commodities exchange that are not for bona fide hedging
purposes (as defined by the CFTC), the aggregate initial margin and premiums
on those positions (excluding the amount by which options are "in-the-money")
may not exceed 5% of the Fund's net assets.
19
<PAGE>
2. The aggregate premiums paid on all options (including options on
securities, stock indices and indices of debt securities and options on
futures contracts) purchased by a Fund that are held at any time will not
exceed 20% of the Fund's net assets.
3. The aggregate margin deposits on all futures contracts and options
thereon held at any time by a Fund will not exceed 5% of the Fund's total
assets.
INTEREST RATE PROTECTION TRANSACTIONS. Balanced Fund may enter into interest
rate protection transactions, including interest rate swaps and interest rate
caps, collars and floors. Interest rate swap transactions involve an agreement
between two parties to exchange payments that are based, for example, on
variable and fixed rates of interest and that are calculated on the basis of a
specified amount of principal (the "notional principal amount") for a
specified period of time. Interest rate cap and floor transactions involve an
agreement between two parties in which the first party agrees to make payments
to the counterparty when a designated market interest rate goes above (in the
case of a cap) or below (in the case of a floor) a designated level on
predetermined dates or during a specified time period. Interest rate collar
transactions involve an agreement between two parties in which payments are
made when a designated market interest rate either goes above a designated
ceiling level or goes below a designated floor level on predetermined dates or
during a specified time period. The Fund intends to use these transactions as
a hedge and not as a speculative investment. Interest rate protection
transactions are subject to risks comparable to those described above with
respect to other hedging strategies.
Balanced Fund may enter into interest rate swaps, caps, collars and floors
on either an asset-based or liability-based basis, depending on whether it is
hedging its assets or its liabilities, and will usually enter into interest
rate swaps on a net basis, i.e., the two payment streams are netted out, with
the Fund receiving or paying, as the case may be, only the net amount of the
two payments. Inasmuch as these interest rate protection transactions are
entered into for good faith hedging purposes, and inasmuch as segregated
accounts will be established with respect to such transactions, Mitchell
Hutchins believes such obligations do not constitute senior securities and,
accordingly, will not treat them as being subject to the Fund's borrowing
restrictions. The net amount of the excess, if any, of the Fund's obligations
over its entitlements with respect to each interest rate swap will be accrued
on a daily basis and appropriate Fund assets having an aggregate net asset
value at least equal to the accrued excess will be maintained in a segregated
account as described above in "Investment Policies and Restrictions--
Segregated Accounts." The Fund also will establish and maintain such
segregated accounts with respect to its total obligations under any interest
rate swaps that are not entered into on a net basis and with respect to any
interest rate caps, collars and floors that are written by the Fund.
Balanced Fund will enter into interest rate protection transactions only
with banks and recognized securities dealers believed by Mitchell Hutchins to
present minimal credit risk in accordance with guidelines established by its
board. If there is a default by the other party to such a transaction, the
Fund will have to rely on its contractual remedies (which may be limited by
bankruptcy, insolvency or similar laws) pursuant to the agreements related to
the transaction.
The swap market has grown substantially in recent years with a large number
of banks and investment banking firms acting both as principals and as agents
utilizing standardized swap documentation. Caps, collars and floors are more
recent innovations for which documentation is less standardized, and
accordingly, they are less liquid than swaps.
20
<PAGE>
DIRECTORS, TRUSTEES AND OFFICERS; PRINCIPAL HOLDERS OF SECURITIES
The directors, trustees and executive officers of the Corporation and/or the
Trust, their ages, business addresses and principal occupations during the
past five years are:
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH CORPORATION/TRUST OTHER DIRECTORSHIPS
---------------------- ---------------------- --------------------
<S> <C> <C>
Margo N. Alexander**; 49 Director/Trustee and Mrs. Alexander is president, chief
President executive officer and a director of
Mitchell Hutchins (since January
1995) and an executive vice presi-
dent and a director of PaineWebber.
Mrs. Alexander is president and a
director or trustee of 29 invest-
ment companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Richard Q. Armstrong; 61 Director/Trustee Mr. Armstrong is chairman and prin-
78 West Brother Drive cipal of RQA Enterprises (manage-
Greenwich, CT 06830 ment consulting firm) (since April
1991 and principal occupation since
March 1995). Mr. Armstrong is also
a director of Hi Lo Automotive,
Inc. He was chairman of the board,
chief executive officer and co-
owner of Adirondack Beverages (pro-
ducer and distributor of soft
drinks and sparkling/still waters)
(October 1993-March 1995). Mr.
Armstrong was a partner of The New
England Consulting Group (manage-
ment consulting firm) (December
1992-September 1993). He was manag-
ing director of LVMH U.S. Corpora-
tion (U.S. subsidiary of the French
luxury goods conglomerate, Luis
Vuitton Moet Hennessey Corporation)
(1987-1991) and chairman of its
wine and spirits subsidiary,
Schieffelin & Somerset Company
(1987-1991). Mr. Armstrong is a di-
rector or trustee of 28 investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
E. Garrett Bewkes, Director/Trustee and Mr. Bewkes is a director of Paine
Jr.**; 70 Chairman of the Board Webber Group Inc. ("PW Group")
of Directors/Trustees (holding company of PaineWebber and
Mitchell Hutchins). Prior to Decem-
ber 1995, he was a consultant to PW
Group. Prior to 1988, he was chair-
man of the board, presi-
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH CORPORATION/TRUST OTHER DIRECTORSHIPS
---------------------- ---------------------- --------------------
<S> <C> <C>
dent and chief executive officer of
American Bakeries Company.
Mr. Bewkes is also a director of
Interstate Bakeries Corporation and
NaPro BioTherapeutics, Inc. Mr.
Bewkes is a director or trustee of
29 investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
Richard R. Burt; 49 Director/Trustee Mr. Burt is chairman of Interna-
1101 Connecticut Avenue, N.W. tional Equity Partners (interna-
Washington, D.C. 20036 tional investments and consulting
firm) (since March 1994) and a
partner of McKinsey & Company (man-
agement consulting firm) (since
1991). He is also a director of
American Publishing Company and Ar-
cher-Daniels-Midland Co. (agricul-
tural commodities). He was the
chief negotiator in the Strategic
Arms Reduction Talks with the for-
mer Soviet Union (1989-1991) and
the U.S. Ambassador to the Federal
Republic of Germany (1985-1989).
Mr. Burt is a director or trustee
of 28 investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Mary C. Farrell**; 47 Director/Trustee Ms. Farrell is a managing director,
senior investment strategist and
member of the Investment Policy
Committee of PaineWebber. Ms.
Farrell joined PaineWebber in 1982.
She is a member of the Financial
Women's Association and Women's
Economic Roundtable, and is em-
ployed as a regular panelist on
Wall $treet Week with Louis
Rukeyser. She also serves on the
Board of Overseers of New York
University's Stern School of Busi-
ness. Ms. Farrell is a director or
trustee of 28 investment companies
for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Meyer Feldberg; 54 Director/Trustee Dean Feldberg is Dean and Professor
Columbia University of Management of the Graduate
101 Uris Hall School of Business, Columbia Uni-
New York, New York 10027 versity. Prior to 1989, he was
president of the Illinois In-
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH CORPORATION/TRUST OTHER DIRECTORSHIPS
---------------------- ---------------------- --------------------
<S> <C> <C>
stitute of Technology. Dean
Feldberg is also a director of
AMSCO International Inc. (medical
instruments and supplies), Feder-
ated Department Stores, Inc. and
New World Communications Group In-
corporated. Dean Feldberg is a di-
rector or trustee of 28 investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
George W. Gowen; 68 Director/Trustee Mr. Gowen is a partner in the law
666 Third Avenue firm of Dunnington, Bartholow &
New York, New York 10017 Miller. Prior to May 1994, he was a
partner in the law firm of Fryer,
Ross & Gowen. Mr. Gowen is a direc-
tor of Columbia Real Estate Invest-
ments, Inc. Mr. Gowen is a director
or trustee of 28 investment compa-
nies for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Frederic V. Malek; 60 Director/Trustee Mr. Malek is chairman of Thayer Cap-
1455 Pennsylvania Avenue, N.W. ital Partners (investment bank) and
Suite 350 a co-chairman and director of CB
Washington, D.C. 20004 Commercial Group Inc. (real es-
tate). From January 1992 to Novem-
ber 1992, he was campaign manager
of Bush-Quayle '92. From 1990 to
1992, he was vice chairman and,
from 1989 to 1990, he was president
of Northwest Airlines Inc., NWA
Inc. (holding company of Northwest
Airlines Inc.) and Wings Holdings
Inc. (holding company of NWA Inc.).
Prior to 1989, he was employed by
the Marriott Corporation (hotels,
restaurants, airline catering and
contract feeding), where he most
recently was an executive vice
president and president of Marriott
Hotels and Resorts. Mr. Malek is
also a director of American Manage-
ment Systems, Inc. (management con-
sulting and computer-related serv-
ices), Automatic Data Processing,
Inc., CB Commercial Group, Inc.
(real estate services), Choice Ho-
tels International (hotel and hotel
franchising), FPL Group, Inc.
(electric services), Integra, Inc.
(bio-medical), ManorCare, Inc.
(healthcare), National Education
Corpo-
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH CORPORATION/TRUST OTHER DIRECTORSHIPS
- ---------------------- ---------------------- --------------------
<S> <C> <C>
ration and Northwest Airlines Inc.
Mr. Malek is a director or trustee
of 28 investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Carl W. Schafer; 60 Director/Trustee Mr. Schafer is president of the At-
P.O. Box 1164 lantic Foundation (charitable foun-
Princeton, New Jersey dation supporting mainly oceano-
08542 graphic exploration and research).
He also is a director of Roadway
Express, Inc. (trucking), The
Guardian Group of Mutual Funds, Ev-
ans Systems, Inc. (a motor fuels,
convenience store and diversified
company), Electronic Clearing
House, Inc. (financial transactions
processing), Wainoco Oil Corpora-
tion and Nutraceutix Inc. (biotech-
nology). Prior to January 1993, Mr.
Schafer was chairman of the Invest-
ment Advisory Committee of the How-
ard Hughes Medical Institute. Mr.
Schafer is a director or trustee of
28 investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
John R. Torell III; 57 Director/Trustee Mr. Torell is chairman of Torell
767 Fifth Avenue Management, Inc. (financial advi-
Suite 4605 sory firm), chairman of Telesphere
New York, NY 10153 Corporation (electronic provider of
financial information), and a part-
ner of Zilkha & Company (merchant
banking and private investment com-
pany). He is the former chairman
and chief executive officer of For-
tune Bancorp (1990-1991 and 1990-
1994, respectively), the former
chairman, president and chief exec-
utive officer of CalFed, Inc. (sav-
ings association) (1988 to 1989)
and former president of Manufactur-
ers Hanover Corp. (bank)
(prior to 1988). Mr. Torell is a
director of American Home Products
Corp., New Colt Inc. (armament man-
ufacturer) and Volt Information
Sciences Inc. Mr. Torell is a di-
rector or trustee of 28 in-
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH CORPORATION/TRUST OTHER DIRECTORSHIPS
- ---------------------- ---------------------- --------------------
<S> <C> <C>
vestment companies for which Mitch-
ell Hutchins or PaineWebber serves
as investment adviser.
T. Kirkham Barneby; 50 Vice President Mr. Barneby is a managing director
and chief investment officer--quan-
titative investments of Mitchell
Hutchins. Prior to September 1994,
he was a senior vice president at
Vantage Global Management. Prior to
June 1993, he was a senior vice
president at Mitchell Hutchins. Mr.
Barneby is a vice president of five
investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
Teresa M. Boyle; 38 Vice President Ms. Boyle is a first vice president
of Mitchell Hutchins. Prior to No-
vember 1993, she was compliance
manager of Hyperion Capital
Management, Inc., an investment
advisory firm. Prior to April 1993,
Ms. Boyle was a vice president and
manager--legal administration of
Mitchell Hutchins. Ms. Boyle is a
vice president of 29 investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
C. William Maher; 35 Vice President and Mr. Maher is a first vice president
Assistant Treasurer and a senior manager of the mutual
fund finance division of Mitchell
Hutchins. Mr. Maher is a vice pres-
ident and assistant treasurer of 29
investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
Dennis McCauley; 50 Vice President Mr. McCauley is a managing director
(Master Series, and chief investment officer--fixed
Inc.) income of Mitchell Hutchins. Prior
to December 1994, he was director
of fixed income investments of IBM
Corporation. Mr. McCauley is a vice
president of 18 investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
</TABLE>
25
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH CORPORATION/TRUST OTHER DIRECTORSHIPS
---------------------- ---------------------- --------------------
<S> <C> <C>
Ann E. Moran; 39 Vice President Ms. Moran is a vice president of
and Assistant Mitchell Hutchins. Ms. Moran is a
Treasurer vice president and assistant trea-
surer of 29 investment companies
for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Dianne E. O'Donnell; 44 Vice President and Ms. O'Donnell is a senior vice pres-
Secretary ident and deputy general counsel of
Mitchell Hutchins. Ms. O'Donnell is
a vice presi- dent and secretary of
28 investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
Emil Polito; 36 Vice President Mr. Polito is a senior vice presi-
dent and director of operations and
control for Mitchell Hutchins. From
March 1991 to September 1993 he was
director of the Mutual Funds Sales
Support and Service Center for
Mitchell Hutchins and PaineWebber.
Mr. Polito is also vice president
of 29 investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Susan P. Ryan; 36 Vice President Ms. Ryan is a senior vice president
(Master Series, and portfolio manager of Mitchell
Inc.) Hutchins. Ms. Ryan has been with
Mitchell Hutchins since 1982. Ms.
Ryan is a vice president of five
investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
Victoria E. Schonfeld; Vice President Ms. Schonfeld is a managing director
46 and general counsel of Mitchell
Hutchins. Prior to May 1994, she
was a partner in the law firm of
Arnold & Porter. Ms. Schonfeld is
a vice president of 29 investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Paul H. Schubert; 33 Vice President Mr. Schubert is a first vice presi-
and Assistant dent and a senior manager of the
Treasurer mutual fund finance division of
Mitchell Hutchins.
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH CORPORATION/TRUST OTHER DIRECTORSHIPS
- ---------------------- ---------------------- --------------------
<S> <C> <C>
From August 1992 to August 1994, he
was a vice president of BlackRock
Financial Management L.P. Prior to
August 1992, he was an audit man-
ager with Ernst & Young LLP. Mr.
Schubert is a vice president and
assistant treasurer of 29 invest-
ment companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Nirmal Singh; 40 Vice President Mr. Singh is a first vice president
(Master Series, and a portfolio manager of Mitchell
Inc.) Hutchins. Prior to September 1993,
he was a member of the portfolio
management team at Merrill Lynch
Asset Management, Inc. Mr. Singh is
a vice president of five investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Julian F. Sluyters; 36 Vice President and Mr. Sluyters is a senior vice presi-
Treasurer dent and the director of the mutual
fund finance division of Mitchell
Hutchins. Mr. Sluyters is a vice
president and treasurer of 29 other
investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
Mark A. Tincher; 41 Vice President Mr. Tincher is a managing director
and chief investment officer--U.S.
equity investments of Mitchell
Hutchins. Prior to March 1995, he
was a vice president and directed
the U.S. funds management and eq-
uity research areas of Chase Man-
hattan Private Bank. Mr. Tincher is
a vice president of 13 investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Craig M. Varrelman; 38 Vice President Mr. Varrelman is a first vice presi-
(Master Series, dent and a portfolio manager of
Inc.) Mitchell Hutchins.
Mr. Varrelman is a vice president
of five investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
NAME AND ADDRESS*; POSITION BUSINESS EXPERIENCE;
AGE WITH CORPORATION/TRUST OTHER DIRECTORSHIPS
------------------ ---------------------- --------------------
<S> <C> <C>
Keith A. Weller; 35 Vice President and Mr. Weller is a first vice president
Assistant Secretary and associate general counsel of
Mitchell Hutchins. Prior to May
1995, he was an attorney in private
practice. Mr. Weller is a vice
president and assistant secretary
of 28 investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
</TABLE>
- --------
* Unless otherwise indicated, the business address of each listed person is
1285 Avenue of the Americas, New York, New York 10019.
** Mrs. Alexander, Mr. Bewkes and Ms. Farrell are "interested persons" of the
Corporation and the Trust as defined in the 1940 Act by virtue of their
positions with PW Group, PaineWebber and/or Mitchell Hutchins.
The Corporation and the Trust each pays directors/trustees who are not
"interested persons" of the Corporation/Trust $1,500 annually for Balanced
Fund or Tactical Allocation Fund, as applicable, an additional $1,000 for the
Corporation's or Trust's second series, and $150 for each board meeting and
separate meeting of a board committee (that is, committee meetings that are
not held on the same day as a board meeting). Thus, the Corporation and Trust
each pays an independent board member $2,500 annually plus any additional
amounts due for board or committee meetings. Messrs Feldberg and Torell serve
as chairmen of the audit and contract review committees of individual funds
within the PaineWebber fund complex and receive additional annual
compensation, aggregating $15,000 each from the relevant funds. All board
members are reimbursed for any expenses incurred in attending meetings. Board
members and officers of the Corporation/Trust own in the aggregate less than
1% of the shares of either Fund. Because PaineWebber and Mitchell Hutchins
perform substantially all of the services necessary for the operation of the
Corporation, the Trust and the Funds, the Corporation and the Trust require no
employees. No officer, director or employee of PaineWebber or Mitchell
Hutchins presently receives any compensation from the Corporation or the Trust
for acting as director, trustee or officer.
28
<PAGE>
The table below includes certain information relating to the compensation of
the Corporation's and the Trust's current board members who held office with
the Corporation or Trust or with other PaineWebber funds during the fiscal
year indicated.
COMPENSATION TABLE
<TABLE>
<CAPTION>
TOTAL
COMPENSATION
FROM THE
AGGREGATE CORPORATION,
COMPENSATION AGGREGATE THE TRUST
FROM THE COMPENSATION AND THE
NAME OF PERSON, POSITION CORPORATION* FROM THE TRUST* COMPLEX+
- ------------------------ ------------ --------------- ------------
<S> <C> <C> <C>
Richard Q. Armstrong,
Director/Trustee................... $ 619 $ 616 $59,873
Richard R. Burt, Director/Trustee... 619 616 51,173
Meyer Feldberg, Director/Trustee.... 2,864 616 96,181
George W. Gowen, Director/Trustee... 2,864 616 92,431
Frederic V. Malek,
Director/Trustee................... 2,864 616 92,431
Carl W. Schafer, Director/Trustee... 619 10,611 62,307
John R. Torell III,
Director/Trustee................... 619 616 60,123
</TABLE>
- --------
Only independent members of the board are compensated by the Corporation or
the Trust and identified above; board members who are "interested persons," as
defined by the 1940 Act, do not receive compensation.
* Represents fees paid to each board member during the period March 1, 1996
through August 31, 1996 for the Corporation and for the fiscal year ended
August 31, 1996 for the Trust.
+ Represents total compensation paid to each board member during the calendar
year ended December 31, 1996; no fund within the fund complex has a pension
or retirement plan.
++ Aggregate compensation for the Corporation and the Trust are divided among
other portfolios.
PRINCIPAL HOLDERS OF SECURITIES. The Funds' records as of November 29, 1996
did not indicate that any shareholder owned more than 5% of any class of a
Fund's shares.
29
<PAGE>
INVESTMENT ADVISORY AND DISTRIBUTION ARRANGEMENTS
INVESTMENT ADVISORY ARRANGEMENTS. Mitchell Hutchins acts as the investment
adviser and administrator of each Fund pursuant to a contract with the
Corporation dated August 4, 1988 and a contract with the Trust dated April 13,
1995, (each an "Advisory Contract"). Under the Advisory Contracts, and, for
Tactical Allocation Fund, substantially similar prior contracts, each Fund
pays Mitchell Hutchins an annual fee, computed daily and paid monthly,
according to the schedule set forth below:
BALANCED FUND
<TABLE>
<CAPTION>
ANNUAL
AVERAGE DAILY NET ASSETS RATE
------------------------ ------
<S> <C>
Up to $500 million................................................... 0.750%
In excess of $500 million up to $1.0 billion......................... 0.725
In excess of $1.0 billion up to $1.5 billion......................... 0.700
In excess of $1.5 billion up to $2.0 billion......................... 0.675
Over $2.0 billion.................................................... 0.650
</TABLE>
TACTICAL ALLOCATION FUND
<TABLE>
<CAPTION>
ANNUAL
AVERAGE DAILY NET ASSETS RATE
------------------------ ------
<S> <C>
Up to $250 million................................................. 0.500%
Over $250 million.................................................. 0.450
</TABLE>
During the period March 1, 1996 through August 31, 1996 and the fiscal years
ended February 29, 1996, February 28, 1995 and February 28, 1994, the
Corporation paid (or accrued) to Mitchell Hutchins investment advisory and
administrative fees of $739,209, $1,584,083, $1,934,650 and $2,326,697
respectively, with respect to Balanced Fund.
For the fiscal years ended August 31, 1996, August 31, 1995 and August 31,
1994, the Trust paid (or accrued) to Mitchell Hutchins and a prior investment
adviser and administrator management fees of $402,466, $279,950, and $487,304,
respectively, with respect to Tactical Allocation Fund.
Under a service agreement with the Corporation that is reviewed by the
Corporation's board of directors annually, PaineWebber provides certain
services to Balanced Fund not otherwise provided by the Fund's transfer agent.
Pursuant to the service agreement, during the period March 1, 1996 through
August 31, 1996, and the fiscal years ended February 29, 1996, February 28,
1995 and February 28, 1994. PaineWebber earned fees in the amounts of $32,992,
$77,050, $100,272 and $116,755 respectively, with respect to the Fund.
Under the terms of the Advisory Contracts, each Fund bears all expenses
incurred in its operation that are not specifically assumed by Mitchell
Hutchins. General expenses of the Corporation or the Trust not readily
identifiable as belonging to the Funds or to the Corporation's or Trust's
other series are allocated among series by or under the direction of the board
in such manner as the board deems to be fair and equitable. Expenses borne by
each Fund include the following (or the Fund's share of the following): (1)
the cost (including brokerage commissions) of securities purchased or sold by
the Fund and any losses incurred in connection therewith; (2) fees payable to
and expenses incurred on behalf of the Fund by Mitchell Hutchins; (3)
organizational expenses; (4) filing fees and expenses relating to the
registration and qualification of the Fund's shares and the Corporation/Trust
under federal and state securities laws and maintenance of such registrations
and qualifications; (5) fees and salaries payable to board members who are not
interested
30
<PAGE>
persons of the Corporation/Trust or Mitchell Hutchins; (6) all expenses
incurred in connection with the board members' services, including travel
expenses; (7) taxes (including any income or franchise taxes) and governmental
fees; (8) costs of any liability, uncollectible items of deposit and other
insurance or fidelity bonds; (9) any costs, expenses or losses arising out of
a liability of or claim for damages or other relief asserted against the
Corporation/Trust or the Fund for violation of any law; (10) legal, accounting
and auditing expenses, including legal fees of special counsel for the
independent board members; (11) charges of custodians, transfer agents and
other agents; (12) costs of preparing share certificates; (13) expenses of
setting in type and printing prospectuses and supplements thereto, statements
of additional information and supplements thereto, reports and proxy materials
for existing shareholders, and costs of mailing such materials to existing
shareholders; (14) any extraordinary expenses (including fees and
disbursements of counsel) incurred by the Corporation/Trust or the Fund; (15)
fees, voluntary assessments and other expenses incurred in connection with
membership in investment company organizations; (16) costs of mailing and
tabulating proxies and costs of meetings of shareholders, the board and any
committees thereof; (17) the cost of investment company literature and other
publications provided to board members and officers; and (18) costs of
mailing, stationery and communications equipment.
Mitchell Hutchins will reimburse each Fund if and to the extent that the
aggregate operating expenses of that Fund exceed applicable limits in any
fiscal year. Currently the most restrictive such limit applicable to each Fund
is 2.5% of the first $30 million of a Fund's average daily net assets, 2.0% of
the next $70 million of its average daily net assets and 1.5% of its average
daily net assets in excess of $100 million. Certain expenses, such as
brokerage commissions, distribution fees, taxes, interest and extraordinary
items, are excluded from this limitation. For the fiscal years ended February
29, 1996, February 28, 1995 and February 28, 1994 (for Balanced Fund) and for
the fiscal years ended August 31, 1995, August 31, 1994 and August 31, 1993
(for Tactical Allocation Fund), no reimbursements were required pursuant to
such limitations for either Fund.
Under the Advisory Contracts, Mitchell Hutchins will not be liable for any
error of judgment or mistake of law or for any loss suffered by either Fund in
connection with the performance of the Advisory Contracts, except a loss
resulting from willful misfeasance, bad faith or gross negligence on the part
of Mitchell Hutchins in the performance of its duties or from reckless
disregard of its duties and obligations thereunder. Each Advisory Contract
terminates automatically with respect to a Fund upon assignment and is
terminable at any time without penalty by the Corporation's or Trust's board
or by vote of the holders of a majority of a Fund's outstanding voting
securities on 60 days' written notice to Mitchell Hutchins, or by Mitchell
Hutchins on 60 days' written notice to the Corporation or the Trust.
The following table shows the approximate net assets as of November 30,
1996, sorted by category of investment objective, of the investment companies
as to which Mitchell Hutchins serves as adviser or sub-adviser. An investment
company may fall into more than one of the categories below.
<TABLE>
<CAPTION>
NET ASSETS
INVESTMENT CATEGORY ($ MIL)
------------------- ----------
<S> <C>
Domestic (excluding Money Market).............................. $ 5,765.5
Global......................................................... 2,902.5
Equity/Balanced................................................ 3,413.6
Fixed Income (excluding Money Market).......................... 5,254.4
Taxable Fixed Income......................................... 3,610.5
Tax-Free Fixed Income........................................ 1,643.9
Money Market Funds............................................. $23,299.9
</TABLE>
31
<PAGE>
Mitchell Hutchins personnel may invest in securities for their own accounts
pursuant to a code of ethics that describes the fiduciary duty owed to
shareholders of PaineWebber funds and other Mitchell Hutchins' advisory
accounts by all Mitchell Hutchins' directors, officers and employees,
establishes procedures for personal investing and restricts certain
transactions. For example, employee accounts generally must be maintained at
PaineWebber, personal trades in most securities require pre-clearance and
short-term trading and participation in initial public offerings generally are
prohibited. In addition, the code of ethics puts restrictions on the timing of
personal investing in relation to trades by PaineWebber funds and other
Mitchell Hutchins advisory clients.
DISTRIBUTION ARRANGEMENTS. Mitchell Hutchins acts as the distributor of the
Class Y shares of each Fund under separate distribution contracts with the
Corporation and the Trust (collectively, "Distribution Contracts") that
require Mitchell Hutchins to use its best efforts, consistent with its other
businesses, to sell shares of each Fund. Class Y shares of the Funds are
offered continuously. Under separate exclusive dealer agreements between
Mitchell Hutchins and PaineWebber relating to the Class Y shares of the Funds
(collectively, "Exclusive Dealer Agreements"), PaineWebber and its
correspondent firms sell each Fund's shares.
PORTFOLIO TRANSACTIONS
Subject to policies established by each board, Mitchell Hutchins is
responsible for the execution of each Fund's portfolio transactions and the
allocation of brokerage transactions. In executing portfolio transactions,
Mitchell Hutchins seeks to obtain the best net results for the Funds, taking
into account such factors as price (including the applicable brokerage
commission or dealer spread), size of order, difficulty of execution and
operational facilities of the firm involved. Generally, bonds are traded on
the OTC market on a "net" basis without a stated commission through dealers
acting for their own account and not as brokers. Prices paid to dealers in
principal transactions generally include a "spread," which is the difference
between the prices at which the dealer is willing to purchase and sell a
specific security at the time. Balanced Fund, for the period March 1, 1996
through August 31, 1996, and for the fiscal years ended February 29, 1996,
February 28, 1995, and February 28, 1994, paid $134,453, $335,166, $495,853,
and $540,773, respectively, in aggregate brokerage commissions. Tactical
Allocation Fund, for the fiscal years ended August 31, 1996, August 31, 1995
and August 31, 1994, paid $41,271, $82,091 and $56,965, respectively, in
aggregate brokerage commissions.
Neither Fund has any obligation to deal with any broker or group of brokers
in the execution of portfolio transactions. Each Fund contemplates that,
consistent with the policy of obtaining the best net results, brokerage
transactions may be conducted through Mitchell Hutchins or its affiliates,
including PaineWebber. Each board has adopted procedures in conformity with
Rule 17e-1 under the 1940 Act to ensure that all brokerage commissions paid to
Mitchell Hutchins and its affiliates are reasonable and fair. Specific
provisions in each Advisory Contract authorize Mitchell Hutchins and any of
its affiliates that are members of a national securities exchange to effect
portfolio transactions for each Fund on such exchange and to retain
compensation in connection with such transactions. Any such transactions will
be effected and related compensation paid only in accordance with applicable
SEC regulations. For the fiscal years ended February 29, 1996, February 28,
1995 and February 28, 1994, Balanced Fund paid $1,350, $7,266 and $4,900,
respectively, in brokerage commissions to PaineWebber. For the period March 1,
1996 through August 31, 1996, Balanced Fund paid $2,220 in brokerage
commissions to PaineWebber, which represented 0.02% of the total brokerage
commissions paid by that Fund and 0.02% of the aggregate dollar amount of
transactions involving the payment of commissions. For the fiscal year ended
August 31, 1996, August 31, 1995, Tactical Allocation Fund paid no brokerage
commissions to PaineWebber. In prior fiscal years, neither Mitchell Hutchins
nor PaineWebber was an affiliate of Tactical Allocation Fund.
32
<PAGE>
Transactions in futures contracts are executed through futures commission
merchants ("FCMs"), who receive brokerage commissions for their services. The
Funds' procedures in selecting FCMs to execute the Funds' transactions in
futures contracts, including procedures permitting the use of Mitchell
Hutchins and its affiliates, are similar to those in effect with respect to
brokerage transactions in securities.
Consistent with the interest of each Fund and subject to the review of the
applicable board, Mitchell Hutchins may cause the Fund to purchase and sell
portfolio securities through brokers who provide the Fund with research,
analysis, advice and similar services. In return for such services, the Fund
may pay to those brokers a higher commission than may be charged by other
brokers, provided that Mitchell Hutchins determines in good faith that such
commission is reasonable in terms either of that particular transaction or of
the overall responsibility of Mitchell Hutchins to the Fund and its other
clients and that the total commissions paid by the Fund will be reasonable in
relation to the benefits to the Fund over the long term. For Balanced Fund's
six months ended August 31, 1996 and fiscal year ended February 28, 1996,
Mitchell Hutchins directed $29,295,885 and $74,360,258, respectively, in
portfolio transactions to brokers chosen because they provided research
services, for which Balanced Fund paid $38,779 and $144,391 in commissions.
For purchases or sales with broker-dealer firms which act as principal,
Mitchell Hutchins seeks best execution. Although Mitchell Hutchins may receive
certain research or execution services in connection with those transactions,
Mitchell Hutchins will not purchase securities at a higher price or sell
securities at a lower price than would otherwise be paid if no weight was
attributed to the services provided by the executing dealer. Moreover,
Mitchell Hutchins will not enter into any explicit soft dollar arrangements
relating to principal transactions and will not receive in principal
transactions the types of services which could be purchased for hard dollars.
Mitchell Hutchins may engage in agency transactions in OTC equity and debt
securities in return for research and execution services. These transactions
are entered into only in compliance with procedures ensuring that the
transaction (including commissions) is at least as favorable as it would have
been if effected directly with a market-maker that did not provide research or
execution services. These procedures include Mitchell Hutchins receiving
multiple quotes from dealers before executing the transactions on an agency
basis.
Research services furnished by the brokers or dealers through which or with
which a Fund effects securities transactions may be used by Mitchell Hutchins
in advising other funds or accounts and, conversely, research services
furnished to Mitchell Hutchins by brokers or dealers in connection with other
funds or accounts that Mitchell Hutchins advises may be used by Mitchell
Hutchins in advising the Fund. Information and research received from such
brokers will be in addition to, and not in lieu of, the services required to
be performed by Mitchell Hutchins under the Advisory Contracts.
Investment decisions for each Fund and for other investment accounts managed
by Mitchell Hutchins are made independently of each other in light of
differing considerations for the various accounts. However, the same
investment decision may occasionally be made for a Fund and one or more of
such accounts. In such cases, simultaneous transactions are inevitable.
Purchases or sales are then averaged as to price and allocated between a Fund
and such other account(s) as to amount according to a formula deemed equitable
to the Fund and such other account(s). While in some cases this practice could
have a detrimental effect upon the price or value of the security as far as
the Fund is concerned or upon its ability to complete its entire order, in
other cases it is believed that coordination and the ability to participate in
volume transactions will be beneficial to the Fund.
The Funds will not purchase securities in underwritings in which Mitchell
Hutchins or any of its affiliates is a member of the underwriting or selling
group, except pursuant to procedures adopted by each board
33
<PAGE>
pursuant to Rule 10f-3 under the 1940 Act. Among other things, these
procedures require that the commission or spread paid in connection with such
a purchase be reasonable and fair, that the purchase be at not more than the
public offering price prior to the end of the first business day after the
date of the public offering and that Mitchell Hutchins or any affiliate
thereof not participate in or benefit from the sale to the Fund.
PORTFOLIO TURNOVER. The portfolio turnover rate for each Fund is calculated
by dividing the lesser of the Fund's annual sales or purchases of portfolio
securities (exclusive of purchases or sales of securities whose maturities at
the time of acquisition were one year or less) by the monthly average value of
the securities in the portfolio during the year. For the period March 1, 1996
through August 31, 1996 and the fiscal years ended February 29, 1996 and
February 28, 1995, the portfolio turnover rates for Balanced Fund were 103%,
188% and 107%, respectively. For the fiscal years ended August 31, 1996 and
August 31, 1995, the portfolio turnover rates for Tactical Allocation Fund
were 6% and 53%, respectively. The higher turnover for the fiscal year ended
August 31, 1995 was due to reallocations of Tactical Allocation Fund's
portfolio in accordance with its systematic asset allocation strategy.
VALUATION OF SHARES
Each Fund determines the net asset value per share separately for each class
of shares as of the close of regular trading (currently 4:00 p.m., Eastern
time) on the NYSE on each Business Day, which is defined as each Monday
through Friday when the NYSE is open. Currently, the NYSE is closed on the
observance of the following holidays: New Year's Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day.
Securities that are listed on stock exchanges are valued at the last sale
price on the day the securities are being valued or, lacking any sales on such
day, at the last available bid price. In cases where securities are traded on
more than one exchange, the securities are generally valued on the exchange
considered by Mitchell Hutchins as the primary market. Securities traded in
the OTC market and listed on the Nasdaq Stock Market ("Nasdaq") are valued at
the last available sale price on Nasdaq at 4:00 p.m., Eastern time; other OTC
securities are valued at the last bid price available prior to valuation.
Where market quotations are readily available, debt securities are valued
based upon those quotations, provided such quotations adequately reflect, in
Mitchell Hutchins' judgment, the fair value of the security. Where such market
quotations are not readily available, such securities are valued based upon
appraisals received from a pricing service using a computerized matrix system,
or based upon appraisals derived from information concerning the security or
similar securities received from recognized dealers in those securities. All
other securities or assets will be valued at fair value as determined in good
faith by or under the direction of the applicable board. The amortized cost
method of valuation generally is used to value debt obligations with 60 days
or less remaining to maturity, unless the applicable board determines that
this does not represent fair value.
34
<PAGE>
PERFORMANCE INFORMATION
Each Fund's performance data quoted in advertising and other promotional
materials ("Performance Advertisements") represent past performance and are
not intended to indicate future performance. The investment return and
principal value of an investment will fluctuate so that an investor's shares,
when redeemed, may be worth more or less than their original cost.
TOTAL RETURN. Average annual total return quotes ("Standardized Return")
used in each Fund's Performance Advertisements are calculated according to the
following formula:
<TABLE>
<S> <C> <C> <C>
P(1 + T)n = ERV
a hypothetical initial payment of $1,000 to purchase shares of a
where: P = specified class
T = average annual total return of shares of that class
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at the
beginning of that period.
</TABLE>
Under the foregoing formula, the time periods used in Performance
Advertisements will be based on rolling calendar quarters, updated to the last
day of the most recent quarter prior to submission of the advertisement for
publication. Total return, or "T" in the formula above, is computed by finding
the average annual change in the value of an initial $1,000 investment over
the period. All dividends and other distributions are assumed to have been
reinvested at net asset value.
Each Fund also may refer in Performance Advertisements to total return
performance data that are not calculated according to the formula set forth
above ("Non-Standardized Return"). Each Fund calculates Non-Standardized
Return for specified periods of time by assuming the investment of $1,000 in
Fund shares and assuming the reinvestment of all dividends and other
distributions. The rate of return is determined by subtracting the initial
value of the investment from the ending value and by dividing the remainder by
the initial value.
The following table shows performance information for the Class Y shares of
Tactical Allocation Fund for the periods indicated. All returns for periods of
more than one year are expressed as an average return. As of August 31, 1996,
no Class Y shares of Balanced Fund were outstanding.
<TABLE>
TACTICAL ALLOCATION FUND
<CAPTION>
CLASS Y
-------
<S> <C>
Fiscal year ended August 31, 1996:
Standardized Return*.................................................. 17.70%
Inception** to August 31, 1996:
Standardized Return*.................................................. 13.88
</TABLE>
- --------
* Class Y shares do not impose an initial or contingent deferred sales
charge; therefore, the performance information also represent a quotation
of Non-Standardized Return for the periods shown.
** The inception date for Class Y shares of Tactical Allocation Fund was May
10, 1993.
OTHER INFORMATION. In Performance Advertisements, each Fund may compare its
Standardized Return and/or its Non-Standardized Return with data published by
Lipper Analytical Services, Inc. ("Lipper") for flexible portfolio funds; CDA
Investment Technologies, Inc. ("CDA"); Wiesenberger Investment
35
<PAGE>
Companies Service ("Wiesenberger"); Investment Company Data Inc. ("ICD"); or
Morningstar Mutual Funds ("Morningstar"); or with the performance of
recognized stock and other indexes, including the Standard & Poor's 500
Composite Stock Price Index, the Dow Jones Industrial Average, the Morgan
Stanley International Capital World Index, the Lehman Brothers 20+ Year
Treasury Bond Index, the Lehman Brothers Government/Corporate Bond Index, the
Salomon Brothers Non-U.S. World Government Bond Index, and changes in the
Consumer Price Index as published by the U.S. Department of Commerce. Each
Fund also may refer in such materials to mutual fund performance rankings and
other data, such as comparative asset, expense and fee levels, published by
Lipper, CDA, Wiesenberger, ICD or Morningstar. Performance Advertisements also
may refer to discussions of the Funds and comparative mutual fund data and
ratings reported in independent periodicals, including (but not limited to)
THE WALL STREET JOURNAL, MONEY Magazine, FORBES, BUSINESS WEEK, FINANCIAL
WORLD, BARRON'S, FORTUNE, THE NEW YORK TIMES, THE CHICAGO TRIBUNE, THE
WASHINGTON POST and THE KIPLINGER LETTERS. Comparisons in Performance
Advertisements may be in graphic form.
Each Fund may include discussions or illustrations of the effects of
compounding in Performance Advertisements. "Compounding" refers to the fact
that, if dividends or other distributions on the Fund investment are
reinvested by being paid in additional Fund shares, any future income or
capital appreciation of the Fund would increase the value, not only of the
original Fund investment, but also of the additional Fund shares received
through reinvestment. As a result, the value of the Fund investment would
increase more quickly than if dividends or other distributions had been paid
in cash.
Each Fund may also compare its performance with the performance of bank
certificates of deposits (CDs) as measured by the CDA Investment Technologies,
Inc. Certificate of Deposit Index, the Bank Rate Monitor National Index and
the averages of yields of CDs of major banks published by Banxquote (R) Money
Markets. In comparing a Fund's performance to CD performance, investors should
keep in mind that bank CDs are insured in whole or in part by an agency of the
U.S. government and offer fixed principal and fixed or variable rates of
interest, and that bank CD yields may vary depending on the financial
institution offering the CD and prevailing interest rates. Fund shares are not
insured or guaranteed by the U.S. government and returns thereon and net asset
value will fluctuate. The debt securities held by each Fund generally have
longer maturities than most CDs and may reflect interest rate fluctuations for
longer term securities. An investment in either Fund involves greater risks
than an investment in either a money market fund or a CD.
TAXES
To continue to qualify for treatment as a regulated investment company
("RIC") under the Internal Revenue Code, each Fund must distribute to its
shareholders for each taxable year at least 90% of its investment company
taxable income (consisting generally of net investment income and net short-
term capital gain) ("Distribution Requirement") and must meet several
additional requirements. With respect to each Fund, these requirements include
the following: (1) the Fund must derive at least 90% of its gross income each
taxable year from dividends, interest, payments with respect to securities
loans and gains from the sale or other disposition of securities, or other
income (including gains from options and futures) derived with respect to its
business of investing in securities ("Income Requirement"); (2) the Fund must
derive less than 30% of its gross income each taxable year from the sale or
other disposition of securities, options or futures held for less than three
months ("Short-Short Limitation"); (3) at the close of each quarter of the
Fund's taxable year, at least 50% of the value of its total assets must be
represented by cash and cash items, U.S. government securities, securities of
other RICs and other securities, with these other securities limited, in
36
<PAGE>
respect of any one issuer, to an amount that does not exceed 5% of the value
of the Fund's total assets and that does not represent more than 10% of the
issuer's outstanding voting securities; and (4) at the close of each quarter
of the Fund's taxable year, not more than 25% of the value of its total assets
may be invested in securities (other than U.S. government securities or the
securities of other RICs) of any one issuer.
Dividends and other distributions declared by a Fund in October, November or
December of any year and payable to shareholders of record on a date in any of
those months will be deemed to have been paid by the Fund and received by the
shareholders on December 31 of that year if the distributions are paid by the
Fund during the following January. Accordingly, those distributions will be
taxed to shareholders for the year in which that December 31 falls.
A portion of the dividends from each Fund's investment company taxable
income (whether paid in cash or in additional Fund shares) may be eligible for
the dividends-received deduction allowed to corporations. The eligible portion
may not exceed the aggregate dividends received by the Fund from U.S.
corporations. However, dividends received by a corporate shareholder and
deducted by it pursuant to the dividends-received deduction are subject
indirectly to the alternative minimum tax.
If Fund shares are sold at a loss after being held for six months or less,
the loss will be treated as long-term, instead of short-term, capital loss to
the extent of any capital gain distributions received on those shares.
Investors also should be aware that if shares are purchased shortly before the
record date for any dividend or capital gain distribution, the shareholder
will pay full price for the shares and receive some portion of the price back
as a taxable distribution.
Each Fund will be subject to a nondeductible 4% excise tax ("Excise Tax") to
the extent it fails to distribute by the end of any calendar year
substantially all of its ordinary income for that year and capital gain net
income for the one-year period ending on October 31 of that year, plus certain
other amounts.
Balanced Fund may invest in the stock of "passive foreign investment
companies" ("PFICs") if the stock is denominated in U.S. dollars and otherwise
is a permissible investment. A PFIC is a foreign corporation that, in general,
meets either of the following tests: (1) at least 75% of its gross income is
passive or (2) an average of at least 50% of its assets produce, or are held
for the production of, passive income. Under certain circumstances, the Fund
will be subject to federal income tax on a portion of any "excess
distribution" received on the stock of a PFIC or of any gain from disposition
of such stock (collectively "PFIC income"), plus interest thereon, even if the
Fund distributes the PFIC income as a taxable dividend to its shareholders.
The balance of the PFIC income will be included in the Fund's investment
company taxable income and, accordingly, will not be taxable to it to the
extent that income is distributed to its shareholders. If the Fund invests in
a PFIC and elects to treat the PFIC as a "qualified electing fund" ("QEF"),
then in lieu of the foregoing tax and interest obligation, the Fund will be
required to include in income each year its pro rata share of the QEF's annual
ordinary earnings and net capital gain (the excess of net long-term capital
gain over net short-term capital loss)--which the Fund may have to distribute
to satisfy the Distribution Requirement and avoid imposition of the Excise
Tax--even if those earnings and gain are not distributed to the Fund by the
QEF. In most instances it will be very difficult, if not impossible, to make
this election because of certain requirements thereof.
Pursuant to proposed regulations, an open-end RIC, such as Balanced Fund,
would be entitled to elect to "mark-to-market" its stock in certain PFICs.
"Marking-to-market," in this context, means recognizing as gain for each
taxable year the excess, as of the end of that year, of the fair market value
of each such PFIC's stock over the owner's adjusted basis in that stock
(including mark-to-market gain for each prior year for which an election was
in effect).
37
<PAGE>
The use of hedging and option income strategies, such as writing (selling)
and purchasing options and futures, involves complex rules that will determine
for income tax purposes the character and timing of recognition of the gains
and losses each Fund realizes in connection therewith. Gains from options and
futures derived by a Fund with respect to its business of investing in
securities will qualify as permissible income under the Income Requirement.
However, income from the disposition of options and futures will be subject to
the Short-Short Limitation if they are held for less than three months.
If a Fund satisfies certain requirements, any increase in value of a
position that is part of a "designated hedge" will be offset by any decrease
in value (whether realized or not) of the offsetting hedging position during
the period of the hedge for purposes of determining whether the Fund satisfies
the Short-Short Limitation. Thus, only the net gain (if any) from the
designated hedge will be included in gross income for purposes of that
limitation. Each Fund will consider whether it should seek to qualify for this
treatment for its hedging transactions. To the extent the Fund does not
qualify for this treatment, it may be forced to defer the closing out of
certain options and futures beyond the time when it otherwise would be
advantageous to do so, in order for the Fund to continue to qualify as a RIC.
Balanced Fund may acquire zero coupon securities or other securities issued
with original issue discount. As a holder of such securities, the Fund must
include in its gross income the portion of the original issue discount that
accrues on the securities during the taxable year, even if the Fund receives
no corresponding payment on them during the year. Because the Fund annually
must distribute substantially all of its investment company taxable income,
including any accrued original issue discount, to satisfy the Distribution
Requirement and avoid imposition of the Excise Tax, the Fund may be required
in a particular year to distribute as a dividend an amount that is greater
than the total amount of cash it actually receives. Those distributions will
be made from the Fund's cash assets or from the proceeds of sales of portfolio
securities, if necessary. The Fund may realize capital gains or losses from
those sales, which would increase or decrease its investment company taxable
income and/or net capital gain. In addition, any such gains may be realized on
the disposition of securities held for less than three months. Because of the
Short-Short Limitation, any such gains would reduce the Fund's ability to sell
other securities or options or futures held for less than three months that it
might wish to sell in the ordinary course of its portfolio management.
OTHER INFORMATION
Prior to August 1995, Balanced Fund was named "PaineWebber Asset Allocation
Fund." Prior to November 1, 1995, Tactical Allocation Fund was named "Mitchell
Hutchins/Kidder, Peabody Asset Allocation Fund" and prior to February 13,
1995, it was named "Kidder, Peabody Asset Allocation Fund." Prior to November
10, 1995, Balanced Fund's Class C shares were called "Class D" shares. Prior
to November 10, 1995, Tactical Allocation Fund's Class C shares were called
"Class B" shares and its Class Y shares were called "Class C" shares.
The Trust is an entity of the type commonly known as a "Massachusetts
business trust." Under Massachusetts law, shareholders of a series of the
Trust could, under certain circumstances, be held personally liable for the
obligations of the Trust or series. The Declaration of Trust states that
persons with claims against the Trust shall look solely to the Trust property
or to the property of one or more series of the Trust for satisfaction of
claims. It also states that notice of such disclaimer may be given in any
obligation, contract, instrument, certificate or undertaking made or issued by
the trustees of the Trust on behalf of the Trust. The Declaration of Trust
also provides for indemnification from the Trust's property for all losses and
expenses of any shareholder held personally liable for the obligations of the
Trust or a series. Thus, the risk of a shareholder's incurring financial loss
on account of shareholder liability is limited to circumstances in which the
Trust or series would be unable to meet its obligations, a possibility that
Mitchell Hutchins believes is remote.
38
<PAGE>
ADDITIONAL REDEMPTION INFORMATION. If conditions exist that make cash
payments undesirable, the Funds reserve the right to honor any request for
redemption by making payment in whole or in part in securities chosen by the
Funds and valued in the same way as they would be valued for purposes of
computing the Fund's net asset value. If payment is made in securities, a
shareholder may incur brokerage expenses in converting these securities into
cash. Each Fund has elected, however, to be governed by Rule 18f-1 under the
1940 Act, under which the Funds are obligated to redeem shares solely in cash
up to the lesser of $250,000 or 1% of the net asset value of the Funds during
any 90-day period for one shareholder. This election is irrevocable unless the
SEC permits its withdrawal.
The Funds may suspend redemption privileges or postpone the date of payment
during any period (1) when the NYSE is closed or trading on the NYSE is
restricted as determined by the SEC, (2) when an emergency exists, as defined
by the SEC, that makes it not reasonably practicable for a Fund to dispose of
securities owned by it or fairly to determine the value of its assets or (3)
as the SEC may otherwise permit. The redemption price may be more or less than
the shareholder's costs, depending on the market value of a Fund's portfolio
at the time.
CLASS-SPECIFIC EXPENSES. Each Fund might determine to allocate certain of
its expenses to the specific classes of the Fund's shares to which those
expenses are attributable.
COUNSEL. The law firm of Kirkpatrick & Lockhart LLP, 1800 Massachusetts
Ave., N.W., Washington, D.C., 20036-1800, serves as counsel to the Corporation
and the Trust. Kirkpatrick & Lockhart LLP also acts as counsel to PaineWebber
and Mitchell Hutchins in connection with other matters.
INDEPENDENT AUDITORS. Price Waterhouse LLP, 1177 Avenue of the Americas, New
York, New York 10036, serves as Balanced Fund's independent accountants. Ernst
& Young LLP, 787 Seventh Avenue, New York, New York 10019, serves as Tactical
Allocation Fund's independent auditors.
FINANCIAL STATEMENTS
Each Fund's Annual Report to Shareholders for the most recent fiscal year is
a separate document supplied with this Statement of Additional Information and
the financial statements, accompanying notes and report of independent
accountants or independent auditors appearing therein are incorporated herein
by this reference.
39
<PAGE>
APPENDIX
DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS
Aaa. Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt 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 risk appear somewhat larger than in 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.
Note: Moody's may apply numerical modifiers, 1, 2 and 3 in each generic
rating classification from Aa through B in its corporate bond rating system.
The modifier 1 indicates that the security ranks in the higher end of its
generic rating category; the modifier 2 indicates a mid-range ranking; and the
modifier 3 indicates that the issue ranks in the lower end of its generic
rating category.
DESCRIPTION OF S&P CORPORATE DEBT RATINGS
AAA. An obligation rated AAA has the highest rating assigned by S&P. The ob-
ligor's capacity to meet its financial commitment on the obligation is ex-
tremely strong; AA. An obligation rated AA differs from the higher rated is-
sues only in small degree; A. An obligation rated A is somewhat more suscep-
tible to the adverse effects of changes in circumstances and economic condi-
tions than obligations in higher rated categories. However, the obligor's ca-
pacity to meet its financial commitment on the obligation is still strong;
BBB. An obligation 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; BB, B, CCC, CC, C. Obligations rated BB, B, CCC, CC and C are re-
garded as having significant speculative characteristics. BB indicates the
lowest 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. An obliga-
tion 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. An obligation
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 ob-
ligation. Adverse business, financial, or economic conditions will likely im-
pair the obligor's capacity or willingness to meet its financial commitment on
the obligation.
A-1
<PAGE>
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.
NR: "NR" indicates that no public rating has been requested, that there is
insufficient information on which to base a rating, or that S&P does not rate
a particular type of obligation as a matter of policy.
DESCRIPTION OF MOODY'S SHORT-TERM DEBT RATINGS
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; 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.
DESCRIPTION OF S&P COMMERCIAL PAPER RATINGS
A-1. This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus (+) sign designation; A-
2. Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated A-1.
A-2
<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THE PROSPECTUS OR IN THIS STATEMENT OF
ADDITIONAL INFORMATION IN CONNECTION WITH THE OFFERING MADE BY THE PROSPECTUS
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY EITHER FUND OR ITS DISTRIBUTOR. THE
PROSPECTUS AND THIS STATEMENT OF ADDITIONAL INFORMATION DO NOT CONSTITUTE AN
OFFERING BY EITHER FUND OR BY THE DISTRIBUTOR IN ANY JURISDICTION IN WHICH SUCH
OFFERING MAY NOT LAWFULLY BE MADE.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Investment Policies and Restrictions....................................... 1
Hedging and Related Strategies............................................. 13
Directors, Trustees and Officers; Principal Holders of Securities.......... 21
Investment Advisory and Distribution Arrangements.......................... 30
Portfolio Transactions..................................................... 32
Valuation of Shares........................................................ 34
Performance Information.................................................... 35
Taxes...................................................................... 36
Other Information.......................................................... 38
Financial Statements....................................................... 39
Appendix................................................................... A-1
</TABLE>
(C)1997 PaineWebber Incorporated
PAINEWEBBER
BALANCED FUND
PAINEWEBBER
TACTICAL ALLOCATION FUND
CLASS Y SHARES
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Statement of Additional Information January 1, 1997
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PAINEWEBBER[LOGO]
