<PAGE>
KEYSTONE INSTITUTIONAL
ADJUSTABLE RATE FUND
PROSPECTUS DECEMBER 10, 1996
AS SUPPLEMENTED DECEMBER 11, 1996
Keystone Institutional Adjustable Rate Fund (the "Fund") is a diversified,
open-end management investment company, commonly known as a mutual fund, that
seeks a high level of current income, consistent with low volatility of
principal, by investing under ordinary circumstances at least 65% of its assets
in adjustable rate securities. Such securities include adjustable rate mortgage
securities that are issued or guaranteed by the United States ("U.S.")
government, its agencies or instrumentalities. The Fund does not attempt to
maintain a constant price per share. The Fund does, however, follow a strategy
that seeks to minimize changes in its net asset value per share by investing
primarily in adjustable rate securities whose interest rates are periodically
reset when market rates change.
The Fund is designed for institutional investors and seeks to provide a
relatively stable net asset value while providing high current income relative
to high-quality, short-term investment alternatives.
The Fund offers Class Y and Z shares. Information on share classes and their
fee and sales charge structures may be found in the "Expense Information,"
"Distribution Plan," "How to Buy Shares," "Alternative Sales Options" and "Fund
Shares" sections of this prospectus.
This prospectus concisely states information about the Fund that you should
know before investing. Please read it and retain it for future reference.
Additional information about the Fund is contained in a statement of
additional information dated December 10, 1996, as supplemented, which has been
filed with the Securities and Exchange Commission and is incorporated by
reference into this prospectus. For a free copy, or for other information about
the Fund, write to the address or call the telephone number provided on this
page.
KEYSTONE INSTITUTIONAL
ADJUSTABLE RATE FUND
200 BERKELEY STREET
BOSTON, MASSACHUSETTS 02116-5034
CALL TOLL FREE 1-800-633-2700
TABLE OF CONTENTS
Page
Expense Information ............................... 2
Financial Highlights .............................. 3
The Fund .......................................... 5
Investment Objective and Policies ................. 5
Investment Restrictions ........................... 7
Risk Factors ...................................... 7
Pricing Shares .................................... 9
Dividends and Taxes ............................... 10
Fund Management and Expenses ...................... 10
Distribution Plan ................................. 12
How to Buy Shares ................................. 13
Alternative Sales Options ......................... 13
How to Redeem Shares .............................. 15
Shareholder Services .............................. 16
Performance Data .................................. 16
Fund Shares ....................................... 16
Additional Information ............................ 17
Additional Investment Information ................. (i)
SHARES OF THE FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK, AND SHARES ARE NOT INSURED OR OTHERWISE PROTECTED BY THE
U.S. GOVERNMENT, THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE
BOARD, OR ANY OTHER GOVERNMENT AGENCY AND INVOLVE RISK, INCLUDING THE POSSIBLE
LOSS OF PRINCIPAL.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<PAGE>
EXPENSE INFORMATION
KEYSTONE INSTITUTIONAL ADJUSTABLE RATE FUND
The purpose of this fee table is to assist investors in understanding the
costs and expenses that an investor in each class of shares of the Fund will
bear directly or indirectly. For a more complete description of the various
costs and expenses, see the "Fund Management and Expenses" and "Distribution
Plan" sections of this prospectus.
<TABLE>
<CAPTION>
ANNUAL FUND OPERATING EXPENSES(1) CLASS Y CLASS Z(2)
(as a percentage of average net assets) SHARES SHARES
-------------- --------------
<S> <C> <C>
Management Fees ...................................................................... 0.30% 0.30%
12b-1 Fees ........................................................................... 0.25% 0.00%
Other Expenses ....................................................................... 0.00% 0.00%
---- ----
Total Fund Operating Expenses ........................................................ 0.55% 0.30%
==== ====
<CAPTION>
EXAMPLE(3) 1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
You would pay the following expenses on a $1,000 investment
in the Fund, assuming (1) 5% annual return and (2)
redemption at the end of each period:
Class Y ................................................. $6 $18 $31 $69
Class Z ................................................. $3 $10 $17 $38
AMOUNTS SHOWN IN THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES; ACTUAL EXPENSES MAY BE
GREATER OR LESS THAN THOSE SHOWN.
<FN>
- ----------
(1) Expense ratios are for the Fund's fiscal year ended September 30, 1996.
(2) Class Z shares are available only to certain investors. See "Alternative Sales Options -- Class Z Shares."
(3) The Securities and Exchange Commission requires use of a 5% annual return figure for purposes of this example. Actual return
for the Fund may be greater or less than 5%.
</FN>
</TABLE>
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE INSTITUTIONAL ADJUSTABLE RATE FUND
CLASS Y SHARES
(FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR)
The following table contains important financial information relating to
the Fund and has been audited by KPMG Peat Marwick LLP, the Fund's independent
auditors. The table appears in the Fund's Annual Report and should be read in
conjunction with the Fund's financial statements and related notes, which also
appear, together with the independent auditors' report, in the Fund's Annual
Report. The Fund's financial statements, related notes, and independent
auditors' report are incorporated by reference into the statement of
additional information. Additional information about the Fund's performance is
contained in its Annual Report, which will be made available upon request and
without charge.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30, MAY 23, 1994 (DATE OF
------------------------ INITIAL PUBLIC OFFERING)
1996(b) 1995 TO SEPTEMBER 30, 1994
------- ---- ------------------------
<S> <C> <C> <C>
NET ASSET VALUE BEGINNING OF YEAR .................. $9.65 $9.61 $9.73
----- ----- -----
INCOME FROM INVESTMENT OPERATIONS:
Net investment income .............................. 0.65 0.64 0.17
Net realized and unrealized loss on investments .... (0.03) (0.02) (0.13)
----- ----- -----
Total from investment operations ................... 0.62 0.62 0.04
----- ----- -----
LESS DISTRIBUTIONS FROM:
Net investment income .............................. (0.58) (0.53) (0.16)
In excess of net investment income ................. (0.01) (0.05) 0
----- ----- -----
Total distributions ................................ (0.59) (0.58) (0.16)
----- ----- -----
NET ASSET VALUE END OF YEAR ........................ $9.68 $9.65 $9.61
===== ===== =====
TOTAL RETURN ....................................... 6.60% 6.60% 0.35%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses ................................... 0.55% 0.55% 0.43%(a)
Net investment income ............................ 6.64% 6.70% 5.03%(a)
Portfolio turnover rate ............................ 85% 56% 63%
------- ------ -----
NET ASSETS END OF YEAR (THOUSANDS) ................. $14,361 $2,871 $ 1
<FN>
- ------------
(a) Annualized.
(b) Per share calculations based on weighted average shares outstanding.
</FN>
</TABLE>
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE INSTITUTIONAL ADJUSTABLE RATE FUND
CLASS Z SHARES
(FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR)
The following table contains important financial information relating to the
Fund and has been audited by KPMG Peat Marwick LLP, the Fund's independent
auditors. The table appears in the Fund's Annual Report and should be read in
conjunction with the Fund's financial statements and related notes, which also
appear, together with the independent auditors' report, in the Fund's Annual
Report. The Fund's financial statements, related notes, and independent
auditors' report are incorporated by reference into the statement of additional
information. Additional information about the Fund's performance is contained in
its Annual Report, which will be made available upon request and without charge.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------------------------------------------------
1996(a) 1995 1994 1993(a) 1992
------- ---- ---- ------- ----
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE BEGINNING OF YEAR $9.65 $9.61 $9.93 $9.88 $10.00
----- ----- ----- ----- ------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income ............ 0.64 0.63 0.63 0.54 0.67
Net realized and unrealized gain
(loss) on investments .......... 0.00 0.01 (0.49) (0.01) (0.15)
----- ----- ----- ----- ------
Total from investment operations . 0.64 0.64 0.14 0.53 0.52
----- ----- ----- ----- ------
LESS DISTRIBUTIONS FROM:
Net investment income ............ (0.60) (0.55) (0.44) (0.48) (0.64)
In excess of net investment income (0.01) (0.05) (0.02) 0 0
----- ----- ----- ----- ------
Total distributions .............. (0.61) (0.60) (0.46) (0.48) (0.64)
----- ----- ----- ----- ------
NET ASSET VALUE END OF YEAR ...... $9.68 $9.65 $9.61 $9.93 $ 9.88
===== ===== ===== ===== ======
TOTAL RETURN ..................... 6.86% 6.87% 1.43% 5.53% 5.46%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses ................. 0.30% 0.30% 0.30% 0.30% 0.30%
Net investment income .......... 6.84% 6.61% 5.15% 5.46% 6.83%
Portfolio turnover rate .......... 85% 56% 63% 81% 88%
------- ------- ------- ------- -------
NET ASSETS END OF YEAR (THOUSANDS) $65,974 $23,616 $25,200 $60,035 $51,625
------- ------- ------- ------- -------
<FN>
(a) Per share calculations based on weighted average shares outstanding.
</FN>
</TABLE>
<PAGE>
THE FUND
The Fund was formed as a Massachusetts business trust on June 19, 1991. The
Fund is one of more than thirty funds advised and managed by Keystone Investment
Management Company ("Keystone"), the Fund's investment adviser.
INVESTMENT OBJECTIVE AND POLICIES
INVESTMENT OBJECTIVE
The Fund seeks a high level of current income consistent with low volatility
of principal. The investment objective of the Fund is fundamental and may not be
changed without approval of the holders of a majority (as defined in the
Investment Company Act of 1940 ("1940 Act")) of the Fund's outstanding shares,
which means the lesser of (1) 67% of the shares represented at a meeting at
which more than 50% of the outstanding shares are represented or (2) more than
50% of the outstanding shares (a "1940 Act Majority").
Any investment involves risk, and there is no assurance that the Fund will
achieve its investment objective.
PRINCIPAL INVESTMENTS
Under ordinary circumstances, the Fund invests at least 65% of its assets in
mortgage securities or other securities collateralized by or representing an
interest in a pool of mortgages (collectively, "Mortgage Securities"), which
securities have interest rates that reset at periodic intervals and are issued
or guaranteed by the U.S. government, its agencies or instrumentalities.
The Fund does not attempt to maintain a constant price per share. However, the
Fund does follow a strategy that seeks to minimize changes in its net asset
value per share by investing primarily in adjustable rate securities, whose
interest rates are periodically reset when market rates change. The average
dollar weighted reset period of adjustable rate securities held by the Fund will
not exceed one year. The Fund seeks to provide a relatively stable net asset
value while providing high current income relative to high-quality, short-term
investment alternatives.
INVESTMENT POLICIES AND APPROACH
Keystone believes that, by investing primarily in Mortgage Securities with
adjustable rates of interest, the Fund will achieve a less volatile net asset
value per share than is characteristic of mutual funds that invest primarily in
U.S. government securities paying a fixed rate of interest.
Unlike fixed rate mortgages and loans that generally decline in value during
periods of rising interest rates, adjustable rate Mortgage Securities ("ARMS")
allow the Fund to participate in increases in interest rates through periodic
adjustments in the coupons of the underlying mortgages or loans, resulting in
both higher current yields and lower price fluctuations in the Fund's net asset
value per share. The Fund is also affected by decreases in interest rates
through periodic decreases in the coupons of the underlying mortgages or loans
resulting in lower income to the Fund. This downward adjustment results in lower
price fluctuations in the net asset value per share in a decreasing interest
rate environment. As the interest rates on the mortgages or loans underlying the
Fund's investments are reset periodically, coupons of portfolio securities will
gradually align themselves to reflect changes in market rates and should cause
the net asset value per share of the Fund to fluctuate less dramatically than it
would if the Fund invested in more traditional long-term, fixed rate mortgages.
The portion of the Fund that is not invested in ARMS, if any, is intended to
increase the Fund's total return from changes in market rates while not
materially increasing the volatility of the net asset value per share.
PERMITTED INVESTMENTS
The Fund invests in Mortgage Securities that are issued or guaranteed by the
U.S. government, one of its agencies or instrumentalities, such as the
Government National Mortgage Association ("GNMA"), the Federal National Mortgage
Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC").
Securities issued by GNMA, but not those issued by FNMA or FHLMC, are backed by
the full faith and credit of the U.S. government.
The Fund invests in mortgage pass-through securities representing
participation interests in pools of residential mortgage loans originated by
U.S. governmental lenders and guaranteed, to the extent provided in such
securities, by the U.S. government, its agencies or instrumentalities. Such
securities, which are ownership interests in the underlying mortgage loans,
differ from conventional debt securities, which provide for periodic payment of
interest in fixed amounts (usually semiannually) and principal payments at
maturity or on specified call dates. Mortgage pass-through securities provide
for monthly payments that are a "pass-through" of the monthly interest and
principal payments (including any prepayments) made by the individual borrowers
on the pooled mortgage loans, net of any fees paid to the guarantor of such
securities and the servicer of the underlying mortgage loans.
The guaranteed mortgage pass-through securities in which the Fund invests
include those issued or guaranteed by GNMA, FNMA and FHLMC. GNMA certificates
are direct obligations of the U.S. government and, as such, are backed by the
full faith and credit of the U.S. government. FNMA is a federally chartered,
privately owned corporation. FHLMC is a corporate instrumentality of the U.S.
government. FNMA and FHLMC certificates are not backed by the full faith and
credit of the U.S. government and are supported only by the credit of FNMA and
FHLMC, which have the right to borrow to meet their obligations from an
existing line of credit with the U.S. Treasury. Although their close
relationship with the U.S. government is believed to make them high quality
securities with minimal credit risks, the U.S. government is not obligated by
law to support either FNMA or FHLMC. Historically, however, there have been no
defaults in any FNMA or FHLMC issues.
Certificates for Mortgage Securities evidence an interest in a specific pool
of mortgages. These certificates are, in most cases, "modified pass-through"
instruments, wherein the issuing agency guarantees the payment of principal and
interest on mortgages underlying the certificates, whether or not such amounts
are collected by the issuer on the underlying mortgages.
Adjustable rate mortgages are an important form of residential financing.
Generally, adjustable rate mortgages are mortgages that have a specified
maturity date and amortize in a manner similar to that of a fixed rate mortgage.
As a result, in periods of declining interest rates there is a reasonable
likelihood that adjustable rate mortgages will behave like fixed rate mortgages
in that current levels of prepayments of principal on the underlying mortgages
could accelerate. However, one difference between adjustable rate mortgages and
fixed rate mortgages is that for certain types of adjustable rate mortgages the
rate of amortization of principal, as well as interest payments, can and does
change in accordance with movements in a particular, pre-specified, published
interest rate index. The amount of interest due a holder of an adjustable rate
mortgage is calculated by adding a specified additional amount (margin) to the
index, subject to limitations or "caps" on the maximum and minimum interest rate
that is charged to the mortgagor during the life of the mortgage or to maximum
and minimum changes in that interest rate during a given period. It is these
special characteristics, unique to the adjustable rate mortgages underlying the
ARMS in which the Fund invests, that are believed to make ARMS attractive
investments for seeking to accomplish the Fund's objective. For further
information, see "Prepayments" in the section on "Risk Factors."
OTHER PERMITTED INVESTMENTS
The Fund may invest in collateralized mortgage obligations ("CMOs") issued
or guaranteed by the U.S. government, its agencies or instrumentalities. The
Fund intends to invest only in CMOs that, in Keystone's opinion, are suitable
in light of the Fund's investment objective and policies. For further
information, see "Additional Investment Information."
In addition, the Fund may enter into repurchase agreements and reverse
repurchase agreements for eligible securities and U.S. government obligations.
For further information, see "Additional Investment Information."
The Fund may also invest up to 35% of its assets under ordinary circumstances
and up to 100% of its assets for temporary defensive purposes in obligations of
the U.S. government, its agencies or instrumentalities, such as the Federal Home
Loan Banks, FNMA, GNMA, FHLMC or the Federal Farm Credit Banks.
The Fund may assume a temporary defensive position, for example, upon
Keystone's determination that market conditions so warrant. The Fund may not be
pursuing its investment objective when it assumes a temporary defensive
position.
The Fund will not invest in derivative Mortgage Securities other than the CMOs
described in "Additional Investment Information."
INVESTMENT RESTRICTIONS
The Fund has adopted the fundamental restrictions summarized below, which may
not be changed without the vote of a 1940 Act Majority of the Fund's outstanding
shares. These restrictions and certain other fundamental and non-fundamental
restrictions are set forth in detail in the statement of additional information.
Unless otherwise stated, all references to the Fund's assets are in terms of
current market value.
Generally the Fund may not do the following: (1) with respect to 75% of its
total assets, invest more than 5% of the value of its total assets in the
securities of any one issuer; this limitation does not apply to investments in
securities issued or guaranteed by the U.S. government, its agencies or
instrumentalities; and (2) borrow money or enter into reverse repurchase
agreements, except that the Fund may (a) enter into reverse repurchase
agreements or (b) borrow money from banks for temporary or emergency purposes in
aggregate amounts of up to one-third of the value of the Fund's net assets;
provided that, while borrowings exceed 5% of the Fund's net assets, any such
borrowings will be repaid before additional investments are made.
The Fund intends to follow the policies of the Securities and Exchange
Commission as they are adopted from time to time with respect to illiquid
securities, including, at this time, (1) treating as illiquid, securities that
may not be sold or disposed of in the ordinary course of business within seven
days at approximately the value at which the Fund has valued such securities on
its books and (2) limiting its holdings of such securities to 15% of net assets.
RISK FACTORS
Like any investment, your investment in the Fund involves an element of risk.
Before you buy shares of the Fund, you should carefully evaluate your ability to
assume the risks your investment in the Fund poses.
By itself, the Fund does not constitute a balanced investment program.
Investors should take into account their investment objectives as well as other
investments when considering the purchase of shares of any investment company.
Certain risks related to the Fund are discussed below. In addition to the
risks discussed in this section, specific risks attendant to individual
securities or investment practices are discussed in "Additional Investment
Information" and the statement of additional information.
Should the Fund need to raise cash to meet a large number of redemptions the
Fund might have to sell portfolio securities at a time when it would be
disadvantageous to do so.
INTEREST RATE RISK
The values of fixed-rate securities fluctuate in response to changes in
interest rates; generally rising when interest rates decline, and falling, when
interest rates rise. As a result, if interest rates increase after a security is
purchased, the security, if sold prior to maturity, may return less than its
cost. The corresponding increase or decrease in the value of fixed-rate
securities generally becomes more significant for instruments with longer
remaining maturities or longer expected remaining lives. Moreover, investment
yields on relatively short-term investments are subject to substantial and rapid
fluctuation.
PREPAYMENTS
The Mortgage Securities in which the Fund principally invests differ from
conventional bonds in that principal is repaid over the life of the investment
rather than at maturity. As a result, the holder of the investment (i.e., the
Fund) receives monthly scheduled payments of principal and interest and may
receive unscheduled principal payments representing prepayments on the
underlying mortgages or loans. When the holder reinvests the payments and any
unscheduled prepayments of principal it receives, it may receive a rate of
interest that is higher or lower than the rate on the existing investment.
RESETS
The Fund invests in ARMS and adjustable rate CMOs that hold securities whose
interest rates are readjusted at intervals of up to three years (generally one
year or less) to an increment over some predetermined interest rate index.
There are three main categories of indices: (1) those based on U.S. Treasury
securities; (2) those derived from a calculated measure, such as a cost of funds
index; or (3) a moving average of mortgage rates. Commonly utilized indices
include the one-year, three-year and five-year constant maturity Treasury rates,
the three-month Treasury Bill rate, the 180-day Treasury Bill rate, rates on
longer-term Treasury securities, the 11th District Federal Home Loan Bank Cost
of Funds, the National Median Cost of Funds, the one-month, three-month,
six-month or one-year London Interbank Offered Rate ("LIBOR"), the prime rate of
a specific bank and commercial paper rates. Some indices, such as the one-year
constant maturity Treasury rate, closely mirror changes in market interest rate
levels. Others, such as the 11th District Home Loan Bank Cost of Funds Index,
tend to lag behind changes in market rate levels and tend to be somewhat less
volatile.
The Fund's net asset value per share could vary to the extent that current
interest rates on Mortgage Securities are different than market interest rates
during periods between coupon reset dates. During periods of rising or falling
interest rates, changes in the coupon rate lag behind changes in the market rate
possibly resulting in a net asset value per share that is slightly lower or
higher, as the case may be, until the coupon resets to market rates.
Shareholders could lose some of their principal loss if they sold their shares
of the Fund during periods of rising interest rates before the interest rates on
the underlying mortgages or loans were adjusted to reflect current market rates.
During periods of fluctuations in interest rates, the Fund's net asset value per
share will fluctuate as well.
CAPS AND FLOORS
The Fund invests in ARMS and CMOs whose underlying securities will frequently
have "caps" and "floors" that limit the maximum amount by which the loan rate to
the borrower may change up or down per reset or adjustment interval and over the
life of the loan.
The Fund will not benefit from increases in interest rates to the extent that
interest rates rise to the point where they cause the current coupon of loans or
mortgages held as investments to reach their maximum allowable annual or
lifetime reset limits (cap rates). An increase in interest rates above the cap
rates would cause such mortgages or loans to "cap out" and to behave more like
long-term fixed rate debt securities. Conversely, the Fund will not benefit from
decreases in interest rates to the extent that prepayments increase. In
addition, when interest rates decline, the Fund's income will be reduced when
the interest rates on underlying adjustable rate mortgages are reduced.
ADDITIONAL FACTORS
In an environment where interest rates on short-term fixed-rate debt
securities are rising faster than interest rates on long-term fixed-rate debt
securities, the market value of Mortgage Securities will typically under perform
other fixed-rate debt securities. In addition, because of the user risk
described above, the Fund's investments may not perform as expected.
ARMS are less effective as a means of "locking in" long-term interest rates
than fixed-rate debt securities, since their market values will generally vary
inversely with changes in market interest rates, (i.e., declining when interest
rates rise and rising when interest rates decline). However, the market value of
ARMS is less likely to decline than fixed-rate debt securities of comparable
maturities during periods of rapidly rising rates. In addition, ARMS have less
potential than fixed-rate debt securities for capital appreciation due to their
adjustable rate features and the likelihood of increased prepayments of
mortgages as interest rates decline.
If ARMS are purchased at a premium, unscheduled principal prepayments may
result in some loss of the holder's principal investment to the extent of the
premium paid over the face value of the security. On the other hand, if ARMS are
purchased at a discount, both a scheduled payment of principal and an
unscheduled prepayment of principal will increase current and total returns and
will accelerate the recognition of income, which, when distributed to
shareholders, will be taxable as ordinary income.
While the Fund may invest in securities that are issued or guaranteed by the
U.S. government, its agencies or instrumentalities, the market value of such
securities is not guaranteed.
For further information about the risks associated with the Fund's investments
and investment techniques, see the section of this prospectus entitled
"Additional Investment Information" and the statement of additional information.
PRICING SHARES
The net asset value of a Fund share is computed each day on which the New York
Stock Exchange (the "Exchange") is open as of the close of trading on the
Exchange (currently 4:00 p.m. eastern time for purposes of pricing Fund shares)
except on days when changes in the value of the Fund's portfolio securities do
not affect the current net asset value of its shares. The Exchange is currently
closed on weekends, New Year's Day, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day. The net asset
value per share of the Fund is arrived at by determining the value of the Fund's
assets, subtracting its liabilities and dividing the result by the number of its
shares outstanding.
The Fund values most of its securities at the mean of the bid and asked price
at the time of valuation and values other securities at fair value according to
procedures established by the Board of Trustees, including valuing certain of
its fixed rate Mortgage Securities on the basis of valuations provided by a
pricing service approved by the Fund's Board of Trustees, which uses information
with respect to transactions in Mortgage Securities, quotations from dealers,
market transactions in comparable securities and various relationships between
securities in determining value.
The Fund values securities (1) with initial and remaining maturities of sixty
days or less at amortized cost (original purchase cost as adjusted for
amortization of premium or accretion of discount), which, when combined with
accrued interest, approximates market; (2) securities with remaining maturities
of more than sixty days when purchased that are held on the sixtieth day prior
to maturity are valued at amortized cost (market value on the sixtieth day
adjusted for amortization of premium or accretion of discount), which, when
combined with accrued interest, approximates market; (3) all other investments
are valued at market value or, where market quotations are not readily
available, at fair value as determined in good faith in accordance with
procedures established by the Board of Trustees.
DIVIDENDS AND TAXES
The Fund has qualified, and intends to continue to qualify, as a regulated
investment company under the Internal Revenue Code of 1986, as amended (the
"Code"). The Fund qualifies if, among other things, it distributes to its
shareholders at least 90% of its net investment income for its fiscal year. The
Fund also intends to make timely distributions, if necessary, sufficient in
amount to avoid the nondeductible 4% excise tax imposed on a regulated
investment company when it fails to distribute, with respect to each calendar
year, at least 98% of its ordinary income for such calendar year and 98% of its
net capital gains for the one-year period ending on October 31 of such calendar
year.
If the Fund qualifies as a regulated investment company, and if it distributes
all of its net investment income and net capital gains, if any, to shareholders,
it will be relieved of any federal income tax liability.
The Fund intends to declare dividends from net investment income daily and
distribute to its shareholders such dividends monthly and declare and distribute
all net realized capital gains if any, annually. Shareholders receive Fund
distributions in the form of additional shares of that class of shares upon
which the distribution is based or, at the shareholder's option, in cash.
Because Class Y shares bear most of the costs of distribution of such shares
through an annual distribution fee, expenses attributable to Class Y shares will
generally be higher than those of Class Z shares, and income distributions paid
by the Fund with respect to Class Z shares will generally be greater than those
paid with respect to Class Y shares.
Dividends and distributions other than capital gains dividends, are taxable as
ordinary income to shareholders who are subject to federal income taxes and may
also be subject to state and local taxes. The Fund advises its shareholders
annually as to the federal tax status of all distributions made during the year.
Any such distribution declared in October, November or December to
shareholders of record in such month and paid by the following January 31 would
be includable in the taxable income of shareholders as if paid on December 31 of
the year in which the distribution was declared.
The Fund intends to distribute its net long-term capital gains as capital gain
dividends; such dividends are treated by shareholders as long-term capital
gains. Such distributions will be designated as long-term capital gain dividends
by a written notice mailed to each shareholder no later than 60 days after the
close of the Fund's fiscal year. If a shareholder receives a capital gain
dividend, then any allowable loss on disposition of Fund shares will be treated
as a long-term capital loss to the extent of such capital gain dividend, if such
shares have been held for six months or less.
Since none of the Fund's income will consist of corporate dividends, no
distributions will qualify for the corporate dividends received deduction.
FUND MANAGEMENT AND EXPENSES
BOARD OF TRUSTEES
Under Massachusetts law, the Fund's Board of Trustees has absolute and
exclusive control over the management and disposition of all assets of the Fund.
Subject to the general supervision of the Fund's Board of Trustees, Keystone
provides investment advice, management and administrative services to the Fund.
INVESTMENT ADVISER
Keystone has provided investment advisory and management services to
investment companies and private accounts since 1932. Keystone is a wholly-owned
subsidiary of Keystone Investments, Inc. ("Keystone Investments"). Keystone
Investments provides accounting, bookkeeping, legal, personnel and general
corporate services to Keystone, its affiliates and the Keystone Investments
Families of Funds. Both Keystone and Keystone Investments are located at 200
Berkeley Street, Boston, Massachusetts 02116-5034.
On December 11, 1996, Keystone Investments succeeded to the business of a
corporation with the same name, but under different ownership, which was
organized in 1989. Keystone Investments is a wholly-owned subsidiary of First
Union National Bank of North Carolina ("FUNB"). FUNB is a subsidiary of First
Union Corporation ("First Union"), the sixth largest bank holding company in the
U.S. based on total assets as of September 30, 1996.
First Union is headquartered in Charlotte, North Carolina, and had $133.9
billion in consolidated assets as of September 30, 1996. First Union and its
subsidiaries provide a broad range of financial services to individuals and
businesses throughout the U.S. The Capital Management Group of FUNB, together
with Lieber & Company and Evergreen Asset Management Corp., wholly-owned
subsidiaries of FUNB, manage or otherwise oversee the investment of over $50
billion in assets belonging to a wide range of clients, including the Evergreen
Family of Funds.
Pursuant to its Investment Advisory and Management Agreement with the Fund
(the "Advisory Agreement"), Keystone manages the investment and reinvestment of
the Fund's assets, supervises the operation of the Fund, and provides all
necessary office space, facilities, and equipment.
The Fund pays Keystone a fee for its services at the annual rate of 0.30% of
the average daily net asset value of shares of the Fund. A pro-rata portion of
the fee is payable in arrears at the end of each day or calender month as
Keystone may, from time to time, specify to the Fund.
The Advisory Agreement continues in effect for two years from its effective
date and, thereafter, from year to year only so long as such continuance is
specifically approved at least annually by the Board of Trustees or by the vote
of shareholders of the Fund. In addition, the terms and annual continuance of
the Advisory Agreement must be approved by the vote of a majority of the
Independent Trustees (Trustees who are not interested persons (as defined in the
1940 Act) of the Fund and who have no direct or indirect financial interest in
the Fund's Distribution Plan or any agreement related thereto) cast in person at
a meeting called for the purpose of voting on such approval. The Advisory
Agreement may be terminated, without penalty, on 60 days' written notice by the
Fund or Keystone or may be terminated by a vote of shareholders of the Fund. The
Advisory Agreement will terminate automatically upon its assignment.
PRINCIPAL UNDERWRITER
Evergreen Keystone Distributor, Inc. (formerly Evergreen Funds Distributor,
Inc.) ("EKD"), a wholly-owned subsidiary of Furman Selz LLC ("Furman Selz"),
which is not affiliated with First Union, is now the Fund's principal
underwriter (the "Principal Underwriter"). EKD replaces Fiduciary Investment
Company ("FICO") as the Fund's principal underwriter. FICO may no longer act as
principal underwriter of the Fund due to regulatory restrictions imposed by the
Glass-Steagall Act upon national banks, such as FUNB and their affiliates, that
prohibit such entities from acting as the underwriters or distributors of mutual
fund shares. While FICO may no longer act as principal underwriter of the Fund
as discussed above, FICO may continue to receive compensation from the Fund or
the Principal Underwriter in respect of underwriting and distribution services
performed prior to the termination of FICO as principal underwriter. Evergreen
Keystone Investment Services, Inc., an affiliate of Keystone, may also be
compensated by the Principal Underwriter for the provision of certain marketing
support services to the Principal Underwriter at an annual rate of up to .75% of
the average daily net assets of the Fund, subject to certain restrictions. Both
EKD and Furman Selz are located at 230 Park Avenue, New York, New York 10169.
SUB-ADMINISTRATOR
Furman Selz provides officers and certain administrative services to the Fund
pursuant to a sub-administration agreement. For its services under that
agreement, Furman Selz receives a fee from Keystone at the maximum annual rate
of .01% of the average daily net assets of the Fund.
It is expected that on or about January 2, 1997, Furman Selz will transfer
EKD, and its related mutual fund distribution and administration business, to
BISYS Group, Inc. ("BISYS"). At that time, BISYS will succeed as
sub-administrator for the Fund. It is not expected that the acquisition of the
mutual fund distribution and administration business by BISYS will affect the
services currently provided by EKD or Furman Selz.
CODE OF ETHICS
The Fund has adopted a Code of Ethics incorporating policies on personal
securities trading as recommended by the Investment Company Institute.
PORTFOLIO MANAGER
Christopher P. Conkey has been the Fund's portfolio manager since 1991. Mr.
Conkey is a Keystone Senior Vice President and Group Leader for the high grade
fixed income area. Mr. Conkey joined Keystone as a fixed income portfolio
manager in 1988.
FUND EXPENSES
Pursuant to the Advisory Agreement, Keystone has agreed to pay certain of the
Fund's expenses, including expenses of the Fund's transfer agent, custodian and
auditors; fees payable to government agencies, including registration and
qualification fees of the Fund and its shares under federal and state securities
laws; expenses of preparing, printing and mailing Fund prospectuses, notices,
reports and proxy material; and expenses of shareholders' and Trustees'
meetings. In addition to the investment advisory and management fee discussed
above, the principal expenses that the Fund is expected to pay include expenses
of its Independent Trustees; brokerage commissions, interest charges and taxes;
legal fees and certain extraordinary expenses. Each class will pay all of the
expenses attributable to it. Such expenses are currently limited to Distribution
Plan expenses.
During the fiscal year ended September 30, 1996, Keystone voluntarily limited
the expenses of the Fund's Class Y and Class Z shares to .55% and .30%,
respectively, of average net class assets annually. Keystone reserves the right
at any time, however, to make a redetermination of whether to continue these
expense limits and, if so, at what rates. For the fiscal year ended September
30, 1996, the Fund paid or accrued to Keystone investment management and
advisory services fees of $121,105 (0.30% of the Fund's average net assets).
For the fiscal year ended September 30, 1996, the Fund paid .55% and .30% of
the average annual net assets of the Class Y and Class Z shares, respectively,
in expenses.
SECURITIES TRANSACTIONS
Under policies established by the Board of Trustees, Keystone selects
broker-dealers to execute transactions subject to the receipt of best execution.
When selecting broker-dealers to execute portfolio transactions for the Fund,
Keystone may consider the number of shares of the Fund sold by the
broker-dealer. In addition, broker-dealers executing portfolio transactions,
from time to time, may be affiliated with the Fund, Keystone, the Principal
Underwriter or their affiliates.
The Fund may pay higher commissions to broker-dealers that provide research
services. Keystone may use these services in advising the Fund as well as in
advising its other clients.
PORTFOLIO TURNOVER
The Fund's portfolio turnover rates for the fiscal years ended September 30,
1996 and 1995 were 85% and 56%, respectively.
DISTRIBUTION PLAN
The Fund bears some of the costs of selling its Class Y shares under a
Distribution Plan adopted with respect to its Class Y shares ("Class Y
Distribution Plan") pursuant to Rule 12b-1 under the 1940 Act. Payments under
the Class Y Distribution Plan are limited to up to 0.35% annually of the average
daily net asset value of Class Y shares.
The NASD limits the amount that the Fund may pay annually in distribution
costs for the sale of its shares and shareholder service fees. The NASD
currently limits annual expenditures to 1% of the aggregate average daily net
asset value of its shares, of which 0.75% may be used to pay such distribution
costs and 0.25% may be used to pay shareholder service fees. The NASD also
limits the aggregate amount that the Fund may pay for such distribution costs to
6.25% of gross share sales since the inception of the 12b-1 Distribution Plan,
plus interest at the prime rate plus 1% on such amounts remaining unpaid from
time to time.
The Class Y Distribution Plan may be terminated at any time by vote of the
Independent Trustees or by vote of a majority of the outstanding Class Y shares.
Payments pursuant to the Class Y Distribution Plan are included in the
operating expenses of that class.
HOW TO BUY SHARES
Shares of the Fund are sold through the Principal Underwriter. Shares are sold
without a sales charge at the public offering price, which equals the net asset
value per share next computed after the Fund receives the purchase order on each
day on which the Exchange is open for business.
Shares are held in "open accounts," i.e., they are credited to the
shareholder's account on the Fund's books. No certificates are issued. All
orders for the purchase of shares are subject to acceptance by the Fund, which
has the right to reject any order.
Shares become entitled to income distributions declared on the first business
day following receipt by the Fund's transfer agent of payment for the shares.
OPENING AN ACCOUNT
First, telephone Evergreen Keystone Service Company (formerly Keystone
Investor Resource Center, Inc.) ("EKSC"), the Fund's transfer agent and dividend
disbursing agent, toll free at 1-800-633-2700 to open an account and obtain an
account or wire identification number. EKSC, a wholly-owned subsidiary of
Keystone, is located at 200 Berkeley Street, Boston, Massachusetts 02116-5034.
Second, arrange with your bank to wire federal funds to EKSC's agent at the
following address (please include your account number)
State Street Bank and Trust Company
Boston, Massachusetts
ABA 011000028 Attn: Mutual Fund Division
For incoming wire A/C 0127-654-2
For credit to KIARF
Client Name and/or Account Number:
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Third, complete and sign the Account Application and mail it to:
Evergreen Keystone Service Company
P.O. Box 2121
Boston, Massachusetts 02106-2121
If appropriate, EKSC may require additional documentation or verification of
authority.
Information on how to wire federal funds is available at any national bank or
any state bank that is a member of the Federal Reserve System. The bank may
charge for these services. Presently, there is no fee for receipt by EKSC of
federal funds wired, but the right to charge for this service is reserved.
ALTERNATIVE SALES OPTIONS The Fund offers two classes of shares.
CLASS Y SHARES
Class Y shares are sold without a sales charge at the time of purchase and are
not subject to a sales charge when they are redeemed. Class Y shares are
available to any investor making a minimum initial purchase aggregating
$1,000,000 or more. There is no minimum amount required for subsequent
purchases.
The Fund has adopted the Class Y Distribution Plan, which provides for
payments at an annual rate of up to 0.35% of the average daily net asset value
of Class Y shares, to pay expenses of the distribution of Class Y shares.
Payments are expected to be made at a rate of 0.25% of the average daily net
assets of Class Y shares. Amounts paid by the Fund under the Class Y
Distribution Plan are generally used to pay the Principal Underwriter and
others' service fees. The Fund may also make payments to the Principal
Underwriter, broker-dealers and others for activities that are primarily
intended to result in sales of Class Y shares, including, but not limited to,
mail promotions and advertising, including the use of member name and address
lists of affinity groups, professional associations, trade groups, industry
associations or other associations (e.g., credit union trade groups), for which
use royalty payments may be made. As a result, income distributions paid by the
Fund with respect to Class Y shares will generally be less than those paid with
respect to Class Z shares. See "Distribution Plan" above.
CLASS Z SHARES
Class Z shares are sold without a sales charge at the time of purchase and are
not subject to a sales charge when they are redeemed. Class Z shares are
available to the following investors making a minimum initial purchase
aggregating $1,000,000 or more: officers, directors or trustees, and employees
of the Fund, Keystone, the Principal Underwriter, or any of their affiliates,
and members of the immediate families of such persons, or any trust, pension,
profit-sharing, or other retirement or benefit plan for the benefit of such
persons; present shareholders of Class Z shares of the Fund; and existing
investment advisory clients of Keystone Institutional, a division of Keystone,
the Principal Underwriter, or any of their affiliates. There is no minimum
amount required for subsequent purchases.
ARRANGEMENTS WITH BROKER-DEALERS AND OTHERS
From time to time, the Principal Underwriter may provide promotional
incentives to certain dealers whose representatives have sold or are expected to
sell significant amounts of the Fund. In addition, from time to time,
broker-dealers may receive additional cash payments. The Principal Underwriter
may provide written information to broker-dealers with whom it has dealer
agreements that relates to sales incentive campaigns conducted by such
broker-dealers for their representatives as well as financial assistance in
connection with pre-approved seminars, conferences and advertising. No such
programs or additional compensation will be offered to the extent they are
prohibited by the laws of any state or any self-regulatory agency, such as the
National Association of Securities Dealers ("NASD").
The Principal Underwriter may, at its own expense, pay concessions in addition
to those described above to broker-dealers that satisfy certain criteria
established from time to time by the Principal Underwriter. These conditions
relate to increasing sales of shares of the Keystone funds over specified
periods and certain other factors. Such payments may, depending on the
broker-dealer's satisfaction of the required conditions, be periodic and may be
up to 1.00% of the value of shares sold by such broker-dealer.
The Principal Underwriter may also pay a transaction fee (up to the level of
the payments allowed to broker-dealers for the sale of such shares, as described
above) to banks and other financial services firms that facilitate transactions
in shares of the Fund.
The Glass-Steagall Act and other banking laws and regulations presently
prohibit member banks of the Federal Reserve System ("Member Banks") or their
non-bank affiliates from sponsoring, organizing, controlling, or distributing
the shares of registered open-end investment companies such as the Fund. Such
laws and regulations also prohibit banks from issuing, underwriting or
distributing securities in general. However, under the Glass-Steagall Act and
such other laws and regulations, a Member Bank or an affiliate thereof may act
as investment adviser, transfer agent or custodian to a registered open-end
investment company and may also act as agent in connection with the purchase of
shares of such an investment company upon the order of its customer. Keystone
and its affiliates, since they are direct or indirect subsidiaries of FUNB, are
subject to and in compliance with the aforementioned laws and regulations. In
the event the Glass-Steagall Act is deemed to prohibit depository institutions
from accepting certain payments from the Fund, or should Congress relax current
restrictions on depository institutions, the Board of Trustees will consider
what action, if any, is appropriate.
In addition, state securities laws on this issue may differ from the
interpretations of federal law expressed herein, and banks and financial
institutions may be required to register as broker-dealers pursuant to state
law.
HOW TO REDEEM SHARES
You may redeem shares of the Fund at net asset value by mail or by using the
telephone or telecommunication redemption privilege.
MAIL REDEMPTIONS
Shares may be redeemed on each day on which the Exchange is open by mailing a
written request to EKSC at the following address:
Evergreen Keystone Service Company
P.O. Box 2121
Boston, Massachusetts 02106-2121
The signatures on the written request must be PROPERLY GUARANTEED by a U.S.
stock exchange member, a bank or other persons eligible to guarantee signatures
under the Securities Exchange Act of 1934 and EKSC's policies when the
circumstances of such redemptions indicate that guaranteed signatures are
appropriate, in the judgment of the Fund or EKSC, for the protection of the
Fund, its shareholders and EKSC. The Fund and EKSC may waive this requirement or
may require additional documentation in certain cases.
TELEPHONE OR TELECOMMUNICATION REDEMPTIONS
You may redeem shares on each day on which the Exchange is open for business
by telephone (toll free 1-800-633-2700), mailgram, fax or other request not
bearing a signature and a signature guarantee to EKSC.
Shareholders must complete and sign the Account Application, including the
Redemption Authorization Section.
Redemption proceeds will be wired in federal funds only to the commercial bank
(and account number) designated by the shareholder on the Account Application.
If EKSC deems it appropriate, additional documentation may be required. Although
at present EKSC pays the wire costs involved, it reserves the right at any time
to require the shareholder to pay such costs.
Except as otherwise noted, neither the Fund, EKSC nor the Principal
Underwriter assumes responsibility for the authenticity of any instructions
received by any of them from a shareholder in writing or by telephone. EKSC will
employ reasonable procedures to confirm that instructions received over the
telephone are genuine. Neither the Fund, EKSC nor the Principal Underwriter will
be liable when following instructions received by telephone that EKSC reasonably
believes to be genuine.
Any change in the bank account designated to receive redemption proceeds must
be made in another Account Application signed by the shareholder (WITH
SIGNATURES PROPERLY GUARANTEED IN THE MANNER DESCRIBED ABOVE) and delivered to
EKSC at the address above.
If a shareholder redeems all the shares in an account, the shareholder will
receive, in addition to the value thereof, all declared but unpaid distributions
thereon.
REDEMPTION OF SHARES IN GENERAL
The Fund reserves the right, at any time, to terminate, suspend or change the
terms of any redemption method described in this prospectus, except redemption
by mail.
The Fund computes the amount due you at the close of the Exchange at the end
of the day on which it has received all proper documentation from you. Payment
will be made within seven days after a properly completed redemption request is
received.
The Fund may temporarily suspend the right to redeem or may extend the date
for payment when (1) the Exchange is closed, other than customary weekend and
holiday closings; (2) trading on the Exchange is restricted; (3) an emergency
exists and the Fund cannot dispose of its investments or fairly determine their
value; or (4) the Securities and Exchange Commission so orders.
SHAREHOLDER SERVICES
Details on all shareholder services may be ob- tained from EKSC by calling
toll free 1-800-633-2700 or from the Principal Underwriter by writing to the
Evergreen Keystone Distributor, Inc., 230 Park Avenue, New York, New York 10169.
SUBACCOUNTS
Special processing has been arranged with EKSC for banks and other
institutions that wish to open multiple accounts (a master account and
subaccounts). An investor wishing to avail himself or herself of EKSC's
subaccounting facilities will be required to enter into a separate agreement,
with the charges to be determined on the basis of the level of services to be
rendered. Subaccounts may be opened with the initial investment or at a later
date and may be established by an investor with registration either by name or
by number.
PERFORMANCE DATA
From time to time, the Fund may advertise "total return" and "current yield."
ALL DATA IS BASED ON HISTORICAL RESULTS. PAST PERFORMANCE SHOULD NOT BE
CONSIDERED REPRESENTATIVE OF RESULTS FOR ANY FUTURE PERIOD OF TIME. Total return
and current yield are computed separately for each class of shares of the Fund.
Total return refers to the Fund's average annual compounded rates of return over
specified periods determined by comparing the initial amount invested in a
particular class to the ending redeemable value of that amount. The resulting
equation assumes reinvestment of all dividends and distributions and deduction
of all recurring charges, if any, applicable to all shareholder accounts.
Current yield quotations represent the yield on an investment for a stated
30-day period computed by dividing net investment income earned per share during
the base period by the maximum offering price per share on the last day of the
base period.
FUND SHARES
The Fund currently issues Class Y and Z shares, which participate in dividends
and distributions and have equal voting, liquidation and other rights except
that (1) expenses related to the distribution of each class of shares or other
expenses that the Board of Trustees may designate as class expenses, from time
to time, are borne solely by each class; (2) each class of shares has exclusive
voting rights with respect to its Distribution Plan, if any; and (3) each class
has a different designation. When issued and paid for, the shares will be fully
paid and nonassessable by the Fund. Shares will have no preference, conversion,
exchange or preemptive rights. Shares are transferable, redeemable and freely
assignable as collateral. There are no sinking fund provisions. The Fund is
authorized to issue additional classes or series of shares.
Shareholders are entitled to one vote for each full share owned and fractional
votes for fractional shares on all matters subject to Fund vote. Shares of the
Fund vote together except when required by law to vote separately by series or
class. The Fund does not have annual meetings. The Fund will have special
meetings, from time to time, as required under its Declaration of Trust and
under the 1940 Act. As provided in the Declaration of Trust of the Fund,
shareholders have the right to remove Trustees by an affirmative vote of
two-thirds of the outstanding shares. A special meeting of the shareholders will
be held when holders of 10% of the outstanding shares request a meeting. As
prescribed by Section 16(c) of the 1940 Act, shareholders may be eligible for
shareholder communication assistance in connection with the special meeting.
Under Massachusetts law, it is possible that a Fund shareholder may be held
personally liable for the Fund's obligations. The Fund's Declaration of Trust
provides, however, that shareholders shall not be subject to any personal
liability for the Fund's obligations and provides indemnification from Fund
assets for any shareholder held personally liable for the Fund's obligations.
Disclaimers of such liability are included in each Fund agreement.
ADDITIONAL INFORMATION
Except as otherwise stated in this prospectus or required by law, the Fund
reserves the right to change the terms of the offer stated in this prospectus
without shareholder approval, including the right to impose or change fees for
services provided.
<PAGE>
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ADDITIONAL INVESTMENT INFORMATION
- --------------------------------------------------------------------------------
The Fund may engage in the following investment practices to the extent
described in the prospectus and the statement of additional information.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with member banks of the Federal
Reserve System having at least $1 billion in assets, primary dealers in U.S.
government securities or other financial institutions believed by Keystone to be
creditworthy. Such persons must be registered as U.S. government securities
dealers with an appropriate regulatory organization. Under such agreements, the
bank, primary dealer or other financial institution agrees upon entering into
the contract to repurchase the security at a mutually agreed upon date and
price, thereby determining the yield during the term of the agreement. This
results in a fixed rate of return insulated from market fluctuations during such
period. Under a repurchase agreement, the seller must maintain the value of the
securities subject to the agreement at not less than the repurchase price, such
value being determined on a daily basis by marking the underlying securities to
their market value. Although the securities subject to the repurchase agreement
might bear maturities exceeding a year, the Fund only intends to enter into
repurchase agreements that provide for settlement within a year and usually
within seven days. Securities subject to repurchase agreements will be held by
the Fund's custodian or in the Federal Reserve book entry system. The Fund does
not bear the risk of a decline in the value of the underlying security unless
the seller defaults under its repurchase obligation. In the event of a
bankruptcy or other default of a seller of a repurchase agreement, the Fund
could experience both delays in liquidating the underlying securities and losses
including (1) possible declines in the value of the underlying securities during
the period while the Fund seeks to enforce its rights thereto; (2) possible
subnormal levels of income and lack of access to income during this period; and
(3) expenses of enforcing its rights. The Board of Trustees of the Fund has
established procedures to evaluate the creditworthiness of each party with whom
the Fund enters into repurchase agreements by setting guidelines and standards
of review for Keystone and monitoring Keystone's actions with regard to
repurchase agreements.
REVERSE REPURCHASE AGREEMENTS
Under a reverse repurchase agreement, the Fund would sell securities and agree
to repurchase them at a mutually agreed upon date and price. The Fund intends to
enter into reverse repurchase agreements to avoid otherwise having to sell
securities during unfavorable market conditions in order to meet redemptions. At
the time the Fund enters into a reverse repurchase agreement, it will establish
a segregated account with the Fund's custodian containing liquid assets such as
U.S. government securities or other high grade debt securities having a value
not less than the repurchase price (including accrued interest) and will
subsequently monitor the account to ensure such value is maintained. Reverse
repurchase agreements involve the risk that the market value of the securities
the Fund is obligated to repurchase may decline below the repurchase price.
COLLATERALIZED MORTGAGE OBLIGATIONS
The Fund will invest only in CMOs issued or guaranteed by the U.S. government,
its agencies or instrumentalities. The Fund intends to invest only in CMOs that,
in Keystone's opinion, are suitable in light of the Fund's investment objective
and policies. The Fund may purchase any class of CMO other than the residual
(final) class or a class whose average life would extend or is shortened by more
than 6 years under modeling scenarios where mortgage commitment rates
immediately rise or fall 300 basis points.
CMOs are debt obligations collateralized by Mortgage Securities and may be
issued by and guaranteed as to principal and interest by the U.S. government,
its agencies or instrumentalities or by private originators of, or investors in,
mortgage loans, including savings and loan associations, mortgage banks,
commercial banks, investment banks and special purpose subsidiaries of the
foregoing. The principal governmental issuer of CMOs is FNMA. In addition, FHLMC
issues a significant number of CMOs. The secondary market for CMOs is actively
traded.
CMOs are structured by redirecting the total payment of principal and interest
on the underlying Mortgage Securities used as collateral to create classes with
different interest rates, maturities and payment schedules. Instead of interest
and principal payments on the underlying Mortgage Securities being passed
through or paid pro-rata to all holders of interests in the underlying Mortgage
Securities, each class of a CMO is paid from and secured by a separate priority
payment of the cash flow generated by the pledged Mortgage Securities.
Most CMO issues have at least four classes. Classes with earlier maturities
receive priority on payments to assure the early maturity. After the first class
is redeemed, excess cash flow not necessary to pay interest on the remaining
classes is directed to the repayment of the next maturing class until that class
is fully redeemed. This process continues until all classes of the CMO issue
have been paid in full. Among the CMO classes available are floating
(adjustable) rate classes, which have characteristics similar to ARMS and
inverse floating rate classes whose coupons vary inversely with the rate of some
market index.
<PAGE>
- ----------------------
Evergreen Keystone
[logo] FUNDS [logo]
- ----------------------
Evergreen Keystone Distributor, Inc.
230 Park Avenue
New York, New York 10169
KIARF-P Sup. 12/96
1.2M
[recycle symbol]
- -------------------------------
KEYSTONE
-------------------
INSTITUTIONAL
ADJUSTABLE
RATE FUND
-------------------
PROSPECTUS
-------------------------------
- ----------------------
Evergreen Keystone
[logo] FUNDS [logo]
- ----------------------
<PAGE>
KEYSTONE INSTITUTIONAL ADJUSTABLE RATE FUND
STATEMENT OF ADDITIONAL INFORMATION
DECEMBER 10, 1996
AS SUPPLEMENTED DECEMBER 11, 1996
This statement of additional information is not a prospectus, but relates
to, and should be read in conjunction with, the prospectus of Keystone
Institutional Adjustable Rate Fund (the "Fund") dated December 10, 1996, as
supplemented. A copy of the prospectus may be obtained from the Fund's principal
underwriter, Evergreen Keystone Distributor, Inc., located at 230 Park Avenue,
New York, New York 10169.
- -------------------------------------------------------------------------------
TABLE OF CONTENTS
- -------------------------------------------------------------------------------
Page
The Fund 2
Investment Restrictions 2
Distributions and Taxes 4
Valuation of Securities 5
Brokerage 6
Distribution Plan 8
Trustees and Officers 10
Investment Adviser 15
Distributor 17
Sub-administrator 19
Declaration of Trust 19
Expenses 21
Standardized Total Return and Yield Quotations 22
Additional Information 23
Financial Statements 26
Appendix A-1
<PAGE>
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THE FUND
- -------------------------------------------------------------------------------
The Fund is an open-end, diversified management investment company, commonly
known as a mutual fund. The Fund was formed as a Massachusetts business trust on
June 19, 1991.
Keystone Investment Management Company ("Keystone") is the Fund's investment
adviser. Evergreen Keystone Distributor, Inc. (formerly Evergreen Funds
Distributor, Inc.) ("EKD" or the "Principal Underwriter") is the Fund's
principal underwriter. Evergreen Keystone Investment Services, Inc. (formerly
Keystone Investment Distributors Company) ("EKIS") is the predecessor to the
Principal Underwriter. See "Investment Adviser" and "Principal Underwriter"
below.
Certain information about the Fund is contained in its prospectus. This
statement of additional information provides additional information about the
Fund.
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INVESTMENT RESTRICTIONS
- -------------------------------------------------------------------------------
The Fund has adopted the fundamental investment restrictions set forth below
which may not be changed without the vote of a majority of the Fund's
outstanding shares (as defined in the Investment Company Act of 1940 (the "1940
Act") as the lesser of (1) 67% of the shares represented at a meeting at which
more than 50% of the outstanding shares are represented or (2) more than 50% of
the outstanding shares). Unless otherwise stated, all references to the assets
of the Fund are in terms of current market value.
The Fund may not do the following:
(1) with respect to 75% of its total assets, invest more than 5% of the
value of its total assets in the securities of any one issuer; this limitation
does not apply to investments in securities issued or guaranteed by the U.S.
government, its agencies or instrumentalities;
(2) invest more than 5% of its total assets in securities of any company
having a record, together with its predecessors, of less than three years of
continuous operations;
(3) pledge more than 15% of its net assets to secure indebtedness; the
purchase or sale of securities on a when issued basis is not deemed to be a
pledge of assets;
(4) borrow money or enter into reverse repurchase agreements, except that
the Fund may enter into reverse repurchase agreements or borrow money from banks
for temporary or emergency purposes in aggregate amounts up to one-third of the
value of the Fund's net assets; provided that while borrowings from banks (not
including reverse repurchase agreements) exceed 5% of the Fund's net assets, any
such excess borrowings will be repaid before additional investments are made;
(5) make loans, except that the Fund may purchase or hold debt securities
consistent with its investment objective, lend portfolio securities valued at
not more than 15% of its total assets to brokers, dealers and financial
institutions, and enter into repurchase agreements;
(6) make short sales of securities or maintain a short position, unless at
all times when a short position is open it owns an equal amount of such
securities or of securities which, without payment of any further consideration,
are convertible into or exchangeable for securities of the same issue as, and
equal in amount to, the securities sold short;
(7) issue senior securities; the purchase or sale of securities on a when
issued basis is not deemed to be the issuance of a senior security;
(8) purchase securities on margin, except that it may obtain such short-term
credit as may be necessary for the clearance of purchases and sales of
securities;
(9) purchase more than 3% of the total outstanding voting securities of any
one investment company, invest more than 5% of its total assets in any one
investment company or invest more than 10% of its total assets in investment
companies in general, except as part of a merger, consolidation, purchase of
assets or similar transaction;
(10) purchase or sell commodities or commodity contracts or real estate,
except that it may purchase and sell securities secured by real estate and
securities of companies which invest in real estate and may engage in financial
futures contracts and related options transactions; and
(11) underwrite securities of other issuers, except that the Fund may
purchase securities from the issuer or others and dispose of such securities in
a manner consistent with its investment objective.
If a percentage limit is satisfied at the time of investment or borrowing, a
later increase or decrease resulting from a change in asset value of a security
or a decrease in Fund assets is not a violation of the limit.
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DISTRIBUTIONS AND TAXES
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The Fund intends to distribute its net investment income daily and its net
capital gains, if any, annually. You will receive distributions as shares,
unless you elect, before the payable date for income dividends or the record
date for capital gains distributions, to receive them as cash. Unless the Fund
receives instructions to the contrary, it will assume that you wish to receive
that distribution and future gains and income distributions in shares. Your
instructions continue in effect until changed in writing. If you have not opted
to receive cash, the Fund will determine the number of shares that you should
receive based on its net asset value per share as computed at the close of
business on the ex-dividend date after adjustment for the distribution.
Capital gains distributions that reduce the net asset value of your shares
below your cost are, to the extent of the reduction, a return of your
investment. Since distributions of capital gains depend upon profits realized
from the sale of the Fund's portfolio securities, they may or may not occur.
Distributions are taxable whether you receive them in cash or additional
shares. Long-term capital gains distributions are taxable as such regardless of
(1) how long you have held the shares or (2) whether you receive them in cash or
in additional shares. If, however, you hold the Fund's shares for less than six
months and redeem them at a loss, you will recognize a long-term capital loss to
the extent of the long-term capital gain distribution received in connection
with such shares.
The Fund intends to distribute only such net capital gains and income as it
has predetermined, to the best of its ability, to be taxable as ordinary income.
The Fund distributes its net investment income on a federal income tax basis,
not based on distributable income as computed on our books. The Fund does not
expect its income dividends to qualify for the corporate dividends received
deduction.
The Fund will advise you annually as to the federal income tax status of
your distributions. These comments relating to the taxation of dividends and
distributions paid on the Fund's shares relate solely to federal income
taxation. Your dividends and distributions may also be subject to state and
local taxes.
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VALUATION OF SECURITIES
- -------------------------------------------------------------------------------
Current values for the Fund's portfolio securities are determined in the
following manner:
(1) securities for which market quotations are readily available are valued
at market value, which is deemed to be the mean of the bid and asked prices at
the time of valuation;
(2) (a) short-term investments that are purchased with maturities of sixty
days or less when purchased are valued at amortized cost (original purchase cost
as adjusted for amortization of premium or accretion of discount), which, when
combined with accrued interest, approximates market;
(b) short-term investments maturing in more than sixty days when purchased
that are held on the sixtieth day prior to maturity are valued at amortized cost
(market value on the sixtieth day adjusted for amortization of premium or
accretion of discount), which, when combined with accrued interest, approximates
market;
(c) short-term instruments having maturities of more than sixty days, for
which market quotations are readily available, are valued at current market
value; and
(3) securities, including restricted securities, for which market quotations
are not readily available, and other assets are valued at prices deemed in good
faith to be fair under procedures established by the Fund's Board of Trustees.
The Fund believes that reliable market quotations are generally not readily
available for purposes of valuing certain securities. As a result, depending on
the particular securities owned by the Fund, it is likely that most of the
valuations for such obligations will be based upon their fair value determined
under procedures that have been approved by the Board of Trustees. The Board of
Trustees has authorized the use of a pricing service to determine the fair value
of the Fund's fixed rate mortgage securities.
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BROKERAGE
- -------------------------------------------------------------------------------
SELECTION OF BROKERS
In effecting transactions in portfolio securities for the Fund, Keystone
seeks the best execution of orders at the most favorable prices. Keystone
determines whether a broker has provided the Fund with best execution and price
in the execution of a securities transaction by evaluating, among other things:
1. overall direct net economic result to the Fund,
2. the efficiency with which the transaction is effected,
3. the broker's ability to effect the transaction where a large block is
involved,
4. the broker's readiness to execute potentially difficult transactions in
the future,
5. the financial strength and stability of the broker, and
6. the receipt of research services, such as analyses and reports concerning
issuers, industries, securities, economic factors and trends and other
statistical and factual information.
The Fund's management weighs these considerations in determining the overall
reasonableness of the brokerage commissions paid.
Should the Fund or Keystone receive research and other statistical and
factual information from a broker, the Fund would consider such services to be
in addition to, and not in lieu of, the services Keystone is required to perform
under the Advisory Agreement. Keystone believes that the cost, value and
specific application of such information are indeterminable and cannot be
practically allocated between the Fund and its other clients who may indirectly
benefit from the availability of such information. Similarly, the Fund may
indirectly benefit from information made available as a result of transactions
effected for Keystone's other clients. Under the Advisory Agreement, Keystone is
permitted to pay higher brokerage commissions for brokerage and research
services in accordance with Section 28(e) of the Securities Exchange Act of
1934. In the event Keystone follows such a practice, it will do so on a basis
that is fair and equitable to the Fund.
Neither the Fund nor Keystone intends on placing securities transactions
with any particular broker. The Fund's Board of Trustees has determined,
however, that the Fund may consider sales of Fund shares as a factor in the
selection of brokers to execute portfolio transactions, subject to the
requirements of best execution described above.
BROKERAGE COMMISSIONS
The Fund expects to purchase and sell its securities and temporary
instruments through principal transactions. Bonds and money market instruments
are normally purchased directly from the issuer or from an underwriter or market
maker for the securities. In general, the Fund will not pay brokerage
commissions for such purchases. Purchases from underwriters will include the
underwriting commission or concession, and purchases from dealers serving as
market makers will include a dealer's mark-up or reflect a dealer's mark-down.
Where transactions are made in the over-the-counter market, the Fund will deal
with primary market makers unless more favorable prices are otherwise
obtainable.
GENERAL BROKERAGE POLICIES
In order to take advantage of the availability of lower purchase prices, the
Fund may participate, if and when practicable, in group bidding for the direct
purchase from an issuer of certain securities.
Keystone makes investment decisions for the Fund independently from those of
its other clients. It may frequently develop, however, that Keystone will make
the same investment decision for more than one client. Simultaneous transactions
are inevitable when the same security is suitable for the investment objective
of more than one account. When two or more of its clients are engaged in the
purchase or sale of the same security, Keystone will allocate the transactions
according to a formula that is equitable to each of its clients. Although, in
some cases, this system could have a detrimental effect on the price or volume
of the Fund's securities, the Fund believes that in other cases its ability to
participate in volume transactions will produce better executions.
The Fund does not purchase portfolio securities from or sell portfolio
securities to Keystone, the Principal Underwriter, or any of their affiliated
persons, as defined in the 1940 Act.
The Board of Trustees will, from time to time, review the Fund's brokerage
policy. Because of the possibility of further regulatory developments affecting
the securities exchanges and brokerage practices generally, the Board of
Trustees may change, modify or eliminate any of the foregoing practices.
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DISTRIBUTION PLAN
- -------------------------------------------------------------------------------
GENERAL
The Fund offers Class Y and Z shares. Class Y shares are offered without an
initial sales charge and are not subject to a sales charge when they are
redeemed. Class Y shares make payments under a distribution plan pursuant to
Rule 12b-1 under the 1940 Act (the "Class Y Distribution Plan").
Class Z shares are also offered without a sales charge at the time of
purchase and are not subject to a sales charge when they are redeemed. There is
no distribution plan with respect to Class Z shares. Class Z shares are
available only to certain investors. The prospectus contains a general
description of how investors may buy shares of the Fund.
Rule 12b-1 under the 1940 Act permits investment companies, such as the
Fund, to use their assets to bear expenses of distributing their shares if they
comply with various conditions, including adoption of a distribution plan
containing certain provisions set forth in Rule 12b-1. The Fund's Class Y
Distribution Plan has been approved by the Fund's Board of Trustees, including a
majority of the Independent Trustees (Trustees who are not interested persons of
the Fund, as defined in the 1940 Act, and who have no direct or indirect
financial interest in the Fund's Distribution Plan or any agreement related
thereto).
The National Association of Securities Dealers, Inc. ("NASD") limits the
amount that the Fund may pay annually in distribution costs for sale of its
shares and shareholder service fees. The NASD limits annual expenditures to
1.00% of the aggregate average daily net asset value of its shares, of which
0.75% may be used to pay such distribution costs and 0.25% may be used to pay
shareholder service fees. The NASD also limits the aggregate amount that the
Fund may pay for such distribution costs to 6.25% of gross share sales since the
inception of the Class Y Distribution Plan, plus interest at the prime rate plus
1.00% on such amounts remaining unpaid from time to time.
CLASS Y DISTRIBUTION PLAN. The Class Y Distribution Plan provides that the Fund
may expend daily amounts at an annual rate up to 0.35% of the Fund's average
daily net asset value attributable to Class Y shares to finance any activity
that is primarily intended to result in the sale of Class Y shares, including
without limitation, expenditures consisting of the payment of service fees to
the Principal Underwriter or others. Such payments are expected to be at a rate
of 0.25% of the average daily net assets of Class Y shares.
Amounts paid by the Fund under the Class Y Distribution Plan are currently
used to pay the Principal Underwriter and others, such as broker-dealers,
service fees at an annual rate of up to 0.25% of the average daily net asset
value of Class Y shares maintained by the Principal Underwriter and such others
and outstanding on the books of the Fund for specified periods. The Fund may
also make payments to the Principal Underwriter, broker-dealers and others for
activities that are primarily intended to result in sales of the Fund's Class Y
shares, including, but not limited to, mail promotions and advertising,
including the use of member name and address lists of affinity groups,
professional associations, trade groups, industry associations, or other
associations, for which use royalty payments may be made.
The Class Y Distribution Plan may be terminated, at any time, by vote of the
Independent Trustees or by vote of a majority of the outstanding voting shares
of the Fund's Class Y shares. Any change in the Class Y Distribution Plan that
would materially increase the distribution expenses of the Fund's Class Y shares
provided for in the Class Y Distribution Plan requires shareholder approval.
Otherwise, the Class Y Distribution Plan may be amended by the Trustees,
including the Independent Trustees.
The total amounts paid by the Fund under the foregoing arrangements may not
exceed the maximum Class Y Distribution Plan limit specified above, and the
amounts and purposes of expenditures under the Class Y Distribution Plan must be
reported to the Independent Trustees quarterly. The Independent Trustees may
require or approve changes in the implementation or operation of the Class Y
Distribution Plan and may also require that total expenditures by the Fund under
the Class Y Distribution Plan be kept within limits lower than the maximum
amount permitted by the Distribution Plan as stated above.
While the Class Y Distribution Plan is in effect, the Fund will be required
to commit the selection and nomination of candidates for Independent Trustees to
the discretion of the Independent Trustees.
The Independent Trustees of the Fund have determined that the sales of the
Fund's Class Y shares resulting from payments under the Class Y Distribution
Plan have benefit the Fund.
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TRUSTEES AND OFFICERS
- -------------------------------------------------------------------------------
The Trustees and officers of the Fund, their addresses, their principal
occupations and some of their affiliations over the last five years are as
follows:
FREDERICK AMLING: Trustee of the Fund; Trustee or Director of all
other funds in the Keystone Investments Families
of Funds; Professor, Finance Department, George
Washington University; President, Amling &
Company (investment advice); and former Member,
Board of Advisers, Credito Emilano (banking).
LAURENCE B. ASHKIN: Trustee of the Fund; Trustee or Director of all
other funds in the Keystone Investments Families
of Funds; Trustee of all the Evergreen funds
other than Evergreen Investment Trust; real
estate developer and construction consultant;
and President of Centrum Equities and Centrum
Properties, Inc.
CHARLES A. AUSTIN III: Trustee of the Fund; Trustee or Director of all
other funds in the Keystone Investments Families
of Funds; Investment Counselor to Appleton
Partners, Inc.; and former Managing Director,
Seaward Management Corporation (investment
advice).
FOSTER BAM: Trustee of the Fund; Trustee or Director of all
other funds in the Keystone Investments Families
of Funds; Trustee of all the Evergreen funds
other than Evergreen Investment Trust; Partner
in the law firm of Cummings & Lockwood;
Director, Symmetrix, Inc. (sulphur company) and
Pet Practice, Inc. (veterinary services); and
former Director, Chartwell Group Ltd.
(Manufacturer of office furnishings and
accessories), Waste Disposal Equipment
Acquisition Corporation and Rehabilitation
Corporation of America (rehabilitation
hospitals).
*GEORGE S. BISSELL: Chairman of the Board and Trustee of the Fund;
Chairman of the Board and Trustee or Director of
all other funds in the Keystone Investments
Families of Funds; Chairman of the Board and
Trustee of Anatolia College; Trustee of
University Hospital (and Chairman of its
Investment Committee); former Director and
Chairman of the Board of Hartwell Keystone; and
former Chairman of the Board, Director and Chief
Executive Officer of Keystone Investments.
EDWIN D. CAMPBELL: Trustee of the Fund; Trustee or Director of all
other funds in the Keystone Investments Families
of Funds; Principal, Padanaram Associates, Inc.;
and former Executive Director, Coalition of
Essential Schools, Brown University.
CHARLES F. CHAPIN: Trustee of the Fund; Trustee or Director of all
other funds in the Keystone Investments Families
of Funds; and former Director, Peoples Bank
(Charlotte, NC).
K. DUN GIFFORD: Trustee of the Fund; Trustee or Director of all
other funds in the Keystone Investments Families
of Funds; Trustee, Treasurer and Chairman of the
Finance Committee, Cambridge College; Chairman
Emeritus and Director, American Institute of
Food and Wine; Chairman and President, Oldways
Preservation and Exchange Trust (education);
former Chairman of the Board, Director, and
Executive Vice President, The London Harness
Company; former Managing Partner, Roscommon
Capital Corp.; former Chief Executive Officer,
Gifford Gifts of Fine Foods; former Chairman,
Gifford, Drescher & Associates (environmental
consulting); and former Director, Keystone
Investments and Keystone.
JAMES S. HOWELL: Trustee of the Fund; Trustee or Director of all
other funds in the Keystone Investments Families
of Funds; Chairman and Trustee of the Evergreen
funds; former Chairman of the Distribution
Foundation for the Carolinas; and former Vice
President of Lance Inc. (food manufacturing).
LEROY KEITH, JR.: Trustee of the Fund; Trustee or Director of all
other funds in the Keystone Investments Families
of Funds; Chairman of the Board and Chief
Executive Officer, Carson Products Company;
Director of Phoenix Total Return Fund and
Equifax, Inc.; Trustee of Phoenix Series Fund,
Phoenix Multi- Portfolio Fund, and The Phoenix
Big Edge Series Fund; and former President,
Morehouse College.
F. RAY KEYSER, JR.: Trustee of the Fund; Trustee or Director of all
other funds in the Keystone Investments Families
of Funds; Chairman and Of Counsel, Keyser,
Crowley & Meub, P.C.; Member, Governor's (VT)
Council of Economic Advisers; Chairman of the
Board and Director, Central Vermont Public
Service Corporation and Lahey Hitchcock Clinic;
Director, Vermont Yan kee Nuclear Power
Corporation, Grand Trunk Corporation, Grand
Trunk Western Railroad, Union Mutual Fire
Insurance Company, New England Guaranty
Insurance Company, Inc., and the Investment
Company Institute; former Director and
President, Associated Industries of Vermont;
former Director of Keystone, Central Vermont
Railway, Inc., S.K.I. Ltd., and Arrow Financial
Corp.; and former Director and Chairman of the
Board, Proctor Bank and Green Mountain Bank.
GERALD M. MCDONELL: Trustee of the Fund; Trustee or Director of all
other funds in the Keystone Investments Families
of Funds; Trustee of the Evergreen funds; and
Sales Representative with Nucor-Yamoto, Inc.
(Steel producer).
THOMAS L. MCVERRY: Trustee of the Fund; Trustee or Director of all
other funds in the Keystone Investments Families
of Funds; Trustee of the Evergreen funds; former
Vice President and Director of Rexham
Corporation; and former Director of Carolina
Cooperative Federal Credit Union.
*WILLIAM WALT PETTIT: Trustee of the Fund; Trustee or Director of all
other funds in the Keystone Investments Families
of Funds; Trustee of the Evergreen funds; and
Partner in the law firm of Holcomb and Pettit,
P.A.
DAVID M. RICHARDSON: Trustee of the Fund; Trustee or Director of all
other funds in the Keystone Investments Families
of Funds; Vice Chair and former Executive Vice
President, DHR International, Inc. (executive
recruit ment); former Senior Vice President,
Boyden International Inc. (executive
recruitment); and Director, Commerce and
Industry Association of New Jersey, 411
International, Inc., and J&M Cumming Paper Co.
RUSSELL A. SALTON, III MD: Trustee of the Fund; Trustee or Director of all
other funds in the Keystone Investments Families
of Funds; Trustee of the Evergreen funds;
Medical Director, U.S. Health Care/Aetna Health
Services; and former Managed Health Care
Consultant; former President, Primary Physician
Care.
MICHAEL S. SCOFIELD: Trustee of the Fund; Trustee or Director of all
other funds in the Keystone Investments Families
of Funds; Trustee of the Evergreen funds; and
Attorney, Law Offices of Michael S. Scofield.
RICHARD J. SHIMA: Trustee of the Fund; Trustee or Director of all
other funds in the Keystone Investments Families
of Funds; Chairman, Environmental Warranty, Inc.
(Insurance agency); Executive Consultant, Drake
Beam Morin, Inc. (executive outplacement);
Director of Connecticut Natural Gas Corporation,
Hartford Hospital, Old State House Association,
Middlesex Mutual Assurance Company, and Enhance
Financial Services, Inc.; Chairman, Board of
Trustees, Hartford Graduate Center; Trustee,
Greater Hartford YMCA; former Director, Vice
Chairman and Chief Investment Officer, The
Travelers Corporation; former Trustee,
Kingswood-Oxford School; and former Managing
Director and Consultant, Russell Miller, Inc.
*ANDREW J. SIMONS: Trustee of the Fund; Trustee or Director of all
other funds in the Keystone Investments Families
of Funds; Partner, Farrell, Fritz, Caemmerer,
Cleary, Barnosky & Armentano, P.C.; Adjunct
Professor of Law and former Associate Dean, St.
John's Univer sity School of Law; Adjunct
Professor of Law, Touro College School of Law;
and former President, Nassau County Bar
Association.
JOHN J. PILEGGI: President and Treasurer of the Fund; President
and Treasurer of all other funds in the Keystone
Investments Families of Funds; President and
Treasurer of the Evergreen funds; Senior
Managing Director, Furman Selz LLC since 1992;
Managing Director from 1984 to 1992; 230 Park
Avenue, Suite 910, New York, NY.
GEORGE O. MARTINEZ: Secretary of the Fund; Secretary of all other
funds in the Keystone Investments Families of
Funds; Senior Vice President and Director of
Administration and Regulatory Services, BISYS
Fund Services; 3435 Stelzer Road, Columbus,
Ohio.
* This Trustee may be considered an "interested person" within the meaning of
the 1940 Act.
Mr. Bissell is deemed an "interested person" of the Fund by virtue of his
ownership of stock of First Union Corporation ("First Union"), of which Keystone
is an indirect wholly-owned subsidiary. See "Investment Adviser." Mr. Pettit and
Mr. Simons may each be deemed an "interested person" as a result of certain
legal services rendered to a subsidiary of First Union by their respective law
firms, Holcomb and Pettit, P.A. and Farrell, Fritz, Caemmerer, Cleary, Barnosky
& Armentano, P.C. As of the date hereof, Mr. Pettit and Mr. Simons are each
applying for an exemption from the Securities and Exchange Commission ("SEC")
which would allow them to retain their status as an Independent Trustee.
After the transfer of EKD and its related mutual fund distribution and
administration business to BISYS, it is expected that all of the officers of the
Fund will be officers and/or employees of BISYS.
During the fiscal year ended September 30, 1996, no Trustee or officer
received any direct remuneration from the Fund. For the year ended December 31,
1995, aggregate compensation received by the Independent Trustees on a fund
complex wide basis (which includes over 30 mutual funds) was $450,716. On
November 21, 1996, the Fund's Trustees and officers as a group did not
beneficially own any of the Fund's outstanding shares.
Except as set forth above, the address of all of the Fund's Trustees and
officers and the address of the Fund is 200 Berkeley Street, Boston,
Massachusetts 02116-5034.
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INVESTMENT ADVISER
- -------------------------------------------------------------------------------
Subject to the general supervision of the Fund's Board of Trustees,
Keystone provides investment advice, management and administrative services to
the Fund. Keystone, organized in 1932, is a wholly-owned subsidiary of Keystone
Investments. Keystone Investments provides accounting, bookkeeping, legal,
personnel, and general corporate services to Keystone, its affiliates, and the
Keystone Investments Families of Funds. Both Keystone and Keystone Investments
are located at 200 Berkeley Street, Boston, Massachusetts 02116-5034.
On December 11, 1996, the predecessor corporation to Keystone Investments
and indirectly each subsidiary of Keystone Investments, including Keystone, the
Fund's investment adviser, were acquired (the "Acquisition") by First Union
National Bank of North Carolina ("FUNB"), a wholly-owned subsidiary of First
Union Corporation ("First Union"). The predecessor corporation to Keystone
Investments was acquired by FUNB by merger into a wholly-owned subsidiary of
FUNB, which entity then assumed the name "Keystone Investments, Inc." and
succeeded to the business of the predecessor corporation. Contemporaneously with
the Acquisition, the Fund entered into a new investment advisory agreement with
Keystone and into a principal underwriting agreement with Evergreen Keystone
Distributor, Inc. (formerly Evergreen Funds Distributor, Inc.) ("EKD"), a
wholly-owned subsidiary of Furman Selz LLC ("Furman Selz"). The new investment
advisory agreement (the "Advisory Agreement") was approved by the shareholders
of the Fund on December 9, 1996, and became effective on December 11, 1996. As a
result of the above transactions, Keystone Management, Inc. ("Keystone
Management"), which, prior to the Acquisition, acted as the Fund's investment
manager, no longer acts as such to the Fund. Keystone currently provides the
Fund with all the services that may previously have been provided by Keystone
Management.
Keystone Investments and each of its subsidiaries, including Keystone, are
now indirectly owned by First Union. First Union is headquartered in Charlotte,
North Carolina, and had $133.9 billion in consolidated assets as of September
30, 1996. First Union and its subsidiaries provide a broad range of financial
services to individuals and businesses throughout the United States. The Capital
Management Group of FUNB, together with Lieber & Company and Evergreen Asset
Management Corp., wholly-owned subsidiaries of FUNB, manage or otherwise oversee
the investment of over $50 billion in assets belonging to a wide range of
clients, including the Evergreen Family of Funds.
Pursuant to the Advisory Agreement, Keystone manages and administers the
Fund's operation and manages the investment and reinvestment of the Fund's
assets in conformity with the Fund's investment objective and restrictions.
The Advisory Agreement stipulates that Keystone shall (i) provide office
space and all necessary office facilities, equipment and personnel in connection
with its services under the Advisory Agreement; (ii) pay or reimburse the Fund
for the compensation of officers and Trustees of the Fund who are affiliated
with Keystone and (iii) pay all expenses of Keystone incurred in connection with
the provision of its services. In addition, Keystone also assumes and pays or
reimburses the Fund for (i) all charges and expenses of any custodian or
depository appointed by the Fund for the safekeeping of its cash, securities and
other property; (ii) all charges and expenses for bookkeeping and auditors;
(iii) all charges and expenses of any transfer agents and registrars appointed
by the Fund; (iv) all costs of certificates representing shares of the Fund; (v)
all fees and expenses involved in registering and maintaining registrations of
the Fund and of its shares with the Securities and Exchange Commission (the
"Commission") and registering or qualifying its shares under state or other
securities laws, including, without limitation, the preparation and printing of
registration statements, prospectuses and statements of additional information
for filing with the Commission and other authorities; (vi) expenses of
preparing, printing and mailing prospectuses and statements of additional
information to shareholders of the Fund; (vii) all expenses of shareholders' and
Trustees' meetings and of preparing, printing and mailing notices, reports and
proxy materials to shareholders of the Fund; and (viii) all charges and expenses
of filing annual and other reports with the Commission and other authorities.
The Fund assumes and pays all other expenses of the Fund, including,
without limitation, (i) fees of the Fund's Independent Trustees; (ii) all
brokers' fees, expenses and commissions and issue and transfer taxes chargeable
to the Fund in connection with transactions involving securities and other
property to which the Fund is a party; (iii) all costs and expenses of
distribution of its Class Y shares incurred pursuant to its Class Y Distribution
Plan adopted pursuant to Rule 12b-1 under the 1940 Act; (iv) all charges and
expenses of legal counsel for the Fund and for the Fund's Independent Trustees
on routine legal matters relating to the Fund, including, without limitation,
legal services rendered in connection with the Fund's existence, business trust
and financial structure and relations with its shareholders, registrations and
qualifications of securities under federal, state and other laws, and issues of
securities; (v) all taxes and business trust fees payable by the Fund to
federal, state or other governmental agencies; (vi) all interest costs of the
Fund; and (vii) all extraordinary expenses and charges of the Fund, including
all charges and expenses of legal counsel to the Fund in connection with
extraordinary matters, including, without limitation, any litigation involving
the Fund, its Trustees, officers, employees or agents. In the event Keystone
provides any of these services or pays any of these expenses, the Fund will
promptly reimburse Keystone therefor.
The Fund pays Keystone a fee for its services to the Fund at the annual
rate of 0.30% of the average daily net asset value of the shares of the Fund. A
pro rata portion of the fee is payable in arrears at the end of each day or
calendar month as Keystone may, from time to time, specify to the Fund.
Currently, Keystone has voluntarily limited the annual expenses of the
Fund's Class Y shares to no more than 0.55% and 0.30% of Class Y's and Class Z's
average daily net assets, respectively. Keystone intends to continue the
foregoing expense limitations on a calendar month-by-month basis. Keystone will
periodically evaluate the foregoing expense limitations and may modify or
terminate them in the future. Keystone will not be required to reimburse the
Fund for amounts in excess of an expense limit if such reimbursement would
result in the Fund's inability to qualify as a regulated investment company
under provisions of the Internal Revenue Code of 1986, as amended (the "Code").
Under the Advisory Agreement, any liability of Keystone in connection with
rendering services thereunder is limited to situations involving its willful
misfeasance, bad faith, gross negligence or reckless disregard of its duties.
The Advisory Agreement continues in effect for two years from its effective
date and, thereafter, from year to year only if approved at least annually by
the Board of Trustees of the Fund or by a vote of a majority of the Fund's
outstanding shares (as defined in the 1940 Act). In either case, the terms of
the Advisory Agreement and continuance thereof must be approved by the vote of a
majority of the Independent Trustees cast in person at a meeting called for the
purpose of voting on such approval. The Advisory Agreement may be terminated,
without penalty, on 60 days' written notice by the Fund's Board of Trustees or
by a vote of a majority of outstanding shares. The Advisory Agreement will
terminate automatically upon its "assignment" as that term is defined in the
1940 Act.
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DISTRIBUTOR
- -------------------------------------------------------------------------------
The Fund has entered into a Principal Underwriting Agreement (the
"Underwriting Agreement") with EKD. EKD, a wholly-owned subsidiary of Furman
Selz LLC ("Furman Selz") which is not affiliated with First Union, is now the
Principal Underwriter. EKD replaces FICO as the Fund's principal underwriter.
FICO may no longer act as principal underwriter of the Funds due to regulatory
restrictions imposed by the Glass-Steagall Act upon national banks such as FUNB
and their affiliates, that prohibit such entities from acting as the
underwriters of mutual fund shares. While FICO may no longer act as principal
underwriter of the Fund as discussed above, FICO may continue to receive
compensation from the Fund or the Principal Underwriter in respect of
underwriting and distribution services performed prior to the termination of
FICO as principal underwriter. In addition, EKIS may also be compensated by the
Principal Underwriter for the provision of certain marketing support services to
the Principal Underwriter at an annual rate of up to .75% of the average daily
net assets of the Fund, subject to certain restrictions. EKD is located at 230
Park Avenue, New York, New York 10169.
The Principal Underwriter, as agent, has agreed to use its best efforts to
find purchasers for the shares. The Principal Underwriter may retain and employ
representatives to promote distribution of the shares and may obtain orders from
broker-dealers, and others, acting as principals, for sales of shares to them.
The Underwriting Agreement provides that the Principal Underwriter will bear the
expense of preparing, printing, and distributing advertising and sales
literature and prospectuses used by it. In its capacity as principal
underwriter, the Principal Underwriter or EKIS, its predecessor, may receive
payments from the Fund pursuant to the Fund's Distribution Plan.
The Underwriting Agreement provides that it will remain in effect as long
as its terms and continuance are approved annually (i) by a vote of a majority
of the Fund's Independent Trustees, and (ii) by vote of a majority of the Fund's
Trustees, in each case, cast in person at a meeting called for that purpose.
The Underwriting Agreement may be terminated, without penalty, on 60 days'
written notice by the Board of Trustees or by a vote of a majority of
outstanding shares. The Underwriting Agreement will terminate automatically upon
its "assignment," as that term is defined in the 1940 Act.
From time to time, if, in the Principal Underwriter's judgment, it could
benefit the sales of Fund shares, the Principal Underwriter may provide to
selected broker-dealers promotional materials and selling aids, including, but
not limited to, personal computers, related software, and Fund data files.
All subscriptions and sales of shares by the Principal Underwriter are at
the public offering price of the shares, as determined in accordance with the
provisions of the Fund's Declaration of Trust, By-Laws, current prospectus and
statement of additional information. All orders are subject to acceptance by the
Fund, and the Fund reserves the right in its sole discretion to reject any order
received. Under the Distribution Agreement, the Fund is not liable to anyone for
failure to accept any order.
The Principal Underwriter has agreed that it will, in all respects, duly
conform with all state and federal laws applicable to the sale of the shares.
The Principal Underwriter has also agreed that it will indemnify and hold
harmless the Fund, and each person who has been, is or may be a Trustee or
officer of the Fund, against expenses reasonably incurred by any of them in
connection with any claim, action, suit or proceeding to which any of them may
be a party, that arises out of or is alleged to arise out of any
misrepresentation or omission to state a material fact on the part of the
Principal Underwriter or any other person for whose acts the Principal
Underwriter is responsible or is alleged to be responsible, unless such
misrepresentation or omission was made in reliance upon written information
furnished by the Fund.
- -------------------------------------------------------------------------------
SUB-ADMINISTRATOR
- -------------------------------------------------------------------------------
Furman Selz will provide officers and certain administrative services to
the Funds pursuant to a sub-administration agreement. For its services under
that agreement Furman Selz will receive from Keystone an annual fee at the
maximum annual rate of .01% of the average daily net assets of the Fund. Furman
Selz is located at 230 Park Avenue, New York, New York 10169.
It is expected that on or about January 2, 1997, Furman Selz will transfer
EKD, and its related mutual fund distribution and administration business, to
BISYS Group, Inc. ("BISYS"). At that time, BISYS will succeed as
sub-administrator for the Fund. It is not expected that the acquisition of the
mutual fund distribution and administration business by BISYS will affect the
services currently provided by EKD or Furman Selz.
- -------------------------------------------------------------------------------
DECLARATION OF TRUST
- -------------------------------------------------------------------------------
MASSACHUSETTS BUSINESS TRUST
The Fund is a Massachusetts business trust established under a Declaration
of Trust dated June 19, 1991, as amended (the "Declaration of Trust"). The Fund
is similar in most respects to a business corporation. The principal distinction
between the Fund and a corporation relates to the shareholder liability
described below. A copy of the Declaration of Trust is on file as an exhibit to
the Fund's Registration Statement. This summary is qualified in its entirety by
reference to the Declaration of Trust.
DESCRIPTION OF SHARES
The Declaration of Trust authorizes the issuance of an unlimited number of
shares of beneficial interest of classes of shares. Each share of the Fund
represents an equal proportionate interest with each other share of the series
or class. Upon liquidation, shares are entitled to a pro rata share in the net
assets of the portfolio of securities underlying the series or class.
Shareholders have no preemptive or conversion rights. Shares are redeemable and
transferable. The Fund offers Class Y and Z but may issue additional classes or
series of shares.
SHAREHOLDER LIABILITY
Pursuant to certain decisions of the Massachusetts courts, shareholders of
a Massachusetts business trust may, under certain circumstances, be held
personally liable for the obligations of the Fund. The possibility of the
shareholders incurring financial loss for that reason appears remote because the
Fund's Declaration of Trust (1) contains an express disclaimer of shareholder
liability for obligations of the Fund; (2) requires that notice of such
disclaimer be given in each agreement, obligation or instrument entered into or
executed by the Fund or the Trustees; and (3) provides for indemnification out
of Fund property for any shareholder held personally liable for the obligations
of the Fund.
VOTING RIGHTS
Under the terms of the Declaration of Trust, the Fund does not hold annual
meetings. At meetings called for the initial election of Trustees or to consider
other matters shares are entitled to one vote per share. Shares generally vote
together as one class on all matters. No amendment may be made to the
Declaration of Trust that adversely affects any class of shares without the
approval of a majority of the shares of that class. Shares have non-cumulative
voting rights, which means that the holders of more than 50% of the shares
voting for the election of Trustees can elect 100% of the Trustees to be elected
at a meeting, and in such event, the holders of the remaining 50% or less of the
shares voting will not be able to elect any Trustees.
After the initial meeting electing Trustees, no further meetings of
shareholders for the purpose of electing Trustees will be held unless required
by law or unless and until such time as less than a majority of the Trustees
holding office have been elected by shareholders, at which time the Trustees
then in office will call a shareholders' meeting for election of Trustees.
Except as set forth above, the Trustees shall continue to hold office
indefinitely, unless otherwise required by law, and may appoint successor
Trustees. A Trustee may be removed from or cease to hold office (as the case may
be) (1) at any time by two- thirds vote of the remaining Trustees; (2) when such
Trustee becomes mentally or physically incapacitated; or (3) at a special
meeting of shareholders by a two-thirds vote of the Fund's outstanding shares.
Any Trustee may voluntarily resign from office.
LIMITATION OF TRUSTEES' LIABILITY
The Declaration of Trust provides that a Trustee shall be liable only for
his own willful defaults and, if reasonable care has been exercised in the
selection of officers, agents, employees or investment advisers, shall not be
liable for any neglect or wrongdoing of any such person; provided, however, that
nothing in the Declaration of Trust shall protect a Trustee against any
liability for his willful misfeasance, bad faith, gross negligence or reckless
disregard of his duties.
The Trustees have absolute and exclusive control over the management and
disposition of all assets of the Fund and may perform such acts as in their sole
judgment and discretion are necessary and proper for conducting the business and
affairs of the Fund or promoting the interests of the Fund and the shareholders.
- -------------------------------------------------------------------------------
EXPENSES
- -------------------------------------------------------------------------------
INVESTMENT ADVISORY FEES
For each of the Fund's last three fiscal years, the table below lists the total
dollar amounts paid by the Fund to Keystone for services rendered under the
Advisory Agreement. The table below also shows the percentage of the Fund's
average net assets represented by Keystone's fees. For more information, see
"Investment Adviser."
Percentage of Fund's
Fiscal Year Fee Paid to Keystone Average Net Assets
Ended under the Advisory Represented by
September 30, Agreement Keystone's Fee
- ------------------ ----------------------- ------------------------
1996 $121,105 0.30%
1995 $ 79,819 0.30%
1994 $123,050 0.30%
DISTRIBUTION PLAN EXPENSES
During the fiscal year ended September 30,, 1996, the Fund paid $23,210 to FICO
under its Distribution Plan. For more information, see "Distribution Plans."
BROKERAGE COMMISSIONS
Listed below are the aggregate dollar amounts paid by the Fund in brokerage
commissions for each of the last three fiscal years. For more information, see
"Brokerage."
For the Fiscal Aggregate Dollar Amount
Year Ended of Brokerage Commissions
September 30, Paid
- ---------------------------- -----------------------------------------
1996 $0
1995 $0
1994 $0
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STANDARDIZED TOTAL RETURN AND YIELD QUOTATIONS
- -------------------------------------------------------------------------------
Total return quotations for a class of shares of the Fund as they may
appear from time to time in advertisements are calculated by finding the average
annual compounded rates of return over one, five and ten year periods, or the
time periods for which such class of shares has been effective, whichever is
relevant, on a hypothetical $1,000 investment that would equate the initial
amount invested in the class to the ending redeemable value. To the initial
investment all dividends and distributions are added, and all recurring fees
charged to all shareholder accounts are deducted. The ending redeemable value
assumes a complete redemption at the end of the relevant periods.
The annual total return for Class Y shares for the fiscal year ended
September 30, 1996, was 6.60%. Average annual total return for Class Y shares
for the period May 23, 1994 (commencement of operations), through the fiscal
period ended September 30, 1996, was 5.77%.
The annual total return for Class Z for the fiscal year ended September 30,
1996, was 6.86%. The average annual total return for Class Z for the period
October 1, 1991 (commencement of operations), through September 30, 1996, was
4.78%.
Current yield quotations as they may appear, from time to time, in
advertisements will consist of a quotation based on a 30-day period ended on the
date of the most recent balance sheet of the Fund, computed by dividing the net
investment income per share earned during the period by the maximum offering
price per share on the last day of the base period. The current yields for Class
Y and Class Z for the 30-day period ended September 30, 1996 were 6.07% and
6.36%, respectively.
Any given yield or total return quotation should not be considered
representative of the Fund's yield or total return for any future period.
- -------------------------------------------------------------------------------
ADDITIONAL INFORMATION
- -------------------------------------------------------------------------------
SMALL ACCOUNTS
The Fund reserves the right to redeem shares in any account in which the
value of shares is less than $1,000. The redemption proceeds will be promptly
paid to the shareholder. Shareholders will be notified if their accounts are
less than such amount and given 60 days to bring the account up to such amount
before the redemption is made.
REDEMPTIONS IN KIND
If conditions arise that would make it undesirable for the Fund to pay for
all redemptions in cash, the Fund may authorize payment to be made in portfolio
securities or other property. The Fund has obligated itself under the 1940 Act,
however, to redeem for cash all shares presented for redemption by any one
shareholder in any 90-day period up to the lesser of $250,000 or 1% of the
Fund's net assets. Securities delivered in payment of redemptions would be
valued at the same value assigned to them in computing the net asset value per
share and would, to the extent permitted by law, be readily marketable.
Shareholders receiving such securities would incur brokerage costs when these
securities are sold.
OTHER INFORMATION
State Street Bank and Trust Company, located at 225 Franklin Street,
Boston, Massachusetts 02110, is custodian of all securities and cash of the Fund
(the "Custodian"). The Custodian performs no investment management functions for
the Fund, but, in addition to its custodial services, is responsible for
accounting and related recordkeeping on behalf of the Fund.
KPMG Peat Marwick LLP, 99 High Street, Boston, Massachusetts 02110,
Certified Public Accountants, are the independent auditors for the Fund.
Evergreen Keystone Service Company (formerly Keystone Investor Resource
Center, Inc.) ("EKSC"), 200 Berkeley Street, Boston, Massachusetts 02116-5034,
is a wholly-owned subsidiary of Keystone and acts as transfer agent and dividend
disbursing agent for the Fund.
Except as otherwise stated in its prospectus or required by law, the Fund
reserves the right to change the terms of the offer stated in its prospectus
without shareholder approval, including the right to impose or change fees for
services provided.
No dealer, salesman or other person is authorized to give any information
or to make any representation not contained in the Fund's prospectus, statement
of additional information or in supplemental sales literature issued by the Fund
or FICO, and no person is entitled to rely on any information or representation
not contained therein.
As of November 21, 1996, the following accounts owned of record 5% or more
of the Fund's Class Y shares:
PERCENTAGE
RECORD OWNER OF CLASS OWNED
------------ --------------
Skyline Telephone Membership Corp 23.758%
Attn: Hobart G. Davis
P.O. Box 759
Jefferson, NC 28694-0759
Solano Partnership Health Plan 21.452%
Attn: Deborah Cox
421 Executive Ct. N#A
Suisun City, CA 94585-4019
William H. Morgan Jr. 21.376%
906 Weightman
Greenwood, MS 38930-2438
M & M Farms 13.024%
906 Weightman
Greenwood, MS 38930-2438
As of November 21, 1996, the following accounts owned of record 5% or more
of the outstanding shares of the Fund's Class Z shares:
PERCENTAGE
RECORD OWNER OF CLASS OWNED
------------ --------------
Bank of New York Trustee 55.859%
FBO Saatchi & Saatchi Cash Bal.
Retirement Plan Trust
Attn: Ms. Amy Nellissen
375 Hudson St
New York, NY 10014-3658
Ampex Retirement Master Trust 22.293%
P.O. Box 1992
Boston, MA 02105-1992
Keystone Investments 12.493%
Defined Benefit Pension Trusts
ATTN: Operations
200 Berkeley Street 25th Floor
Boston, MA 02116-5022
Keystone Investment Distributor 6.545%
Attn: Corporate Finance Dept.
21st Floor
200 Berkeley Street
Boston, MA 02116-5022
The Fund's prospectus and statement of additional information omit certain
information contained in its registration statement filed with the Commission,
which may be obtained from the Commission's principal office in Washington, D.C.
upon payment of the fee prescribed by the rules and regulations promulgated by
the Commission.
- -------------------------------------------------------------------------------
FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
The following financial statements of the Fund are incorporated by
reference herein from the Fund's Annual Report, as filed with the Commission:
Schedule of Investments and Statement of Assets and Liabilities as of
September 30, 1996;
Statement of Operations for the year ended September 30, 1996;
Statements of Changes in Net Assets for each of the years in the two-year
period ended September 30, 1996;
Financial Highlights for each of the years in the two-year period ended
September 30, 1996, and the period from May 23, 1994 (date of initial
public offering), to September 30, 1994, for Class Y shares;
Financial Highlights for each of the years in the five-year period ended
September 30, 1996, for Class Z shares;
Notes to Financial Statements; and
Independent Auditors' Report dated November 1, 1996.
A copy of the Fund's Annual Report will be furnished upon request and
without charge. Requests may be made in writing to EKSC, P.O. Box 2121, Boston,
Massachusetts 02106-2121 or by calling EKSC toll free at 1-800-343-2898.
<PAGE>
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APPENDIX
- -------------------------------------------------------------------------------
U.S. GOVERNMENT SECURITIES
Securities issued or guaranteed by the U.S. government include a variety of
Treasury securities that differ only in their interest rates, maturities and
dates of issuance. Treasury bills have maturities of one year or less. Treasury
notes have maturities of one to ten years and Treasury bonds generally have
maturities of greater than ten years at the date of issuance. Government
National Mortgage Association ("GNMA") securities include GNMA mortgage
pass-through certificates. Such securities are supported by the full faith and
credit of the U.S. government.
Securities issued or guaranteed by U.S. government agencies or
instrumentalities include securities issued or guaranteed by the Federal Housing
Administration, Farmers Home Administration, Export-Import Bank of the U.S.,
Small Business Administration, General Services Administration, Central Bank for
Cooperatives, Federal Home Loan Banks, Federal Loan Mortgage Corporation,
Federal Intermediate Credit Banks, Federal Land Banks, Maritime Administration,
The Tennessee Valley Authority, District of Columbia Armory Board and Federal
National Mortgage Association.
Some obligations of U.S. government agencies and instrumentalities, such as
securities of Federal Home Loan Banks, are supported by the right of the issuer
to borrow from the Treasury. Others, such as bonds issued by the Federal
National Mortgage Association, a private corporation, are supported only by the
credit of the instrumentality. The U.S. government is not obligated by law to
provide support to an instrumentality it sponsors. U.S. government securities
held by the Fund do not include international agencies or instrumentalities in
which the U.S. government, its agencies or instrumentalities participate, such
as the World Bank, Asian Development Bank or the Inter-American Development
Bank, or issues insured by the Federal Deposit Insurance Corporation.
CORPORATE BOND RATINGS
S&P RATINGS
A Standard & Poor's Corporation ("S&P") corporate bond rating is a current
assessment of the creditworthiness of an obligor, including obligors outside the
United States, with respect to a specific obligation. This assessment may take
into consideration obligors such as guarantors, insurers, or lessees. Ratings of
foreign obligors do not take into account currency exchange and related
uncertainties. The ratings are based on current information furnished by the
issuer or obtained by S&P from other sources it considers reliable.
The ratings are based, in varying degrees, on the following considerations:
1. likelihood of default - capacity and willingness of the obligor as to
the timely payment of interest and repayment of principal in accordance with the
terms of the obligation;
2. nature of and provisions of the obligation; and
3. protection afforded by and relative position of the obligation in the
event of bankruptcy, reorganization or other arrangement under the laws of
bankruptcy and other laws affecting creditors' rights.
PLUS (+) OR MINUS (-): To provide more detailed indications of credit
quality, ratings from AA to A may be modified by the addition of a plus or minus
sign to show relative standing within the major rating categories.
Eligible bond ratings are as follows:
1. AAA - Debt rated AAA has the highest rating assigned by S&P. Capacity to
pay interest and repay principal is extremely strong.
2. AA - Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
MOODY'S RATINGS
Eligible ratings of Moody's Investors Service, Inc. ("Moody's") are as
follows:
1. Aaa - Bonds that 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-edge." 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 fundamentally strong position of such issues.
2. Aa - Bonds that 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 that
make the long term risks appear somewhat larger than in Aaa securities.
Moody's applies 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.
ADJUSTABLE RATE SECURITIES RATINGS
S&P RATINGS
An S&P rating of an issue secured by a pool of mortgages is a measure of
the likelihood that cash flow from the mortgages is sufficient for timely
payment of interest and principal on the rated security. Each rating category
generally defines an adverse economic climate that is likely to impact the
performance of the mortgages in the pool over time. The rating process for
commercial mortgages, like all asset-backed financings, involves a credit, legal
structure and cash flow analysis.
The credit analysis involves an analysis of the originator and an
evaluation of the credit quality of the loans and their risk characteristics,
such as property types, geographic locations, loan maturity dates, loan-to-value
ratios, lien status and loan seasoning.
The legal structure analysis involves a review of legal documents to
determine the documents accurately reflect the specifics of the financing and a
review of flow of funds and investment restrictions of any reserve fund or
credit enhancement.
The cash flow analysis involves identification of the type of security
created out of the cash flow from the pool of commercial mortgages and the
payment terms of the security. Once these items are identified, the individual
loan and pool analysis are applied to determine cash flow scenarios for the
pool.
Eligible ratings are as follows:
1. AAA - Securities rated AAA have the highest rating assigned by S&P and
reflect certainty that the issuer at all times will have pledged collateral such
that scheduled cash flow and assumed reinvestment income thereon will be
sufficient to pay annual interest on the securities and redeem principal at
maturity.
2. AA - Securities rated AA reflect certainty that amounts available from
distributions on the mortgage loans and from reserves will be sufficient to pay
monthly interest and return principal.
MOODY'S RATINGS
Moody's rating provides a system of gradation by which the relative credit
risks of investments in adjustable rate securities can be judged. Moody's
factors into its ratings the frequency, severity and timing of defaults in order
to provide an assessment of the appropriate risk premium for taking on credit
risk. In rating adjustable rate securities, Moody's uses the same letter system
as that for corporate bonds. In assessing risk, on average, the risks associated
with Aaa and Aa rated Moody's corporate bonds would apply to adjustable
securities rated Aaa or Aa by Moody's. See the description of Moody's corporate
bond ratings set forth above.
MONEY MARKET INSTRUMENTS
Money market securities are instruments with remaining maturities of one
year or less such as bank certificates of deposit, bankers' acceptances,
commercial paper (including master demand notes) and obligations issued or
guaranteed by the U.S. government, its agencies or instrumentalities, some of
which may be subject to repurchase agreements.
COMMERCIAL PAPER
Commercial paper will consist of issues rated at the time of purchase A-1
by S&P, PRIME-1 by Moody's, or F-1 by Fitch Investors Service, Inc. ("Fitch's");
or, if not rated, will be issued by companies that have an outstanding debt
issue rated at the time of purchase Aaa, Aa or A by Moody's, or AAA, AA or A by
S&P, or will be determined by Keystone to be of comparable quality.
S&P RATINGS
An S&P commercial paper rating is a current assessment of the likelihood of
timely payment of debt having an original maturity of no more than 365 days.
Ratings are graded into four categories, ranging from "A" for the highest
quality obligations to "D" for the lowest. The top category is as follows:
1. A: Issues assigned this highest rating are regarded as having the
greatest capacity for timely payment. Issues in this category are delineated
with the numbers 1, 2 and 3 to indicate the relative degree of safety.
2. A-1: This designation indicates that the degree of safety regarding
timely payment is either overwhelming or very strong. Those issues determined to
possess overwhelming safety characteristics are denoted with a plus (+) sign
designation.
MOODY'S RATINGS
The term "commercial paper" as used by Moody's means promissory obligations
not having an original maturity in excess of nine months. Moody's commercial
paper ratings are opinions of the ability of issuers to repay punctually
promissory obligations not having an original maturity in excess of nine months.
Moody's employs the following designation, judged to be investment grade, to
indicate the relative repayment capacity of rated issuers.
The rating PRIME-1 is the highest commercial paper rating assigned by
Moody's. Issuers rated PRIME-1 (or related supporting institutions) are deemed
to have a superior capacity for repayment of short term promissory obligations.
Repayment capacity of PRIME-1 issuers is normally evidenced by the following
characteristics:
1. leading market positions in well-established industries;
2. high rates of return on funds employed
3. conservative capitalization structures with moderate reliance on debt
and ample asset protection;
4. broad margins in earnings coverage of fixed financial charges and high
internal cash generation; and
5. well established access to a range of financial markets and assured
sources of alternate liquidity.
In assigning ratings to issuers whose commercial paper obligations are
supported by the credit of another entity or entities, Moody's evaluates the
financial strength of the affiliated corporations, commercial banks, insurance
companies, foreign governments or other entities, but only as one factor in the
total rating assessment.
CERTIFICATES OF DEPOSIT
Certificates of deposit are receipts issued by a bank in exchange for the
deposit of funds. The issuer agrees to pay the amount deposited plus interest to
the bearer of the receipt on the date specified on the certificate. The
certificate usually can be traded in the secondary market prior to maturity.
Certificates of deposit will be limited to U.S. dollar denominated
certificates of United States banks, including their branches abroad, and of
U.S. branches of foreign banks, that are members of the Federal Reserve System
or the Federal Deposit Insurance Corporation and have at least $1 billion in
assets as of the date of their most recently published financial statements, or
of savings and loan associations that are members of the Federal Savings and
Loan Insurance Corporation, and have at least $1 billion in assets as of the
date of their most recently published financial statements.
The Fund will not acquire time deposits or obligations issued by the
International Bank for Reconstruction and Development, the Asian Development
Bank or the Inter-American Development Bank. Additionally, the Fund does not
intend to purchase such foreign securities (except to the extent that
certificates of deposit of foreign branches of U.S. banks may be deemed foreign
securities) or purchase certificates of deposit, bankers' acceptances or other
similar obligations issued by foreign banks.
BANKERS' ACCEPTANCES
Bankers' acceptances typically arise from short term credit arrangements
designed to enable businesses to obtain funds to finance commercial
transactions. Generally, an acceptance is a time draft drawn on a bank by an
exporter or an importer to obtain a stated amount of funds to pay for specific
merchandise. The draft is then "accepted" by the bank that, in effect,
unconditionally guarantees to pay the face value of the instrument on its
maturity date. The acceptance may then be held by the accepting bank as an
earning asset or it may be sold in the secondary market at the going rate of
discount for a specific maturity. Although maturities for acceptances can be as
long as 270 days, most acceptances have maturities of six months or less.
Bankers' acceptances acquired by the Fund must have been accepted by U.S.
commercial banks, including foreign branches of U.S. commercial banks, having
total assets at the time of purchase in excess of $1 billion and must be payable
in U.S. dollars.
