Filed Pursuant to Rule 497(c)
Registration File No.: 33-44782
PROSPECTUS
DECEMBER 30, 1993
Dean Witter Diversified Income Trust (the "Fund") is an open-end
diversified management investment company whose primary investment objective is
a high level of current income. As a secondary objective, the Fund seeks to
maximize total return but only to the extent consistent with its primary
objective. The Fund seeks to achieve its objectives by equally allocating its
assets among three separate groupings of various types of fixed income
securities. Up to one-third of the securities in which the Fund may invest will
include securities rated Baa/BBB or lower. (See "Investment Objective and
Policies.")
Shares of the Fund are continuously offered at net asset value without
the imposition of a sales charge. However, redemptions and/or repurchases are
subject in most cases to a contingent deferred sales charge, scaled down from
5% to 1% of the amount redeemed, if made within six years of purchase, which
charge will be paid to the Fund's Distributor, Dean Witter Distributors Inc.
See "Redemptions and Repurchases--Contingent Deferred Sales Charge." In
addition, the Fund pays the Distributor a Rule 12b-1 distribution fee pursuant
to a Plan of Distribution at the annual rate of 0.85% of the lesser of the (i)
average daily aggregate net sales or (ii) average daily net assets of the Fund.
See "Purchase of Fund Shares--Plan of Distribution."
This Prospectus sets forth concisely the information you should know
before investing in the Fund. It should be read and retained for future
reference. Additional information about the Fund is contained in the Statement
of Additional Information, dated December 30, 1993, which has been filed with
the Securities and Exchange Commission, and which is available at no charge
upon request of the Fund at the address or telephone numbers listed below. The
Statement of Additional Information is incorporated herein by reference.
Dean Witter
Diversified Income Trust
Two World Trade Center
New York, New York 10048
(212) 392-2550
(800) 526-3143
TABLE OF CONTENTS
Prospectus Summary/ 2
Summary of Fund Expenses/ 3
Financial Highlights/ 4
The Fund and its Management/ 4
Investment Objectives and Policies/ 5
Investment Restrictions/19
Purchase of Fund Shares/19
Shareholder Services/21
Redemptions and Repurchases/24
Dividends, Distributions and Taxes/25
Performance Information/26
Additional Information/27
Appendix/28
Shares of the Fund are not deposits or obligations of, or guaranteed or
endorsed by, any bank, and the shares are not federally insured by the Federal
Deposit Insurance Corporation, the Federal Reserve Board, or any other agency.
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.
DEAN WITTER DISTRIBUTORS INC.
DISTRIBUTOR
<PAGE>
PROSPECTUS SUMMARY
===============================================================================
The
Fund
The Fund is organized as a Massachusetts business trust, and is an
open-end diversified management investment company which allocates an equal
portion of its total assets among three groupings of fixed-income securities.
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Shares
Offered
Shares of beneficial interest with $0.01 par value (see page 27).
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Offering
Price
At net asset value without sales charge (see page 19). Shares redeemed
within six years of purchase are subject to a contingent deferred sales charge
under most circumstances (see pages 23-24).
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Minimum
Purchase
Minimum initial investment, $1000; minimum subsequent investment, $100
(see page 19).
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Investment
Objectives
A high level of current income; total return (income plus capital
appreciation) is a secondary objective.
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Investment
Policies
A balanced allocation of assets consisting of approximately one-third
of the Trust's assets invested equally in each of the following categories: 1.
high quality fixed-income securities issued or guaranteed by the U.S.
Government, its agencies and instrumentalities, issued or guaranteed by foreign
governments, or issued by foreign or U.S. companies which include bank
instruments, commercial paper, loan participation interests and certain indexed
securities, which have remaining maturities at the time of purchase of not more
than three years; 2. high quality fixed rate and adjustable rate mortgage-
backed securities and asset-backed securities; and 3. high yield, high risk
fixed-income securities, primarily rated Baa/BBB or lower, and non-rated
securities of comparable quality. (see pages 4-18).
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Investment
Manager
Dean Witter InterCapital Inc. ("InterCapital"), the Investment Manager
of the Fund, serves as investment manager, manager, investment adviser, sub-
adviser, administrator or sub-administrator to seventy-nine investment
companies and other portfolios with assets of approximately $70.7 billion at
November 30, 1993 (see page 4).
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Management
Fee
The Investment Manager receives a monthly fee at the annual rate of
0.40% of daily net assets (see page 5).
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Dividends and
Capital Gains
Distributions
Dividends are declared and paid monthly. Capital gains distributions,
if any, are paid at least once a year or are retained for reinvestment by the
Fund. Dividends and capital gains distributions are automatically invested in
additional shares at net asset value unless the shareholder elects to receive
cash (see page 25).
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Distributor
and
Distribution
Fee
Dean Witter Distributors Inc. (the "Distributor"). The Distributor
receives from the Fund a distribution fee accrued daily and payable monthly at
the rate of 0.85% per annum of the lesser of (i) the Fund's average daily
aggregate net sales or (ii) the Fund's average daily net assets. This fee
compensates the Distributor for the services provided in distributing shares of
the Fund and for sales-related expenses. The Distributor also receives the
proceeds of any contingent deferred sales charges (see pages 19-20).
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<PAGE>
Redemption--
Contingent
Deferred
Sales
Charge
Shares are redeemable by the shareholder at net asset value. An account
may be involuntarily redeemed if the total value of the account is less than
$100. Although no commission or sales load is imposed upon the purchase of
shares, a contingent deferred sales charge (scaled down from 5% to 1%) is
imposed on any redemption of shares if after such redemption the aggregate
current value of an account with the Fund falls below the aggregate amount of
the investor's purchase payments made during the six years preceding the
redemption. However, there is no charge imposed on redemption of shares
purchased through reinvestment of dividends or distributions (see pages 23-25).
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Risks
The value of the Fund's portfolio securities, and therefore the net
asset value of the Fund's shares, may increase or decrease due to various
factors, principally changes in prevailing interest rates. Generally, a rise in
interest rates will result in a decrease in net asset value, while a drop in
interest rates will result in an increase in net asset value. Mortgage-backed
securities are subject to prepayments or refinancings of the mortgage pools
underlying such securities which may have an impact upon the yield and the net
asset value of the Fund's shares. Asset-backed securities involve risks
resulting mainly from the fact that such securities do not usually contain the
complete benefit of a security interest in the related collateral. Certain of
the high yield, high risk fixed-income securities in which the Fund may invest
are subject to greater risk of loss of income and principal than the higher
rated lower yielding fixed-income securities. The foreign securities and
markets in which the Fund will invest pose different and generally greater
risks than those risks customarily associated with domestic securities and
markets including fluctuations in foreign currency exchange rates, foreign tax
rates and foreign securities exchange controls. The Fund may enter into
repurchase agreements and reverse repurchase agreements, may purchase
securities on a when-issued and delayed delivery basis and may utilize certain
investment techniques including options and futures for hedging purposes all of
which involve certain special risks (see pages 11 through 18).
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The above is qualified in its entirety by the detailed information appearing
elsewhere in this Prospectus and in the Statement of Additional Information.
2
<PAGE>
SUMMARY OF FUND EXPENSES
===============================================================================
The following table illustrates all expenses and fees that a shareholder of
the Fund will incur. The expenses and fees set forth in the table are for the
fiscal year ended October 31, 1993.
Shareholder Transaction Expenses
- --------------------------------
Maximum Sales Charge Imposed on Purchases......................... None
Maximum Sales Charge Imposed on Reinvested Dividends.............. None
Deferred Sales Charge
(as a percentage of the lesser of original purchase price or
redemption proceeds)............................................. 5.0%
A contingent deferred sales charge is imposed at the following
declining rates:
Year Since Purchase Payment Made Percentage
-------------------------------- ----------
First........................................ 5.0%
Second ...................................... 4.0%
Third ....................................... 3.0%
Fourth....................................... 2.0%
Fifth........................................ 2.0%
Sixth ....................................... 1.0%
Seventh and thereafter....................... None
Redemption Fees.................................................. None
Exchange Fee..................................................... None
Annual Fund Operating Expenses (as a Percentage of Average Net Assets)
- ----------------------------------------------------------------------
Management Fees* (after fee waiver)............................... 0.36%
12b-1 Fees**...................................................... 0.85%
Other Expenses*................................................... 0.37%
Total Fund Operating Expenses..................................... 1.58%
* The Investment Manager had undertaken to assume all expenses (except
the 12b-1 fee and brokerage fees) and to waive the compensation
provided for in its Management Agreement until January 1, 1993. "Management
Fees" (after fee waiver) as shown above, is for the fiscal year of the
Fund ended October 31, 1993 (assuming no fee waiver, the management fee
would be 0.40%). "Other Expenses" (after expense assumption) as shown above
is for the fiscal year of the Fund ended October 31, 1993. (assuming no
expense assumption, "Other Expenses" would have been 0.41%).
** A portion of the 12b-1 fee equal to 0.20% of the Fund's average daily net
assets is characterized as a service fee within the meaning of National
Association of Securities Dealers, Inc. ("NASD") guidelines.
EXAMPLE*** 1 year 3 years 5 years 10 years
- ---------- ------ ------- ------- --------
You would pay the following expenses
on a $1,000 investment, assuming
(1) 5% annual return and
(2) redemption at the end of
each time period: ................ $66 $80 $106 $188
You would pay the following expenses
on the same investment, assuming no
reedemption: ..................... $16 $50 $ 86 $188
- ----------
*** The expenses disclosed above do not reflect the assumption or waiver of any
expenses or the waiver of any compensation by the Investment Manager.
THE ABOVE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR
FUTURE EXPENSES OR PERFORMANCE. ACTUAL EXPENSES OF THE FUND MAY BE GREATER OR
LESS THAN THOSE SHOWN.
The purpose of this table is to assist the investor in understanding the
various costs and expenses that an investor in the Fund will bear directly or
indirectly. For a more complete description of these costs and expenses, see
"The Fund and its Management," "Plan of Distribution" and "Redemptions and
Repurchases."
Long-term shareholders of the Fund may pay more in sales charges and
distribution fees than the economic equivalent of the maximum front-end sales
charges permitted by the NASD.
3
<PAGE>
FINANCIAL HIGHLIGHTS
===============================================================================
THE FOLLOWING PER SHARE DATA AND RATIOS FOR A SHARE OF BENEFICIAL INTEREST
OUTSTANDING THROUGHOUT EACH PERIOD HAVE BEEN AUDITED BY PRICE WATERHOUSE,
INDEPENDENT ACCOUNTANTS. THE PER SHARE DATA AND RATIOS SHOULD BE READ IN
CONJUNCTION WITH THE FINANCIAL STATEMENTS, NOTES THERETO AND THE REPORT OF
INDEPENDENT ACCOUNTANTS WHICH ARE CONTAINED IN THE STATEMENT OF ADDITIONAL
INFORMATION. FURTHER INFORMATION ABOUT THE PERFORMANCE OF THE FUND IS CONTAINED
IN THE FUND'S ANNUAL REPORT TO SHAREHOLDERS, WHICH MAY BE OBTAINED WITHOUT
CHARGE UPON REQUEST TO THE FUND.
For the period
For the year April 9, 1992*
ended through
October 31, 1993 October 31, 1992
---------------- ----------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period..... $ 10.01 $ 10.00
-------- -------
Investment income--net................... 0.77 0.37
Realized and unrealized gain-net......... 0.20 -0-
-------- -------
Total from investment operations 0.97 0.37
-------- -------
Less dividends and distributions:
Dividends from net investment income.... (0.73) (0.36)
Distributions to shareholders from net
realized gains on investments.......... (0.05) 0
-------- -------
Total dividends and distributions........ (0.78) (0.36)
-------- -------
Net asset value, end of period........... $ 10.20 $ 10.01
======== =======
TOTAL INVESTMENT RETURN+.................. 10.00% 3.73%(1)
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (in thousands). $167,137 $55,297
Ratio of expenses to average net assets.. 1.58%(4) 0.85%(2)(3)
Ratio of net investment income to
average net assets...................... 7.92%(4) 7.86%(2)(3)
Portfolio turnover rate.................. 117% 37%
- ---------
* Date of commencement of operations.
+ Does not reflect the deduction of sales load.
(1) Not annualized.
(2) Annualized.
(3) If the Fund had borne all expenses that were assumed or waived by the
Investment Manager, the above annualized expense ratio would have been
2.08% and the above annualized investment income--net ratio would have
been 6.63%.
(4) If the Fund had borne all expenses that were assumed or waived by the
Investment Manager (Note 2), the above annualized expense ratio would
have been 1.66% and the above annualized investment income--net ratio
would have been 7.84%.
See Notes to Financial Statements
THE FUND AND ITS MANAGEMENT
==============================================================================
Dean Witter Diversified Income Trust (the "Fund") is an open-end
diversified management investment company. The Fund is a trust of the type
commonly known as a "Massachusetts business trust" and was organized under the
laws of The Commonwealth of Massachusetts on December 20, 1991.
Dean Witter InterCapital Inc. ("InterCapital" or the "Investment
Manager"), whose address is Two World Trade Center, New York, New York 10048,
is the Fund's Investment Manager. The Investment Manager, which was
incorporated in July, 1992, is a wholly-owned subsidiary of Dean Witter,
Discover & Co. ("DWDC"),
4
<PAGE>
a balanced financial services organization providing a broad range of
nationally marketed credit and investment products.
The Investment Manager acts as investment manager, manager, investment
adviser, sub-adviser, administrator or sub-administrator to seventy-nine
investment companies, twenty-seven of which are listed on the New York Stock
Exchange, with combined total assets of approximately $68.7 billion as of
November 30, 1993. The Investment Manager also manages portfolios of pension
plans, other institutions and individuals which aggregated approximately $2.0
billion at such date.
The Fund has retained the Investment Manager, pursuant to an Investment
Management Agreement, to provide administrative services, manage its business
affairs and manage the investment of the Fund's assets, including the placing
of orders for the purchase and sale of portfolio securities. The Fund's Board
of Trustees reviews the various services provided by the Manager to ensure that
the Fund's general investment policies and programs are being properly carried
out and that administrative services are being provided to the Fund in a
satisfactory manner.
As full compensation for the services and facilities furnished to the
Fund and for expenses of the Fund assumed by the Investment Manager, the Fund
pays the Investment Manager monthly compensation calculated daily by applying
the annual rate of 0.40% to the Fund's net assets determined as of the close of
each business day.
The Fund's expenses include: the fee of the Investment Manager, the fee
pursuant to the Plan and Agreement of Distribution (see "Purchase of Fund
Shares"); taxes; certain legal, transfer agent, custodian and auditing fees;
and printing and other expenses relating to the Fund's operations which are not
expressly assumed by the Investment Manager under its Management Agreement with
the Fund. The Investment Manager assumed all operating expenses (except for the
Plan of Distribution fee and brokerage fees) and waive the compensation
provided for in its Investment Management Agreement until January 1, 1993.
INVESTMENT OBJECTIVES AND POLICIES
===============================================================================
The primary investment objective of the Fund is to provide a high level
of current income. As a secondary objective the Fund seeks to maximize total
return but only to the extent consistent with its primary objective. The
investment objectives of the Fund are fundamental policies and may not be
changed without the approval of the holders of a majority of the Fund's shares.
There is no assurance that the Fund's investment objectives will be achieved.
The Fund will seek to achieve its investment objectives by investing at
least 65% of its total assets in fixed-income securities and by equally
allocating, under normal circumstances, an approximately one-third portion of
its total assets among three separate groupings of various types of fixed-
income securities. The Investment Manager will adjust the Fund's assets not
less than quarterly to reflect any changes in the relative values of the
securities in each grouping so that following the adjustment the value of the
Fund's investments in each grouping will be equal to the extent practicable.
The three groupings in which the Fund will invest its total assets are
as follows:
1. High quality fixed-income securities issued or guaranteed by the
U.S. Government, its agencies or instrumentalities or high quality fixed income
securities issued or guaranteed by a foreign government or supranational
organization or any of their political subdivisions, authorities, agencies or
instrumentalities or fixed income securities issued by a corporation, all of
which are rated AAA or AA by Standard & Poor's Corporation ("S&P") or Aaa or Aa
by Moody's Investors Service, Inc. ("Moody's") or, if unrated, are determined
by the Investment Manager to be of equivalent quality; in certificates of
deposit and bankers' acceptances issued or guaranteed by, or time deposits
maintained at, banks (including foreign branches of U.S.
5
<PAGE>
banks or U.S. or foreign branches of foreign banks) having total assets of more
than $500 million and determined by the Investment Manager to be of high
creditworthiness; commercial paper rated A-1 or A-2 by S&P, Prime-1 or Prime-2
by Moody's or Duff 1 or Duff 2 by Duff & Phelps Inc. or, if unrated, issued by
U.S. or foreign companies having outstanding debt securities rated A or higher
by S&P or Moody's; and in loan participation interests having a remaining term
not exceeding one year in loans extended by banks to such companies. Certain
foreign securities purchased by the Fund will not have received ratings by a
recognized U.S. rating agency. In such cases the Investment Manager will review
the issuers of such securities with respect to the quality of their management,
bal-ance sheet and financial ratios, cash flows and earnings to establish that
the securities purchased by the Fund are of a comparable quality to issuers
receiving high quality ratings by a recognized U.S. rating agency.
All of the securities described above will have remaining maturities, at the
time of purchase, of not more than three years.
The Investment Manager will actively manage the Fund's assets in this
grouping in accordance with a global market strategy (see "Portfolio
Management," page 18). Consistent with such a strategy, the Investment Manager
intends to allocate the Fund's investments among securities denominated in the
currencies of a number of foreign countries and, within each such country,
among different types of debt securities. The Investment Manager will adjust
the Fund's exposure to different currencies based on its perception of the most
favorable markets and issuers. In allocating the Fund's assets among various
markets, the Investment Manager will assess the relative yield and anticipated
direction of interest rates in particular markets, the level of inflation,
liquidity and financial soundness of each market, and the general market and
economic conditions existing in each market as well as the relationship of
currencies of various countries to the U.S. dollar and to each other. In its
evaluations, the Investment Manager will utilize its internal financial,
economic and credit analysis resources as well as information obtained from
other sources.
A portion of the Fund's investments in securities of U.S. issuers are likely
to be in commercial paper, bankers acceptances and other short-term debt
instruments issued by U.S. corporations. However, at times during which there
exists large-scale political or economic uncertainty, the Fund is likely to
increase its investments in U.S. Government securities. In such cases, the
securities which the Fund are most likely to purchase are U.S. Treasury bills
and U.S. Treasury notes with remaining maturities of under three years, both of
which are direct obligations of the U.S. Government. The Fund may also purchase
securities issued by various agencies and instrumentalities of the U.S.
Government. These will include obligations backed by the full faith and credit
of the United States (such as those issued by the Government National Mortgage
Association); obligations whose issuing agency or instrumentality has the right
to borrow, to meet its obligations, from an existing line of credit with the
U.S. Treasury (such as those issued by the Federal National Mortgage
Association); and obligations backed by the credit of the issuing agency or
instrumentality (such as those issued by the Federal Farm Credit System).
The securities in which the Fund will be investing may be denominated
in any currency or multinational currency, including the U.S. dollar. In
addition to the U.S. dollar, such currencies will include, among others: the
Australian dollar; Deutsche mark; Japanese yen; French franc; British pound;
Canadian dollar; Swiss franc; Dutch guilder; Austrian schilling; Spanish
peseta; Swedish krona; and European Currency Unit ("ECU").
The Fund may invest, without limitation in this grouping, in notes and
commercial paper, the principal amount of which is indexed to certain specific
foreign currency exchange rates. Indexed notes and commercial paper typically
provide that their principal amount is adjusted upwards or downwards (but not
below zero) at maturity to reflect fluctuations in the exchange rate between
two currencies during the period the obligation is outstanding, depending on
the terms of the specific security. In selecting the two currencies, the
Investment Manager will consider the correlation and relative yields of various
currencies. The Fund will purchase an indexed obligation using the currency in
6
<PAGE>
which it is denominated and, at maturity, will receive interest and principal
payments thereon in that currency. The amount of principal payable by the
issuer at maturity, however, will vary (i.e., increase or decrease) in response
to the change (if any) in the exchange rates between the two specified
currencies during the period from the date the instrument is issued to its
maturity date. The potential for realizing gains as a result of changes in
foreign currency exchange rates may enable the Fund to hedge the currency in
which the obligation is denominated (or to effect cross-hedges against other
currencies) against a decline in the U.S. dollar value of investments
denominated in foreign currencies, while providing an attractive money market
rate of return. The Fund will purchase such indexed obligations to generate
current income or for hedging purposes and will not speculate in such
obligations.
As indicated above, the Fund may invest in securities denominated in a
multi-national currency unit. An illustration of a multi-national currency unit
is the ECU, which is a "basket" consisting of specified amounts of the
currencies of the member states of the European Community, a Western European
economic cooperative organization that includes, among other countries, France,
West Germany, The Netherlands and the United Kingdom. The specific amounts of
currencies comprising the ECU may be adjusted by the Council of Ministers of
the European Community to reflect changes in relative values of the underlying
currencies. The Investment Manager does not believe that such adjustments will
adversely affect holders of ECU-denominated obligations or the marketability of
such securities. European supranational entities, in particular, issue ECU-
denominated obligations. The Fund may invest in securities denominated in the
currency of one nation although issued by a governmental entity, corporation or
financial institution of another nation. For example, the Fund may invest in a
British pound-denominated obligation issued by a United States corporation.
Such investments involve credit risks associated with the issuer and currency
risks associated with the currency in which the obligation is denominated.
2. (i) Fixed-rate and adjustable rate mortgage-backed securities
("Mortgage-Backed Securities") which are issued or guaranteed by the United
States Government, its agencies or instrumentalities or by private issuers
which are rated Aaa by Moody's or AAA by S&P or, if not rated, are determined
to be of comparable quality by the Investment Manager and (ii) securities
backed by other assets such as automobile or credit card receivables and home
equity loans ("Asset-Backed Securities") which are rated Aaa by Moody's or AAA
by S&P or, if not rated are determined to be of comparable quality by the
Investment Manager. The term Mortgage-Backed Securities as used herein includes
adjustable rate mortgage securities and derivative mortgage products such as
collateralized mortgage obligations and stripped mortgage-backed securities,
all as described below.
There are currently three basic types of Mortgage-Backed Securities:
(i) those issued or guaranteed by the United States Government or 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 United States); (ii) those issued by private issuers that
represent an interest in or are collateralized by Mortgage-Backed Securities
issued or guaranteed by the United States Government or one of its agencies or
instrumentalities; and (iii) those issued by private issuers that represent an
interest in or are collateralized by whole mortgage loans or Mortgage-Backed
Securities without a government guarantee but usually having some form of
private credit enhancement.
The Fund will invest in mortgage pass-through securities representing
participation interests in pools of residential mortgage loans originated by
United States governmental or private lenders such as banks, broker-dealers and
financing corporations and guaranteed, to the extent provided in such
securities, by the United States Government or one of 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-
7
<PAGE>
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 may
invest 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 United States. FNMA is a federally
chartered, privately owned corporation and FHLMC is a corporate instrumentality
of the United States. FNMA and FHLMC certificates are not backed by the full
faith and credit of the United States, but the issuing agency or
instrumentality has the right to borrow, to meet its obligations, from an
existing line of credit with the U.S. Treasury. The U.S. Treasury has no legal
obligation to provide such line of credit and may choose not to do so.
Certificates for Mortgage-Backed 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 Mortgage Securities. The Fund may also invest in
adjustable rate mortgage securities ("ARMs"), which are pass-through mortgage
securities collateralized by mortgages with adjustable rather than fixed rates.
ARMs eligible for inclusion in a mortgage pool generally provide for a fixed
initial mortgage interest rate for either the first three, six, twelve or
thirteen scheduled monthly payments. Thereafter, the interest rates are subject
to periodic adjustment based on changes to a designated benchmark index.
ARMs contain maximum and minimum rates beyond which the mortgage
interest rate may not vary over the lifetime of the security. In addition,
certain ARMs provide for additional limitations on the maximum amount by which
the mortgage interest rate may adjust for any single adjustment period.
Alternatively, certain ARMs contain limitations on changes in the required
monthly payment. In the event that a monthly payment is not sufficient to pay
the interest accruing on an ARM, any such excess interest is added to the
principal balance of the mortgage loan, which is repaid through future monthly
payments. If the monthly payment for such an instrument exceeds the sum of the
interest accrued at the applicable mortgage interest rate and the principal
payment required at such point to amortize the outstanding principal balance
over the remaining term of the loan, the excess is utilized to reduce the then
outstanding principal balance of the ARM.
Private Mortgage Pass-Through Securities. Private mortgage pass-through
securities are structured similarly to the GNMA, FNMA and FHLMC mortgage pass-
through securities and are issued by originators of and investors in mortgage
loans, including savings and loan associations, mortgage banks, commercial
banks, investment banks and special purpose subsidiaries of the foregoing.
These securities usually are backed by a pool of conventional fixed rate or
adjustable rate mortgage loans. Since private mortgage pass-through securities
typically are not guaranteed by an entity having the credit status of GNMA,
FNMA and FHLMC, such securities generally are structured with one or more types
of credit enhancement.
Collateralized Mortgage Obligations and Multiclass Pass-Through
Securities. Collateralized mortgage obligations or "CMOs" are debt obligations
collateralized by mortgage loans or mortgage pass-through securities.
Typically, CMOs are collateralized by GNMA, FNMA or FHLMC Certificates, but
also may be collateralized by whole loans or private mortgage pass-through
securities (such collateral collectively hereinafter referred to as "Mortgage
Assets"). Multiclass pass-through securities are equity interests in a trust
composed of Mortgage Assets. Payments of principal of and interest on the
Mortgage Assets, and any reinvestment income thereon, provide the funds to pay
debt service on the CMOs or make scheduled distributions on the multiclass
pass-through securities. CMOs may be issued by agencies or instrumentalities of
the United States government, or by private originators of, or investors in,
mortgage loans, including savings and loan associations, mortgage banks,
8
<PAGE>
commercial banks, investment banks and special purpose subsidiaries of the
foregoing. The issuer of a series of CMOs may elect to be treated as a Real
Estate Mortgage Investment Conduit ("REMIC"). REMICs include governmental
and/or private entities that issue a fixed pool of mortgages secured by an
interest in real property. REMICs are similar to CMOs in that they issue
multiple classes of securities, but unlike CMOs, which are required to be
structured as debt securities, REMICs may be structured as indirect ownership
interests in the underlying assets of the REMICs themselves. However, there are
no effects on the Fund from investing in CMOs issued by entities that have
elected to be treated as REMICs, and all future references to CMOs shall also
be deemed to include REMICs. In addition, in reliance upon a recent
interpretation by the staff of the Securities and Exchange Commission, the Fund
may invest without limitation in CMOs and other Mortgage-Backed Securities
which are not by definition excluded from the provisions of the Investment
Company Act of 1940, as amended, and which have obtained exemptive orders from
such provisions from the Securities and Exchange Commission.
In a CMO, a series of bonds or certificates is issued in multiple
classes. Each class of CMOs, often referred to as a "tranche", is issued at a
specific fixed or floating coupon rate and has a stated maturity or final
distribution date. Principal prepayments on the Mortgage Assets may cause the
CMOs to be retired substantially earlier than their stated maturities or final
distribution dates. Interest is paid or accrues on all classes of the CMOs on a
monthly, quarterly or semi-annual basis. Certain CMOs may have variable or
floating interest rates and others may be stripped (securities which provide
only the principal or interest feature of the underlying security).
The principal of and interest on the Mortgage Assets may be allocated
among the several classes of a CMO series in a number of different ways.
Generally, the purpose of the allocation of the cash flow of a CMO to the
various classes is to obtain a more predictable cash flow to the individual
tranches than exists with the underlying collateral of the CMO. As a general
rule, the more predictable the cash flow is on a CMO tranche, the lower the
anticipated yield will be on that tranche at the time of issuance relative to
prevailing market yields on Mortgage-Backed Securities. As part of the pro-
cess oof creating more predictable cash flows on most of the tranches in a
series of CMOs, one or more tranches generally must be created that absorb most
of the volatility in the cash flows on the underlying mortgage loans. The
yields on these tranches are generally higher than prevailing market yields on
Mortgage-Backed Securities with similar maturities. As a result of the
uncertainty of the cash flows of these tranches, the market prices of and yield
on these tranches generally are more volatile.
The Fund also may invest in, among other things, parallel pay CMOs and
Planned Amortization Class CMOs ("PAC Bonds"). Parallel pay CMOs are structured
to provide payments of principal on each payment date to more than one class.
These simultaneous payments are taken into account in calculating the stated
maturity date or final distribution date of each class, which, as with other
CMO structures, must be retired by its stated maturity date or final
distribution date but may be retired earlier. PAC Bonds generally require
payments of a specified amount of principal on each payment date. PAC Bonds
always are parallel pay CMOs with the required principal payment on such
securities having the highest priority after interest has been paid to all
classes.
Stripped Mortgage-Backed Securities. Stripped Mortgage-Backed
Securities are derivative multiclass mortgage securities. Stripped Mortgage-
Backed Securities may be issued by agencies or instrumentalities of the United
States Government, or by private originators of, or investors in, mortgage
loans, including savings and loan associations, mortgage banks, commercial
banks, investment banks and special purpose subsidiaries of the foregoing.
Stripped Mortgage-Backed Securities usually are structured with two
classes that receive different proportions of the interest and principal
distribution on a pool of Mortgage Assets. A common type of Stripped Mortgage-
Backed Securities will have one class receiving some of the interest and most
of the principal from the Mortgage Assets, while the other class will receive
most of the interest and the remainder of the principal. In the most extreme
case, one class will receive all of the interest (the interest-only or "IO"
class), while
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the other class will receive all of the principal (the principal-only or "PO"
class). PO classes generate income through the accretion of the deep discount
at which such securities are purchased, and, while PO classes do not receive
periodic payments of interest, they receive monthly payments associated with
scheduled amortization and principal prepayment from the Mortgage Assets
underlying the PO class. The yield to maturity on an IO class is extremely
sensitive to the rate of principal payments (including prepayments) on the
related underlying Mortgage Assets, and a rapid rate of principal repayments
may have a material adverse effect on the Fund's yield to maturity. If the
underlying Mortgage Assets experience greater than anticipated prepayments of
principal, the Fund may fail to fully recoup its initial investment in these
securities even if the securities are rated Aaa by Moody's or AAA by S&P.
The Fund may purchase Stripped Mortgage-Backed Securities for income,
or for hedging purposes to protect the Fund's portfolio against interest rate
fluctuations. For example, since an IO class will tend to increase in value as
interest rates rise, it may be utilized to hedge against a decrease in value of
other fixed-income securities in a rising interest rate environment. The Fund
understands that the staff of the Securities and Exchange Commission considers
Stripped Mortgage-Backed Securities representing interest only or principal
only components of U.S. Government or other debt securities to be illiquid
securities. The Fund will treat such securities as illiquid so long as the
staff maintains such a position. The Fund may not invest more than 10% of its
total assets in illiquid securities.
Asset-Backed Securities. The securitization techniques used to develop
Mortgage-Backed Securities are also applied to a broad range of other assets.
Through the use of trusts and special purpose corporations, various types of
assets, primarily automobile and credit card receivables and home equity loans,
are being securitized in pass-through structures similar to the mortgage pass-
through structures described above or in a pay-through structure similar to the
CMO structure.
New instruments and variations of existing Mortgage-Backed Securities
and Asset-Backed Securities continue to be developed. The Fund may invest in
any such instruments or variations as may be developed, to the extent
consistent with its investment objectives and policies and applicable
regulatory requirements.
3. High yield, high risk fixed-income securities rated Baa or lower by
Moody's or BBB or lower by S&P or, if not rated, are determined by the
Investment Manager to be of comparable quality. The high yield, high risk
fixed-income securities in this grouping may include both convertible and
nonconvertible debt securities and preferred stock. Fixed-income securities
rated Baa by Moody's or BBB by S&P have speculative characteristics greater
than those of more highly rated bonds, while fixed-income securities rated Ba
or BB or lower by Moody's and Standard & Poor's, respectively, are considered
to be speculative investments. Furthermore, the Fund does not have any minimum
quality rating standard for its investments. As such, the Fund may invest in
securities rated as low as Caa, Ca or C by Moody's or CCC, CC, C or C1 by
Standard & Poor's. Fixed-income securities rated Caa or Ca by Moody's may
already be in default on payment of interest or principal, while bonds rated C
by Moody's, their lowest bond rating, can be regarded as having extremely poor
prospects of ever attaining any real investment standing. Bonds rated C1 by
S&P, their lowest bond rating, are no longer making interest payments.
A description of corporate bond ratings is contained in the Appendix.
Non-rated securities will also be considered for investment by the Fund when
the terms of the securities themselves makes them appropriate investments for
the Fund.
The ratings of fixed-income securities by Moody's and S&P are a
generally accepted barometer of credit risk. However, as the creditworthiness
of issuers of lower-rated fixed-income securities is more problematical than
that of issuers of higher-rated fixed-income securities, the achievement of the
Fund's investment objectives will be more dependent upon the Investment
Manager's own credit analysis than would be the case with a mutual fund
investing primarily in higher quality bonds. The Investment Manager will
utilize a security's credit rating as simply one indication of an issuer's
creditworthiness and will principally rely upon its own
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analysis of any security currently held by the Fund or potentially purchasable
by the Fund for its portfolio.
SPECIAL RISK CONSIDERATIONS
All fixed-income securities are subject to two types of risks: the
credit risk and the interest rate risk. The credit risk relates to the ability
of the issuer to meet interest or principal payments or both as they come due.
Generally, higher yielding fixed-income securities are subject to a credit risk
to a greater extent than lower yielding fixed-income securities. The interest
rate risk refers to the fluctuations in the net asset value of any portfolio of
fixed-income securities resulting from the inverse relationship between price
and yield of fixed-income securities; that is, when the general level of
interest rates rises, the prices of outstanding fixed-income securities
decline, and when interest rates fall, prices rise.
Foreign Securities. Investors should carefully consider the risks of
investing in securities of foreign issuers and securities denominated in non-
U.S. currencies. Fluctuations in the relative rates of exchange between the
currencies of different nations may affect the value of the Fund's investments.
Changes in foreign currency exchange rates relative to the U.S. dollar will
affect the U.S. dollar value of the Fund's assets denominated in that currency
and thereby impact upon the Fund's yield on such assets and the net asset value
of a share of the Fund as well as the value of the Fund's distributions. For
example, if a substantial portion of the Fund's assets are denominated in
Japanese yen and the relative exchange rate of the yen falls with respect to
the U.S. dollar (i.e., a yen is worth a smaller fraction of a dollar than it
had been) then the Fund will be receiving a lesser amount of interest on its
fixed-income securities denominated in yen (when converted into U.S. dollars)
and when the Fund's assets are valued for purposes of determining the net asset
value per share of the Fund, the net assets of the Fund reflected by the yen-
denominated securities will have declined in U.S. dollar value and the net
asset value of the Fund (always stated in U.S. dollars) may have also declined.
Foreign currency exchange rates are determined by forces of supply and
demand on the foreign exchange markets. These forces are themselves affected by
the international balance of payments and other economic and financial
conditions, government intervention, speculation and other factors. Moreover,
foreign currency exchange rates may be affected by the regulatory control of
the exchanges on which the currencies trade. The foreign currency transactions
of the Fund will be conducted on a spot basis or through forward contracts or
futures contracts (see below). The Fund may incur certain costs in connection
with these currency transactions.
Investments in foreign securities will also occasion risks relating to
political and economic developments abroad, including the possibility of
expropriations or confiscatory taxation, limitations on the use or transfer of
Fund assets and any effects of foreign social, economic or political
instability. Foreign companies are not subject to the regulatory requirements
of U.S. companies and, as such, there may be less publicly available
information about such companies. Moreover, foreign companies are generally not
subject to uniform accounting, auditing and financial standards and
requirements comparable to those applicable to U.S. companies.
Securities of foreign issuers may be less liquid than comparable
securities of U.S. issuers and, as such, their price changes may be more
volatile. Furthermore, foreign exchanges and broker-dealers are generally
subject to less government and exchange scrutiny and regulation than their
American counterparts. Brokerage commissions, dealer concessions and other
transaction costs may be higher on foreign markets than the U.S. In addition,
differences in clearance and settlement procedures on foreign markets may
occasion delays in settlements of Fund trades effected in such markets.
Inability to dispose of portfolio securities due to settlement delays could
result in losses to the Fund due to subsequent declines in value of such
securities and the inability of the Fund to make intended security purchases
due to settlement problems could result in a failure of the Fund to make
potentially advantageous investments.
-------------
Mortgage-Backed and Asset-Backed Securities. Mortgage-Backed and Asset-
Backed Securities have certain different characteristics than traditional debt
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<PAGE>
securities. Among the major differences are that interest and principal
payments are made more frequently, usually monthly, and that principal may be
prepaid at any time because the underlying mortgage loans or other assets
generally may be prepaid at any time. As a result, if the Fund purchases such a
security at a premium, a prepayment rate that is faster than expected may
reduce yield to maturity, while a prepayment rate that is slower than expected
may have the opposite effect of increasing yield to maturity. Alternatively, if
the Fund purchases these securities at a discount, faster than expected
prepayments will increase, while slower than expected prepayments may reduce,
yield to maturity. The Fund may invest a portion of its assets in derivative
Mortgage-Backed Securities such as Stripped Mortgage-Backed Securities which
are highly sensitive to changes in prepayment and interest rates. The
Investment Manager will seek to manage these risks (and potential benefits) by
investing in a variety of such securities and through hedging techniques.
Mortgage-Backed and Asset-Backed Securities, like all fixed income
securities, generally decrease in value as a result of increases in interest
rates. In addition, although generally the value of fixed-income securities
increases during periods of falling interest rates and, as stated above,
decreases during periods of rising interest rates, as a result of prepayments
and other factors, this is not always the case with respect to Mortgage-Backed
and Asset-Backed Securities.
Although the extent of prepayments on a pool of mortgage loans depends
on various economic and other factors, as a general rule prepayments on fixed
rate mortgage loans will increase during a period of falling interest rates and
decrease during a period of rising interest rates. Accordingly, amounts
available for reinvestment by the Fund are likely to be greater during a period
of declining interest rates and, as a result, likely to be reinvested at lower
interest rates than during a period of rising interest rates. Asset-Backed
Securities, although less likely to experience the same prepayment rates as
Mortgage-Backed Securities, may respond to certain of the same factors
influencing prepayments, while at other times different factors, such as
changes in credit use and payment patterns resulting from social, legal and
economic factors, will predominate. Mortgage-Backed and Asset-Backed Securities
generally decrease in value as a result of increases in interest rates and may
benefit less than other fixed income securities from declining interest rates
because of the risk of prepayment.
There are certain risks associated specifically with CMOs. CMOs issued
by private entities are not U.S. Government securities and are not guaranteed
by any government agency, although the securities underlying a CMO may be
subject to a guarantee. Therefore, if the collateral securing the CMO, as well
as any third party credit support or guarantees, is insufficient to make
payment, the holder could sustain a loss. However, as stated above, the Fund
will invest only in CMOs which are rated AAA by S&P or Aaa by Moody's or, if
unrated, are determined to be of comparable quality. Also, a number of
different factors, including the extent of prepayment of principal of the
Mortgage Assets, affect the availability of cash for principal payments by the
CMO issuer on any payment date and, accordingly, affect the timing of principal
payments on each CMO class.
Asset-Backed Securities involve certain risks that are not posed by
Mortgage-Backed Securities, resulting mainly from the fact that Asset-Backed
Securities do not usually contain the complete benefit of a security interest
in the related collateral. For example, credit card receivables generally are
unsecured and the debtors are entitled to the protection of a number of state
and federal consumer credit laws, some of which may reduce the ability to
obtain full payment. In the case of automobile receivables, due to various
legal and economic factors, proceeds from repossessed collateral may not always
be sufficient to support payments on these securities.
------------
High Yield Securities. Because of the special nature of the Fund's
investment in high yield securities, commonly known as "junk bonds", the
Investment Manager must take account of certain special considerations in
assessing the risks associated with such investments. Although the growth of
the high yield securities market in the 1980s had paralleled a long economic
expansion, recently many issuers have been affected by adverse economic and
market conditions.
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<PAGE>
It should be recognized that an economic downturn or increase in interest rates
is likely to have a negative effect on the high yield bond market and on the
value of the high yield securities held by the Fund, as well as on the ability
of the securities' issuers to repay principal and interest on their borrowings.
The prices of high yield securities have been found to be less
sensitive to changes in prevailing interest rates than higher-rated
investments, but are likely to be more sensitive to adverse economic changes or
individual corporate developments. During an economic downturn or substantial
period of rising interest rates, highly leveraged issuers may experience
financial stress which would adversely affect their ability to service their
principal and interest payment obligations, to meet their projected business
goals or to obtain additional financing. If the issuer of a fixed-income
security owned by the Fund defaults, the Fund may incur additional expenses to
seek recovery. In addition, periods of economic uncertainty and change can be
expected to result in an increased volatility of market prices of high yield
securities and a concomitant volatility in the net asset value of a share of
the Fund. Moreover, the market prices of certain of the Fund's portfolio
securities which are structured as zero coupon and payment-in-kind securities
are affected to a greater extent by interest rate changes and thereby tend to
be more volatile than securities which pay interest periodically and in cash
(see "Dividends, Distributions and Taxes" for a discussion of the tax
ramifications of investments in such securities).
The secondary market for high yield securities may be less liquid than
the markets for higher quality securities and, as such, may have an adverse
effect on the market prices of certain securities. The limited liquidity of the
market may also adversely affect the ability of the Fund's Trustees to arrive
at a fair value for certain high yield securities at certain times and could
make it difficult for the Fund to sell certain securities.
New laws and proposed new laws may have a potentially negative impact
on the market for high yield bonds. For example, present legislation requires
federally-insured savings and loan associations to divest their investments in
high yield bonds. This legislation and other proposed legislation may have an
adverse effect upon the value of high yield securities and a concomitant
negative impact upon the net asset value of a share of the Fund.
During the fiscal period ended October 31, 1993, the monthly dollar weighted
average ratings of the debt obligations held by the Fund, expressed as a
percentage of the Fund's total investments, were as follows:
PERCENTAGE OF
RATINGS TOTAL INVESTMENTS
- ------- -----------------
AAA/Aaa 48.2%
AA/Aa 6.4%
A/A 0%
BBB/Baa 0%
BB/Ba 4.8%
B/B 22.0%
CCC/Caa 4.9%
CC/Ca 0%
C/C 0%
D 0%
Unrated 18.8%
OTHER INVESTMENT POLICIES
Repurchase Agreements. The Fund may enter into repurchase agreements,
which may be viewed as a type of secured lending by the Fund, and which
typically involve the acquisition by the Fund of debt securities from a selling
financial institution such as a bank, savings and loan association or broker-
dealer. The agreement provides that the Fund will sell back to the institution,
and that the institution will repurchase, the underlying security at a
specified price and at a fixed time in the future, usually not more than seven
days from the date of purchase.
Reverse Repurchase Agreements and Dollar Rolls. The Fund may also use
reverse repurchase agreements and dollar rolls as part of its investment
strategy. Reverse repurchase agreements involve sales by the Fund of portfolio
assets concurrently with an agreement by the Fund to repurchase the same assets
at a later date at a fixed price. During the reverse repurchase agreement
period, the Fund continues to receive principal and interest payments on these
securities. Generally, the effect of such a transaction is that the Fund can
recover all or most of the cash invested in the portfolio securities involved
during the term of the
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reverse repurchase agreement, while it will be able to keep the interest income
associated with those portfolio securities. Such transactions are only
advantageous if the interest cost to the Fund of the reverse repurchase
transaction is less than the cost of obtaining the cash otherwise.
The Fund may enter into dollar rolls in which the Fund sells securities
for delivery in the current month and simultaneously contracts to repurchase
substantially similar (same type and coupon) securities on a specified future
date. During the roll period, the Fund foregoes principal and interest paid on
the securities. The Fund is compensated by the difference between the current
sales price and the lower forward price for the future purchase (often referred
to as the "drop") as well as by the interest earned on the cash proceeds of the
initial sale.
The Fund will establish a segregated account with its custodian bank in
which it will maintain cash, U.S. Government securities or other liquid high
grade debt obligations equal in value to its obligations in respect of reverse
repurchase agreements and dollar rolls. Reverse repurchase agreements and
dollar rolls involve the risk that the market value of the securities the Fund
is obligated to repurchase under the agreement may decline below the repurchase
price. In the event the buyer of securities under a reverse repurchase
agreement or dollar roll files for bankruptcy or becomes insolvent, the Fund's
use of the proceeds of the agreement may be restricted pending a determination
by the other party, or its trustee or receiver, whether to enforce the Fund's
obligation to repurchase the securities. Reverse repurchase agreements and
dollar rolls are speculative techniques involving leverage, and are considered
borrowings by the Fund. Under the requirements of the Investment Company Act of
1940, as amended (the "Act"), the Fund is required to maintain an asset
coverage (including the proceeds of the borrowings) of at least 300% of all
borrowings. The Fund does not expect to engage in reverse repurchase agreements
and dollar rolls with respect to greater than 25% of the Fund's total assets.
When-Issued and Delayed Delivery Securities and Forward Commitments.
From time to time, in the ordinary course of business, the Fund may purchase
securities on a when-issued or delayed delivery basis or may purchase or sell
securities on a forward commitment basis. When such transactions are
negotiated, the price is fixed at the time of the commitment, but delivery and
payment can take place a month or more after the date of the commitment. There
is no overall limit on the percentage of the Fund's assets which may be
committed to the purchase of securities on a when-issued, delayed delivery or
forward commitment basis. An increase in the percentage of the Fund's assets
committed to the purchase of securities on a when-issued, delayed delivery or
forward commitment basis may increase the volatility of the Fund's net asset
value.
When, As and If Issued Securities. The Fund may purchase securities on
a "when, as and if issued" basis under which the issuance of the security
depends upon the occurrence of a subsequent event, such as approval of a
merger, corporate reorganization, leveraged buyout or debt restructuring. If
the anticipated event does not occur and the securities are not issued, the
Fund will have lost an investment opportunity. There is no overall limit on the
percentage of the Fund's assets which may be committed to the purchase of
securities on a "when, as and if issued" basis. An increase in the percentage
of the Fund's assets committed to the purchase of securities on a "when, as and
if issued" basis may increase the volatility of its net asset value.
Restricted Securities. The Fund may invest up to 5% of its total assets
in securities for which there is no readily available market including certain
of those which are subject to restrictions on resale because they have not been
registered under the Securities Act of 1933, as amended (the "Securities Act")
or which are otherwise not readily marketable. (Securities eligible for resale
pursuant to Rule 144A under the Securities Act, and determined to be liquid
pursuant to the procedures discussed in the following paragraph, are not
subject to the foregoing restriction.) These securities are generally referred
to as private placements or restricted securities. Limitations on the resale of
such securities may have an adverse effect on their marketability, and may
prevent the Fund from disposing of them promptly at reasonable prices. The Fund
may have to bear the expense of registering such
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<PAGE>
securities for resale and the risk of substantial delays in effecting such
registration.
The Securities and Exchange Commission has adopted Rule 144A under the
Securities Act of 1933, which permits the Fund to sell restricted securities to
qualified institutional buyers without limitation. The Investment Manager,
pursuant to procedures adopted by the Trustees of the Fund, will make a
determination as to the liquidity of each restricted security purchased by the
Fund. If a restricted security is determined to be "liquid," such security will
not be included within the category "illiquid securities," which under current
policy may not exceed 15% of the Fund's total assets.
Lending of Portfolio Securities. Consistent with applicable regulatory
requirements, the Fund may lend its portfolio securities to brokers, dealers
and other financial institutions, provided that such loans are callable at any
time by the Fund (subject to certain notice provisions described in the
Statement of Additional Information), and are at all times secured by cash or
cash equivalents such as money market instruments, which are maintained in a
segregated account pursuant to applicable regulations and that are at least
equal to the market value, determined daily, of the loaned securities. In the
event the borrower defaults on its obligation to return the loaned securities,
as a result of bankruptcy or otherwise, the Fund will seek to sell the
collateral, which action could involve costs or delays. In such case the Fund's
ability to recover its investment may be restricted or delayed.
Common Stocks. The Fund may invest in common stocks in an amount up to
20% of its total assets in the circumstances described below when consistent
with the Fund's investment objectives.
The Fund may acquire common stocks when attached to or included in a
unit with fixed-income securities, or when acquired upon conversion of fixed-
income securities or upon exercise of warrants attached to fixed-income
securities and may purchase common stocks directly when such acquisitions are
determined by the Investment Manager to further the Fund's investment
objectives.
For example, the Fund may purchase the common stock of companies
involved in takeovers or recapitalizations where the issuer, or a controlling
stockholder, has offered, or pursuant to a "going private" transaction is
effecting, an exhange of its common stock for newly-issued fixed-income
securities. By purchasing the common stock of the company issuing the fixed-
income securities prior to the consummation of the transaction or exchange
offer, the Fund will be able to obtain the fixed-income securities directly
from the issuer at their face value, eliminating the payment of a dealer's
mark-up otherwise payable when fixed-income securities are acquired from third
parties, thereby increasing the net yield to the shareholders of the Fund.
While the Fund will incur brokerage commissions in connection with its purchase
of common stocks, it is anticipated that the amount of such commissions will be
significantly less than the amount of such mark-up.
Fixed-income securities acquired by the Fund through the purchase of
common stocks under the circumstances described in the preceding paragraph are
subject to the general credit risks and interest rate risks to which all fixed-
income securities purchased by the Fund are subject. Such securities generally
will be rated Baa/BBB or lower as are the other high yield, high risk fixed
income securities in which the Fund may invest. In addition, since corporations
involved in takeover situations are often highly leveraged, that factor will be
evaluated by the Investment Manager as part of its credit risk determination
with respect to the purchase of particular common stocks for the Fund's
investment portfolio. In the event the Fund purchases common stock of a
corporation in anticipation of a transaction (pursuant to which the common
stock is to be exchanged for fixed-income securities) which fails to take
place, the Investment Manager will continue to hold such common stocks for the
Fund's portfolio only if it determines that continuing to hold such common
stock under those circumstances is consistent with the Fund's investment
objectives.
OPTIONS AND FUTURES TRANSACTIONS
The Fund is permitted to enter into call and put options on its
portfolio securities, including U.S. Government Securities and Mortgage-Backed
Securities and on various foreign currencies which are listed on several U.S.
and foreign securities exchanges and are
15
<PAGE>
written in over-the-counter transactions ("OTC options"). Listed options are
issued or guaranteed by the exchange on which they trade or by a clearing
corporation such as the Options Clearing Corporation ("OCC"). The Fund is
permitted to write covered call options on portfolio securities which are
denominated in either U.S. dollars or foreign currencies, without limit, in
order to hedge against the decline in the value of a security or currency in
which such security is denominated and to close out long call option positions.
The Fund may purchase listed and OTC call and put options in amounts equalling
up to 5% of its total assets. The Fund may purchase call options only to close
out a covered call position or to protect against an increase in the price of a
security it anticipates purchasing or, in the case of call options on a foreign
currency, to hedge against an adverse exchange rate change of the currency in
which the security it anticipates purchasing is denominated vis-a-vis the
currency in which the exercise price is denominated. The Fund may purchase put
options on securities which it holds in its portfolio only to protect itself
against a decline in the value of the security. The Fund may also purchase put
options to close out written put positions. There are no other limits on the
Fund's ability to purchase call and put options.
The Fund may purchase and sell financial futures contracts that are
currently traded, or may in the future be traded, on U.S. and foreign commodity
exchanges on such underlying fixed-income securities as U.S. Treasury bonds,
notes, and bills, Mortgage-Backed Securities and/or any foreign government
fixed-income security ("interest rate" futures), on various currencies
("currency" futures) and on such indexes of U.S. or foreign fixed-income
securities as may exist or come into being, such as the Moody's Investment
Grade Corporate Bond Index ("index" futures). The Fund will purchase or sell
interest rate futures contracts for the purpose of hedging some or all of the
value of its portfolio securities (or anticipated portfolio securities) against
changes in prevailing interest rates. The Fund will purchase or sell index
futures contracts for the purpose of hedging some or all of its portfolio (or
anticipated portfolio) securities against changes in their prices.
The Fund may also purchase and write call and put options on futures
contracts which are traded on an exchange and enter into closing transactions
with respect to such options to terminate an existing position. The Fund will
purchase and write options on futures contracts for identical purposes to those
set forth above for the purchase of a futures contract and the sale of a
futures contract or to close out a long or short position in futures contracts.
Risks of Options and Futures Transactions. The Fund may close out its
position as writer of an option, or as a buyer or seller of a futures contract,
only if a liquid secondary market exists for options or futures contracts of
that series. There is no assurance that such a market will exist, particularly
in the case of OTC options, as such options will generally only be closed out
by entering into a closing purchase transaction with the purchasing dealer.
Also, Exchanges may limit the amount by which the price of many futures
contracts may move on any day. If the price moves equal the daily limit on
successive days, then it may prove impossible to liquidate a futures position
until the daily limit moves have ceased.
While the futures contracts and options transactions to be engaged in
by the Fund for the purpose of hedging the Fund's portfolio securities are not
speculative in nature, there are risks inherent in the use of such instruments.
One such risk is that the Fund's Investment Manager could be incorrect in its
expectations as to the direction or extent of various interest rate or price
movements or the time span within which the movements take place. For example,
if the Fund sold futures contracts for the sale of securities in anticipation
of an increase in interest rates, and then interest rates went down instead,
causing bond prices to rise, the Fund would lose money on the sale. Another
risk which will arise in employing futures contracts to protect against the
price volatility of portfolio securities is that the prices of securities,
currencies and indexes subject to futures contracts (and thereby the futures
contract prices) may correlate imperfectly with the behavior of the U.S. dollar
cash prices of the Fund's portfolio securities and their denominated
currencies. Another such risk is that prices of interest rate futures contracts
may not move in tandem with the changes in prevailing interest rates against
which the Fund seeks a hedge. See the Statement of Additional Information for
further discussion of such risks.
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<PAGE>
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
In order to hedge against adverse price movements in the securities
held in its portfolio and the currencies in which they are denominated (as well
as the securities it might wish to purchase and their denominated currencies)
the Fund may engage in transactions in forward foreign currency contracts. A
forward foreign currency exchange contract ("forward contract") involves an
obligation to purchase or sell a currency at a future date, which may be any
fixed number of days from the date of the contract agreed upon by the parties,
at a price set at the time of the contract. The Fund may enter into forward
contracts as a hedge against fluctuations in future foreign exchange rates.
The Fund will enter into forward contracts under various circumstances.
When the Fund enters into a contract for the purchase or sale of a security
denominated in a foreign currency, it may, for example, desire to "lock in" the
price of the security in U.S. dollars or some other foreign currency which the
Fund is temporarily holding in its portfolio. By entering into a forward
contract for the purchase or sale, for a fixed amount of dollars or other
currency, of the amount of foreign currency involved in the underlying security
transactions, the Fund will be able to protect itself against a possible loss
resulting from an adverse change in the relationship between the U.S. dollar or
other currency which is being used for the security purchase and the foreign
currency in which the security is denominated during the period between the
date on which the security is purchased or sold and the date on which payment
is made or received.
At other times, when, for example, the Investment Manager believes that
the currency of a particular foreign country may suffer a substantial decline
against the U.S. dollar or some other foreign currency, the Fund may enter into
a forward contract to sell, for a fixed amount of dollars or other currency,
the amount of foreign currency approximating the value of some or all of the
Fund's portfolio securities (or securities which the Fund has purchased for its
portfolio) denominated in such foreign currency. Under identical circumstances,
the Fund may enter into a forward contract to sell, for a fixed amount of U.S.
dollars or other currency, an amount of foreign currency other than the
currency in which the securities to be hedged are denominated approximating the
value of some or all of the portfolio securities to be hedged. This method of
hedging, called "cross-hedging," will be selected by the Investment Manager
when it is determined that the foreign currency in which the portfolio
securities are denominated has insufficient liquidity or are trading at a
discount as compared with some other foreign currency with which it tends to
move in tandem.
In addition, when the Fund's Investment Manager anticipates purchasing
securities at some time in the future, and wishes to lock in the current
exchange rate of the currency in which those securities are denominated against
the U.S. dollar or some other foreign currency, the Fund may enter into a
forward contract to purchase an amount of currency equal to some or all of the
value of the anticipated purchase, for a fixed amount of U.S. dollars or other
currency.
Lastly, the Fund is permitted to enter into forward contracts with
respect to currencies in which certain of its portfolio securities are
denominated and on which options have been written (see "Options and Futures
transactions").
In all of the above circumstances, if the currency in which the Fund's
portfolio securities (or anticipated portfolio securities) are denominated
rises in value with respect to the currency which is being purchased (or sold),
then the Fund will have realized fewer gains than had the Fund not entered into
the forward contracts. Moreover, the precise matching of the forward contract
amounts and the value of the securities involved will not generally be
possible, since the future value of such securities in foreign currencies will
change as a consequence of market movements in the value of those securities
between the date the forward contract is entered into and the date it matures.
The successful use of the foregoing investment practices draws upon the
Investment Manager's special skills and experience with respect to such
instruments and usually depends upon the Investment Manager's ability to
forecast currency exchange rate movements correctly. Should exchange rates move
in an unexpected manner, the Fund may not achieve the anticipated benefits of
forward contracts or may realize losses and thus be in a worse position than if
such strategies had not been
17
<PAGE>
used. Unlike many exchange-traded futures contracts and options on futures
contracts, there are no daily price fluctuation limits with respect to options
on currencies and forward contracts, and adverse market movements could
therefore continue to an unlimited extent over a period of time. In addition,
the correlation between movements in the prices of such instruments and
movements in the price of currencies hedged or used for cover will not be
perfect and could produce unanticipated losses.
The Fund is not required to enter into such transactions with regard to
its foreign currency-denominated securities and will not do so unless deemed
appropriate by the Investment Manager. The Fund generally will not enter into a
forward contract with a term of greater than one year, although it may enter
into forward contracts for periods of up to five years. The Fund may be limited
in its ability to enter into hedging transactions involving forward contracts
by the Internal Revenue Code requirements relating to qualifications as a
regulated investment company (see "Dividends, Distributions and Taxes").
Except as specified, the investment policies and practices discussed
above are not fundamental policies of the Fund and may be changed without
shareholder approval.
PORTFOLIO MANAGEMENT
The Fund's portfolio is actively managed by its Investment Manager with
a view to achieving the Fund's investment objectives. In determining which
securities to purchase for the Fund or hold in the Fund's portfolio, the
Investment Manager will rely on information from various sources, including the
rating of the security, research, analysis and appraisals of brokers and
dealers, including Dean Witter Reynolds Inc. ("DWR"), a broker-dealer affiliate
of InterCapital, the views of Trustees of the Fund and others regarding
economic developments and interest rate trends, and the Investment Manager's
own analysis of factors they deem relevant. The Fund is managed within
InterCapital's High Yield Bond Group, which manages six funds and fund
portfolios, with approximately $1.3 billion in assets at November 30, 1993.
Peter M. Avelar, Rajesh K. Gupta and Vinh Q. Tran have been the primary
portfolio managers of the Fund since its inception. Peter M. Avelar, Senior
Vice President of InterCapital, has been managing portfolios comprised of high
yield fixed-income securities at InterCapital since December, 1990. Prior to
joining InterCapital, Mr. Avelar was affiliated with PaineWebber Asset
Management as a First Vice President and Portfolio Manager. Rajesh K. Gupta,
Senior Vice President of InterCapital, has been managing portfolios comprised
of government securities at InterCapital for over five years. Vinh Q. Tran,
Vice President of InterCapital, has been managing portfolios comprised of
worldwide fixed-income securities at InterCapital since February, 1989. Prior
to joining InterCapital, Mr. Tran was affiliated with Aetna Life and Casualty
Co. as a Director of International Investments.
Securities purchased by the Fund are generally sold by dealers acting
as principal for their own accounts. Brokerage commissions are not normally
charged but such transactions generally involve costs in the form of spreads
between bid and asked prices. Orders for transactions in other portfolio
securities and commodities are placed for the Fund with a number of brokers and
dealers, including DWR. Pursuant to an order of the Securities and Exchange
Commission, the Fund may effect principal transactions in certain money market
instruments with DWR. In addition, the Fund may incur brokerage commissions on
transactions conducted through DWR.
The Fund may sell portfolio securities without regard to the length of
time that they have been held, in order to take advantage of new investment
opportunities or yield differentials, or because the Fund desires to preserve
gains or limit losses due to changing economic conditions, interest rate
trends, or the financial condition of the issuer.
The expenses of the Fund relating to its portfolio management are
likely to be greater than those incurred by other investment companies
investing primarily in securities issued by domestic issuers such as custodial
costs, brokerage commissions and other transaction charges related to investing
on foreign markets are generally higher than in the United States. Short-term
gains and losses may result from the aforementioned portfolio transactions. See
"Dividends, Distributions and Taxes" for a discussion of the tax implications
of the Fund's trading policy.
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<PAGE>
INVESTMENT RESTRICTIONS
===============================================================================
The investment restrictions listed below are among the restrictions
which have been adopted by the Fund as fundamental policies. Under the Act, a
fundamental policy may not be changed without the vote of a majority of the
outstanding voting securities of the Fund, as defined in the Act. For purposes
of the following limitations (with the exception of Restriction 4): (i) all
percentage limitations apply immediately after a purchase or initial
investment, and (ii) any subsequent change in any applicable percentage
resulting from market fluctuations or other changes in total or net assets does
not require elimination of any security from the portfolio.
The Fund may not:
1. Invest more than 5% of its total assets in the securities of any one
issuer (other than obligations of, or guaranteed by, the United States
Government, its agencies or instrumentalities).
2. Invest more than 5% of the value of its total assets in securities
of issuers having a record, together with predecessors, of less than three
years of continuous operation. This restriction shall not apply to Mortgage-
Backed and Asset-Backed Securities or to any obligation issued or guaranteed by
the United States Government, its agencies or instrumentalities.
3. Invest 25% or more of the value of its total assets in securities of
issuers in any one industry, except that the Fund will invest at least 25% of
its total assets in Mortgage-Backed Securities under normal market conditions.
For the purpose of this restriction, gas, electric, water and telephone
utilities will be treated as being a separate industry. This restriction does
not apply to obligations issued or guaranteed by the United States Government
or its agencies or instrumentalities.
4. Borrow money in excess of 33 1/3% of the Fund's total assets
(including the proceeds of the borrowings).
5. Purchase more than 10% of the voting securities, or more than 10% of
any class of securities, of any issuer. For purposes of this restriction, all
outstanding debt securities of an issuer are considered as one class and all
preferred stocks of an issuer are considered as one class.
PURCHASE OF FUND SHARES
===============================================================================
The Fund offers its shares for sale to the public on a continuous
basis. Pursuant to a Distribution Agreement between the Fund and Dean Witter
Distributors Inc. (the "Distributor"), an affiliate of the Investment Manager,
shares of the Fund are distributed by the Distributor and offered by DWR and
other dealers who have entered into selected dealer agreements with the
Distributor ("Selected Broker-Dealers"). The principal executive office of the
Distributor is located at Two World Trade Center, New York, New York 10048.
The minimum initial purchase is $1,000. Subsequent purchases of $100 or
more may be made by sending a check, payable to Dean Witter Diversified Income
Trust, directly to Dean Witter Trust Company (the "Transfer Agent") at P.O. Box
1040, Jersey City, NJ 07303 or by contacting an account executive of
DWR or other Selected-Broker Dealer. In the case of investments pursuant to
Systematic Payroll Deduction Plans (including Individual Retirement Plans), the
Fund, in its discretion, may accept investments without regard to any minimum
amounts which would otherwise be required if the Fund has reason to believe
that additional investments will increase the investment in all accounts under
such Plans to at least $1,000. Certificates for shares purchased will not be
issued unless a request is made by the shareholder in writing to the Transfer
Agent. The offering price will be the net asset value per share next determined
following receipt of an order (see "Determination of Net Asset Value").
Shares of the Fund are sold through the Distributor on a normal five
business day settlement basis;
19
<PAGE>
that is payment is due on the fifth business day (settlement date) after the
order is placed with the Distributor. Since DWR and other Selected Broker-
Dealers forward investors' funds on settlement date, they will benefit from the
temporary use of the funds if payment is made prior thereto. As noted above,
orders placed directly with the Transfer Agent must be accompanied by payment.
Investors will be entitled to receive dividends and capital gains distributions
if their order is received by the close of business on the day prior to the
record date for such distributions. While no sales charge is imposed at the
time shares are purchased, a contingent deferred sales charge may be imposed at
the time of redemption (see "Redemptions and Repurchases"). The Fund and the
Distributor reserve the right to reject any purchase orders.
PLAN OF DISTRIBUTION
The Fund has adopted a Plan of Distribution pursuant to Rule 12b-1
under the Act (the "Plan"), under which the Fund pays the Distributor a fee,
which is accrued daily and payable monthly, at an annual rate of 0.85% of the
lesser of: (a) the average daily aggregate gross sales of the Fund's shares
since the inception of the Fund (not including reinvestments of dividends or
capital gains distributions), less the average daily aggregate net asset value
of the Fund's shares redeemed since the Fund's inception upon which a
contingent deferred sales charge has been imposed or waived; or (b) the Fund's
average daily net assets. This fee is treated by the Fund as an expense in the
year it is accrued. A portion of the fee payable pursuant to the Plan, equal to
0.20% of the Fund's average daily net assets, is characterized as a service fee
within the meaning of NASD guidelines.
Amounts paid under the Plan are paid to the Distributor to compensate
it for the services provided and the expenses borne by the Distributor and
others in the distribution of the Fund's shares, including the payment of
commissions for sales of the Fund's shares and incentive compensation to and
expenses of DWR's account executives and others who engage in or support
distribution of shares, including overhead and telephone expenses; printing and
distribution of prospectuses and reports used in connection with the offering
of the Fund's shares to other than current shareholders; and preparation,
printing and distribution of sales literature and advertising materials. In
addition, the Distributor may utilize fees paid pursuant to the Plan to
compensate DWR and other Selected Broker-Dealers for their opportunity costs in
advancing such amounts, which compensation would be in the form of a carrying
charge on any unreimbursed distribution expenses.
For the fiscal year ended October 31, 1993, the Fund accrued payments
under the Plan amounting to $882,934, which amount is equal to 0.85% of the
Fund's average daily net assets for the fiscal period. These payments accrued
under the Plan were calculated pursuant to clause (b) of the compensation
formula under the Plan.
At any given time, the expenses in distributing shares of the Fund may
be in excess of the total of (i) the payments made by the Fund pursuant to the
Plan, and (ii) the proceeds of contingent deferred sales charges paid by
investors upon the redemption of shares (see "Redemptions and Repurchases--
Contingent Deferred Sales Charge"). For example, if $1 million in expenses in
distributing shares of the Fund had been incurred and $750,000 had been
received as described in (i) and (ii) above, the excess expense would amount to
$250,000. The Distributor has advised the Fund that such excess amount,
including the carrying charge described above, totalled $4,663,472 at October
31, 1993, which was equal to 2.79% of the Fund's net assets on such date.
Because there is no requirement under the Plan that the Distributor be
reimbursed for all distribution expenses or any requirement that the Plan be
continued from year to year, this excess amount does not constitute a liability
of the Fund. Although there is no legal obligation for the Fund to pay expenses
incurred in excess of payments made to the Distributor under the Plan, and the
proceeds of contingent deferred sales charges paid by investors upon redemption
of shares, if for any reason the Plan is terminated the Trustees will consider
at that time the manner in which to treat such expenses. Any cumulative
expenses incurred, but not yet recovered through distribution fees or
contingent deferred sales charges, may or may not be recovered through future
distribution fees or contingent deferred sales charges.
20
<PAGE>
DETERMINATION OF NET ASSET VALUE
The net asset value per share of the Fund is determined by taking the
value of all the assets of the Fund, subtracting all liabilities, dividing by
the number of shares outstanding and adjusting the result to the nearest cent.
The net asset value per share is determined by the Investment Manager as of
4:00 P.M. New York time on each day that the New York Stock Exchange is open.
The net asset value per share will not be determined on Good Friday and on such
other federal and non-federal holidays as are observed by the New York Stock
Exchange.
In the calculation of the Fund's net asset value: (1) an equity
portfolio security listed or traded on the New York or American Stock Exchange
or other domestic or foreign stock exchange is valued at its latest sale price
on that exchange; if there were no sales that day, the security is valued at
the latest bid price (in cases where securities are traded on more than one
exchange, the securities are valued on the exchange designated as the primary
market by the Trustees); and (2) all other portfolio securities for which over-
the-counter market quotations are readily available are valued at the latest
bid price. When market quotations are not readily available, including
circumstances under which it is determined by the Investment Manager that sale
or bid prices are not reflective of a security's market value, portfolio
securities are valued at their fair value as determined in good faith under
procedures established by and under the general supervision of the Fund's
Trustees. For valuation purposes, quotations of foreign portfolio securities,
other assets and liabilities and forward contracts stated in foreign currency
are translated into U.S. dollar equivalents at the prevailing market rates as
of the morning of valuation.
Short-term debt securities with remaining maturities of sixty days or
less at the time of purchase are valued at amortized cost, unless the Trustees
determine such does not reflect the securities' market value, in which case
these securities will be valued at their fair value as determined by the
Trustees.
Certain of the Fund's portfolio securities may be valued by an outside
pricing service approved by the Fund's Trustees. The pricing service utilizes a
matrix system incorporating security quality, maturity and coupon as the
evaluation model parameters, and/or research evaluations by its staff,
including review of broker-dealer market price quotations in determining what
it believes is the fair valuation of the portfolio securities valued by such
pricing service.
Generally, trading in foreign securities, as well as corporate bonds,
United States Government securities and money market instruments, is
substantially com-pleted each day at various times prior to the regular close
of the New York Stock Exchange. The values of such securities used in computing
the net asset value of the Fund's shares are determined as of such times.
Foreign currency exchange rates are also generally determined prior to the
regular close of the New York Stock Exchange. Occasionally, events which affect
the values of such securities and such exchange rates may occur between the
times at which they are determined and the close of the New York Stock Exchange
and will therefore not be reflected in the computation of the Fund's net asset
value. If events materially affecting the value of such securities occur during
such period, then these securities will be valued at their fair value as
determined in good faith under procedures established by and under the
supervision of the Trustees.
SHAREHOLDER SERVICES
===============================================================================
Automatic Investment of Dividends and Distributions. All income
dividends and capital gains distributions are automatically paid in full and
fractional shares of the Fund (or, if specified by the shareholder, any other
open-end investment company for which InterCapital serves as investment manager
(collectively, with the Fund, the "Dean Witter Funds")), unless the shareholder
requests that they be paid in cash. Shares so acquired are not subject to the
imposition of a contingent deferred sales charge upon their redemption (see
"Redemptions and Repurchases").
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<PAGE>
EasyInvest SM. Shareholders may subscribe to EasyInvest, an automatic
purchase plan which provides for any amount from $100 to $5,000 to be
transferred automatically from a checking or savings account, on a semi-
monthly, monthly or quarterly basis, to the Fund's Transfer Agent for
investment in shares of the Fund.
Systematic Withdrawal Plan. A systematic withdrawal plan (the
"Withdrawal Plan") is available for shareholders who own or purchase shares of
the Fund having a minimum value of $10,000 based upon the then current net
asset value. The Withdrawal Plan provides for monthly or quarterly (March,
June, September, December) checks in any dollar amount, not less than $25, or
in any whole percentage of the account balance, on an annualized basis. Any
applicable contingent deferred sales charge will be imposed on shares redeemed
under the Withdrawal Plan (see "Redemptions and Repurchases--Contingent
Deferred Sales Charge"). Therefore, any shareholder participating in the
Withdrawal Plan will have sufficient shares redeemed from his or her account so
that the proceeds (net of any applicable contingent deferred sales charge) to
the shareholder will be the designated monthly or quarterly amount.
Shareholders should contact their DWR or other Selected Broker-Dealer
account executive or the Transfer Agent for further information about any of
the above services.
Tax Sheltered Retirement Plans. Retirement plans are available through
the Distributor for use by corporations, the self-employed, eligible Individual
Retirement Accounts and Custodial Accounts under Section 403(b)(7) of the
Internal Revenue Code. Adoption of such plans should be on advice of legal
counsel or tax adviser.
For further information regarding plan administration, custodial fees
and other details, investors should contact their account executive or the
Transfer Agent.
EXCHANGE PRIVILEGE
The Fund makes available to its shareholders an "Exchange Privilege"
allowing the exchange of shares of the Fund for shares of other Dean Witter
Funds sold with a contingent deferred sales charge ("CDSC funds"), and for
shares of Dean Witter Short-Term U.S. Treasury Trust, Dean Witter Limited Term
Municipal Trust, Dean Witter Short-Term Bond Fund and five Dean Witter Funds
which are money market funds (the foregoing eight non-CDSC funds are
hereinafter referred to as the "Exchange Funds"). Exchanges may be made after
the shares of the Fund acquired by purchase (not by exchange or dividend
reinvestment) have been held for thirty days. There is no waiting period for
exchanges of shares acquired by exchange or dividend reinvestment.
An exchange to another CDSC fund or any Exchange Fund that is not a
money market fund is on the basis of the next calculated net asset value per
share of each fund after the exchange order is received. When exchanging into a
money market fund from the Fund, shares of the Fund are redeemed out of the
Fund at their next calculated net asset value and the proceeds of the
redemption are used to purchase shares of the money market fund at their net
asset value determined the following business day. Subsequent exchanges between
any of the money market funds and any of the CDSC funds can be effected on the
same basis. No contingent deferred sales charge ("CDSC") is imposed at the time
of any exchange, although any applicable CDSC will be imposed upon ultimate
redemption. Shares of the Fund acquired in exchange for shares of another CDSC
fund having a different CDSC schedule than that of this Fund will be subject to
the CDSC schedule of this Fund, even if such shares are subsequently re-
exchanged for shares of the CDSC fund originally purchased. During the period
of time the shareholder remains in the Exchange Fund (calculated from the last
day of the month in which the Exchange Fund shares were acquired), the holding
period (for the purpose of determining the rate of the CDSC) is frozen. If
those shares are subsequently reexchanged for shares of a CDSC fund, the
holding period previously frozen when the first exchange was made resumes on
the last day of the month in which shares of a CDSC fund are reacquired. Thus,
the CDSC is based upon the time (calculated as described above) the shareholder
was invested in a
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<PAGE>
CDSC fund (see "Redemptions and Repurchases-- Contingent Deferred Sales
Charge"). However, in the case of shares of the Fund exchanged into an Exchange
Fund, upon a redemption of shares which results in a CDSC being imposed, a
credit (not to exceed the amount of the CDSC) will be given in an amount equal
to the Exchange Fund 12b-1 distribution fees which are attributable to those
shares. (Exchange Fund 12b-1 distribution fees are described in the
prospectuses for those funds.)
In addition, shares of the Fund may be acquired in exchange for shares
of Dean Witter Funds sold with a front-end sales charge ("front-end sales
charge funds") but shares of the Fund, however acquired, may not be exchanged
for shares of front-end sales charge funds. Shares of a CDSC fund acquired in
exchange for shares of a front-end sales charge fund (or in exchange for shares
of other Dean Witter Funds for which shares of a front-end sales charge fund
have been exchanged) are not subject to any CDSC upon their redemption.
Purchases and exchanges should be made for investment purposes only. A
pattern of frequent exchanges may be deemed by the Investment Manager to be
abusive and contrary to the best interests of the Fund's other shareholders
and, at the Investment Manager's discretion, may be limited by the Fund's
refusal to accept additional purchases and/or exchanges from the investor.
Although the Fund does not have any specific definition of what constitutes a
pattern of frequent exchanges, and will consider all relevant factors in
determining whether a particular situation is abusive and contrary to the best
interests of the Fund and its other shareholders, investors should be aware
that the Fund and each of the other Dean Witter Funds may in their discretion
limit or otherwise restrict the number of times this Exchange Privilege may be
exercised by any investor. Any such restriction will be made by the Fund on a
prospective basis only, upon notice to the shareholder not later than ten days
following such shareholder's most recent exchange. Also, the Exchange Privilege
may be terminated or revised at any time by the Fund and/or any of such Dean
Witter Funds for which shares of the Fund may be exchanged, upon such notice as
may be required by applicable regulatory agencies.
If DWR or other Selected Broker-Dealer is the current dealer of record
and its account numbers are part of the account information, shareholders may
initiate an exchange of shares of the Fund for shares of any of the Dean Witter
Funds (for which the Exchange Privilege is available) pursuant to this Exchange
Privilege by contacting their account executive (no Exchange Privilege
Authorization Form is required). Other shareholders (and those shareholders who
are clients of DWR or another Selected Broker-Dealer but who wish to make
exchanges directly by writing or telephoning the Transfer Agent) must complete
and forward to the Transfer Agent an Exchange Privilege Authorization Form,
copies of which may be obtained from the Transfer Agent, to initiate an
exchange. If the Authorization Form is used, exchanges may be made in writing
or by contacting the Transfer Agent at (800) 526-3143 (toll free). The Fund
will employ reasonable procedures to confirm that exchange instructions
communicated over the telephone are genuine. Such procedures may include
requiring various forms of personal identification such as name, mailing
address, social security or other tax identification number and DWR or other
Selected Broker-Dealer account number (if any). Telephone instructions may also
be recorded. If such procedures are not employed, the Fund may be liable for
any losses due to unauthorized or fraudulent instructions. Telephone exchange
instructions will be accepted if received by the Transfer Agent between 9:00
and 4:00 p.m., New York time, on any day the New York Stock Exchange is open.
Any shareholder wishing to make an exchange who has previously filed an
Exchange Privilege Authorization Form and who is unable to reach the Fund by
telephone should contact his or her DWR or other Selected Broker-Dealer account
executive, if appropriate, or make a written exchange request. Shareholders are
advised that during periods of drastic economic or market changes it is
possible that the telephone exchange procedures may be difficult to implement,
although this has not been the experience of the Dean Witter Funds in the past.
Shareholders should contact their DWR or other Selected Broker-Dealer
account executive or the Transfer Agent for further information about the
Exchange Privilege.
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<PAGE>
REDEMPTIONS AND REPURCHASES
===============================================================================
Redemption. Shares of the Fund can be redeemed for cash at any time at
their current net asset value per share next determined; however, such
redemption proceeds may be reduced by the amount of any applicable contingent
deferred sales charges (see below). If shares are held in a shareholder's
account without a share certificate, a written request for redemption sent to
the Fund's Transfer Agent at P.O. Box 983, Jersey City, NJ 07303 is required.
If certificates are held by the shareholder(s), the shares may be redeemed by
surrendering the certificate(s) with a written request for redemption, along
with any additional information required by the Transfer Agent.
Contingent Deferred Sales Charge. Shares of the Fund which are held for
six years or more after purchase (calculated from the last day of the month in
which the shares were purchased) will not be subject to any charge upon
redemption. Shares redeemed sooner than six years after purchase may, however,
be subject to a charge upon redemption. This charge is called a "contingent
deferred sales charge" ("CDSC"), which will be a percentage of the dollar
amount of shares redeemed and will be assessed on an amount equal to the lesser
of the current market value or the cost of the shares being redeemed. The size
of this percentage will depend upon how long the shares have been held, as set
forth in the table below:
CONTINGENT DEFERRED
YEAR SINCE SALES CHARGE
PURCHASE AS A PERCENTAGE OF
PAYMENT MADE AMOUNT REDEEMED
------------ -------------------
First.............................. 5.0%
Second............................. 4.0%
Third.............................. 3.0%
Fourth............................. 2.0%
Fifth.............................. 2.0%
Sixth.............................. 1.0%
Seventh and thereafter............. None
A CDSC will not be imposed on: (i) any amount which represents an
increase in value of shares purchased within the six years preceding the
redemption; (ii) the current net asset value of shares purchased more than six
years prior to the redemption; and (iii) the current net asset value of shares
purchased through reinvestment of dividends or distributions and/or shares
acquired in exchange for shares of Dean Witter Funds sold with a front-end
sales charge or of other Dean Witter Funds acquired in exchange for such
shares. Moreover, in determining whether a CDSC is applicable it will be
assumed that amounts described in (i), (ii) and (iii) above (in that order) are
redeemed first.
In addition, the CDSC, if otherwise applicable, will be waived in the
case of: (i) redemptions of shares held at the time a shareholder dies or
becomes disabled, only if the shares are (a) registered either in the name of
an individual shareholder (not a trust), or in the names of such shareholder
and his or her spouse as joint tenants with right of survivorship, or (b) held
in a qualified corporate or self-employed retirement plan, Individual
Retirement Account or Custodial Account under Section 403(b)(7) of the Internal
Revenue Code, provided in either case that the redemption is requested within
one year of the death or initial determination of disability, and (ii)
redemptions in connection with the following retirement plan distributions: (a)
lump-sum or other distributions from a qualified corporate or self-employed
retirement plan following retirement (or in the case of a "key employee" of a
"top heavy" plan, following attainment of age 59 1/2); (b) distributions from
an Individual Retirement Account or Custodial Account under Section 403(b)(7)
of the Internal Revenue Code following attainment of age 59 1/2; and (c) a tax-
free return of an excess contribution to an IRA. For the purpose of determining
disability, the Distributor utilizes the definition of disability contained in
Section 72(m)(7) of the Internal Revenue Code, which relates to the inability
to engage in gainful employment. All waivers will be granted only following
receipt by the Distributor of confirmation of the shareholder's entitlement.
Repurchase. DWR and other Selected Broker-Dealers are authorized to
repurchase shares represented by a share certificate which is delivered to any
of their offices. Shares held in a shareholder's account without a share
certificate may also be repurchased by
24
<PAGE>
DWR and other Selected Broker-Dealers upon the telephonic request of the
shareholder. The repurchase price is the net asset value next computed (see
"Purchase of Fund Shares") after such repurchase order is received by DWR or
other Selected Broker-Dealer, reduced by any applicable CDSC.
The CDSC, if any, will be the only fee imposed by the Fund, the
Distributor, DWR, and other Selected Broker-Dealers. The offer by DWR and other
Selected Broker-Dealers to repurchase shares may be suspended without notice by
them at any time. In that event, shareholders may redeem their shares through
the Fund's Transfer Agent as set forth above under "Redemption."
Payment for Shares Redeemed or Repurchased. Payment for shares
presented for repurchase or redemption will be made by check within seven days
after receipt by the Transfer Agent of the certificate and/or written request
in good order. Such payment may be postponed or the right of redemption
suspended under unusual circumstances. If the shares to be redeemed have
recently been purchased by check, payment of the redemption proceeds may be
delayed for the minimum time needed to verify that the check used for
investment has been honored (not more than fifteen days from the time of
receipt of the check by the Transfer Agent). Shareholders maintaining margin
accounts with DWR or another Selected Broker-Dealer are referred to their
account executive regarding restrictions on redemption of shares of the Fund
pledged in the margin account.
Reinstatement Privilege. A shareholder who has had his or her shares
redeemed or repurchased and has not previously exercised this reinstatement
privilege may, within thirty days after the date of the redemption or
repurchase, reinstate any portion or all of the proceeds of such redemption or
repurchase in shares of the Fund at the net asset value next determined after a
reinstatement request, together with the proceeds, is received by the Transfer
Agent and receive a pro rata credit for any CDSC paid in connection with such
redemption or repurchase.
Involuntary Redemption. The Fund reserves the right, on sixty days'
notice, to redeem at their net asset value the shares of any shareholder (other
than shares held in an Individual Retirement Account or custodial account under
Section 403(b)(7) of the Internal Revenue Code) whose shares have a value of
less than $100 as a result of redemptions or repurchases, or such lesser amount
as may be fixed by the Board of Trustees. However, before the Fund redeems such
shares and sends the proceeds to the shareholder, it will notify the
shareholder that the value of the shares is less than $100 and allow the
shareholder sixty days to make an additional investment in an amount which will
increase the value of the account to $100 or more before the redemption is
processed. No CDSC will be imposed on any involuntary redemption.
DIVIDENDS, DISTRIBUTIONS AND TAXES
===============================================================================
Dividends and Distributions. The Fund intends to declare and pay
monthly income dividends and to distribute net short-term and net long-term
capital gains, if any, at least once each year. The Fund may, however,
determine either to distribute or to retain all or a portion of any long-term
capital gains in any year for reinvestment.
All dividends and capital gains distributions will be paid in
additional Fund shares and automatically credited to the shareholder's account
without issuance of a share certificate unless the shareholder requests in
writing that all dividends and/or distributions be paid in cash. (See
"Shareholder Services--Automatic Investment of Dividends and Distributions".)
Taxes. Because the Fund intends to distribute all of its net investment
income and net capital gains to shareholders and otherwise remain qualified as
a regulated investment company under Subchapter M of the Internal Revenue Code,
it is not expected that the Fund will be required to pay any federal income tax
on such income and capital gains.
25
<PAGE>
Gains or losses on the Fund's transactions in certain listed options on
and futures and options on futures traded on U.S. exchanges generally are
treated as 60% long-term gain or loss and 40% short-term gain or loss. When the
Fund engages in options and futures transactions, various tax regulations
applicable to the Fund may have the effect of causing the Fund to recognize a
gain or loss for tax purposes before that gain or loss is realized, or to defer
recognition of a realized loss for tax purposes. Recognition, for tax purposes,
of an unrealized loss may result in a lesser amount of the Fund's realized net
gains being available for distribution.
Shareholders who are required to pay taxes on their income will
normally have to pay federal income taxes, and any applicable state and/or
local income taxes, on the dividends and distributions they receive from the
Fund. Such dividends and distributions, to the extent that they are derived
from net investment income and net short-term capital gains, are taxable to the
shareholder as ordinary dividend income regardless of whether the shareholder
receives such distributions in additional shares or in cash.
Distributions of net long-term capital gains, if any, are taxable to
shareholders as long-term capital gains regardless of how long a shareholder
has held the Fund's shares and regardless of whether the distribution is
received in additional shares or in cash. Since the Fund's income is expected
to be derived primarily from interest rather than dividends, only a small
portion, if any, of the Fund's dividends and distributions is expected to be
eligible for the dividends received deduction to corporation shareholders.
After the end of the calendar year, shareholders will receive full
information on their dividends and capital gains distributions for tax
purposes.
To avoid being subject to a 31% federal backup withholding tax on
taxable dividends, capital gains distributions and the proceeds of redemptions
and repurchases, shareholders' taxpayer identification num-
bers must be furnished and certified as to their accuracy. Shareholders who are
not citizens or residents of, or entities organized in, the United States may
be subject to withholding taxes of up to 30% on certain payments received from
the Fund.
Dividends, interest and gains received by the Fund may give rise to
withholding and other taxes imposed by foreign countries. If it qualifies for
and has made the appropriate election with the Internal Revenue Service, the
Fund will report annually to its shareholders the amount per share of such
taxes, to enable shareholders to claim United States foreign tax credits or
deductions with respect to such taxes. In the absence of such an election, the
Fund would deduct foreign tax in computing the amount of its distributable
income.
The foregoing discussion relates solely to the federal income tax
consequences of an investment in the Fund. Distributions may also be subject to
state and local taxes; therefore, each shareholder is advised to consult his or
her own tax adviser.
PERFORMANCE INFORMATION
===============================================================================
From time to time the Fund may quote its "yield" and/or its "total
return" in advertisements and sales literature. Both the yield and the total
return of the Fund are based on historical earnings and are not intended to
indicate future performance. The yield of the Fund is computed by dividing the
Fund's net investment income over a 30-day period by an average value (using
the average number of shares entitled to receive dividends and the net asset
value per share at the end of the period), all in accordance with applicable
regulatory requirements. Such amount is compounded for six months and then
annualized for a twelve-month period to derive the Fund's yield.
The "average annual total return" of the Fund refers to a figure
reflecting the average annualized percentage increase (or decrease) in the
value of an initial investment in the Fund of $1,000 over the life of the Fund.
Average annual total return reflects all income earned by the Fund, any
appreciation or depreciation of the Fund's assets and all expenses incurred by
the Fund, for the stated periods. It also assumes
26
<PAGE>
reinvestment of all dividends and distributions paid by the Fund.
In addition to the foregoing, the Fund may advertise its total return
over different periods of time by means of aggregate, average, and year-by-year
or other types of total return figures. The Fund may also advertise the growth
of hypothetical investments of $10,000, $50,000 and $100,000 in shares of the
Fund. The Fund from time to time may also advertise its performance relative to
certain performance rankings and indexes compiled by independent organizations
(such as mutual fund performance rankings of Lipper Analytical Services, Inc.).
ADDITIONAL INFORMATION
===============================================================================
Voting Rights. All shares of beneficial interest of the Fund are of
$0.01 par value and are equal as to earnings, assets and voting privileges.
The Fund is not required to hold Annual Meetings of Shareholders and in
ordinary circumstances the Fund does not intend to hold such meetings. The
Trustees may call Special Meetings of Shareholders for action by shareholder
vote as may be required by the Act or the Declaration of Trust. Under certain
circumstances, the Trustees may be removed by action of the Trustees or by the
shareholders.
Under Massachusetts law, shareholders of a business trust may, under
certain circumstances, be held personally liable as partners for the
obligations of the Fund. However, the Declaration of Trust contains an express
disclaimer of shareholder liability for acts or obligations of the Fund,
requires that Fund obligations include such disclaimer and provides for
indemnification and reimbursement of expenses out of the Fund's property for
any shareholder held personally liable for the obligations of the Fund. Thus,
the risk of a shareholder incurring financial loss on account of shareholder
liability is limited to circumstances in which the Fund itself would be unable
to meet its obligations. Given the above limitations on shareholder personal
liability and the nature of the Fund's assets and operations, the possibility
of the Fund being unable to meet its obligations is remote and, in the opinion
of Massachusetts counsel to the Fund, the risk to Fund shareholders of personal
liability is remote.
Shareholder Inquiries. All inquiries regarding the Fund should be
directed to the Fund at the telephone number or address set forth on the front
cover of this Prospectus.
27
<PAGE>
APPENDIX--RATINGS OF INVESTMENTS
===============================================================================
MOODY'S INVESTORS SERVICE INC. ("MOODY'S")
BOND RATINGS
------------
Aaa Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt 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 the fundamentally strong position of such issues.
Aa Bonds which are rated Aa are judged to be of high quality by
all standards. Together with the Aaa group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds because
margins of protection may not be as large as in Aaa securities or fluctuation
of protective elements may be of greater amplitude or there may be other
elements present which make the long-term risks appear somewhat larger than in
Aaa securities.
A Bonds which are rated A possess many favorable investment
attributes and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment sometime in the
future.
Baa Bonds which are rated Baa are considered as medium grade
obligations; i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics as
well.
Bonds rated Aaa, Aa, A and Baa are considered investment
grade bonds.
Ba Bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate, and
therefore not well safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class.
B Bonds which are rated B generally lack characteristics of
desirable investments. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
Caa Bonds which are rated Caa are of poor standing. Such issues may
be in default or there may be present elements of danger with respect to
principal or interest.
Ca Bonds which are rated Ca present obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings.
C Bonds which are rated C are the lowest rated class of bonds,
and issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
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<PAGE>
Conditional Rating: Municipal bonds for which the security depends upon
the completion of some act or the fulfillment of some condition are rated
conditionally. These are bonds secured by (a) earnings of projects under
construction, (b) earnings of projects unseasoned in operation experience, (c)
rentals which begin when facilities are completed, or (d) payments to which
some other limiting condition attaches. Parenthetical rating denotes probable
credit stature upon completion of construction or elimination of basis of
condition.
Rating Refinements: Moody's may apply numerical modifiers, 1, 2 and 3
in each generic rating classification from Aa through B in its corporate and
municipal 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 a modifier 3 indicates that the issue ranks in the lower
end of its generic rating category.
COMMERCIAL PAPER RATINGS
Moody's Commercial Paper ratings are opinions of the ability to repay
punctually promissory obligations not having an original maturity in excess of
nine months. Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment capacity of rated issuers:
Prime-1, Prime-2, Prime-3.
Issuers rated Prime-1 have a superior capacity for repayment of short-
term promissory obligations. Issuers rated Prime-2 have a strong capacity for
repayment of short-term promissory obligations; and Issuers rated Prime-3 have
an acceptable capacity for repayment of short-term promissory obligations.
Issuers rated Not Prime do not fall within any of the Prime rating categories.
STANDARD & POOR'S CORPORATION ("STANDARD & POOR'S")
BOND RATINGS
A Standard & Poor's bond rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. This
assessment may take into consideration obligors such as guarantors, insurers,
or lessees.
The ratings are based on current information furnished by the issuer or
obtained by Standard & Poor's 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.
Standard & Poor's does not perform an audit in connection with any
rating and may, on occasion, rely on unaudited financial information. The
ratings may be changed, suspended or withdrawn as a result of changes in, or
unavailability of, such information, or for other reasons.
AAA Debt rated AAA has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the highest-rated issues only in small degree.
29
<PAGE>
A Debt rated A has a strong capacity to pay interest and repay principal
although they are somewhat more susceptible to the adverse effects of changes
in circumstances and economic conditions than debt in higher-rated categories.
BBB Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than for debt in higher-rated categories.
Bonds rated AAA, AA, A and BBB are considered investment grade bonds.
BB Debt rated BB has less near-term vulnerability to default than other
speculative grade debt. However, it faces major ongoing uncertainties or
exposure to adverse business, financial or economic conditions which could lead
to inadequate capacity to meet timely interest and principal payment.
B Debt rated B has a greater vulnerability to default but presently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial or economic conditions would likely impair capacity or
willingness to pay interest and repay principal.
CCC Debt rated CCC has a current identifiable vulnerability to default, and
is dependent upon favorable business, financial and economic conditions to meet
timely payments of interest and repayments of principal. In the event of
adverse business, financial or economic conditions, it is not likely to have
the capacity to pay interest and repay principal.
CC The rating CC is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC rating.
C The rating C is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC--debt rating.
CI The rating CI is reserved for income bonds on which no interest is
being paid.
NR Indicates that no rating has been requested, that there is insufficient
information on which to base a rating or that Standard & Poor's does not rate a
particular type of obligation as a matter of policy.
Bonds rated BB, B, CCC, CC and C are regarded as having predominantly
speculative characteristics with respect to capacity to pay interest and repay
principal. BB indicates the least degree of speculation and C the highest
degree of speculation. While such debt will likely have some quality and
protective characteristics, these are outweighed by large uncertainties or
major risk exposures to adverse conditions.
Plus (+) or minus (-): The ratings from AA to CCC may be modified by
the addition of a plus or minus sign to show relative standing within the major
ratings categories.
In the case of municipal bonds, the foregoing ratings are sometimes
followed by a "p" which indicates that the rating is provisional. A provisional
rating assumes the successful completion of the project being financed by the
bonds being rated and indicates that payment of debt service requirements is
largely or entirely dependent upon the successful and timely completion of the
project. This rating, however, while addressing credit quality subsequent to
completion of the project, makes no comment on the likelihood or risk of
default upon failure of such completion.
30
<PAGE>
COMMERCIAL PAPER RATINGS
Standard and Poor's 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. The commercial paper rating is not a recommendation to purchase
or sell a security. The ratings are based upon current information furnished by
the issuer or obtained by S&P from other sources it considers reliable. The
ratings may be changed, suspended, or withdrawn as a result of changes in or
unavailability of such information. Ratings are graded into group categories,
ranging from "A" for the highest quality obligations to "D" for the lowest.
Ratings are applicable to both taxable and tax-exempt commercial paper. The
categories are as follows:
Issues assigned A ratings are regarded as having the greatest capacity
for timely payment. Issues in this category are further refined with the
designation 1, 2 and 3 to indicate the relative degree of safety.
A-1 indicates that the degree of safety regarding timely payment is very
strong.
A-2 indicates capacity for timely payment on issues with this designation
is strong. However, the relative degree of safety is not as overwhelming as for
issues designated "A-1".
A-3 indicates a satisfactory capacity for timely payment. Obligations
carrying this designation are, however, somewhat more vulnerable to the adverse
effects of changes in circumstances than obligations carrying the higher
designations.
31
<PAGE>
Dean Witter
Diversified Income Trust
Two World Trade Center
New York, New York 10048
TRUSTEES
Jack F. Bennett
Charles A. Fiumefreddo
Edwin J. Garn
John R. Haire
Dr. John E. Jeuck
Dr. Manuel H. Johnson
Paul Kolton
Michael E. Nugent
Albert T. Sommers
Edward R. Telling
OFFICERS
Charles A. Fiumefreddo
Chairman and Chief Executive Officer
Sheldon Curtis
Vice President, Secretary and
General Counsel
Peter M. Avelar
Vice President
Rajesh K. Gupta
Vice President
Vinh Q. Tran
Vice President
Thomas F. Caloia
Treasurer
CUSTODIAN
The Bank of New York
110 Washington Street
New York, New York 10286
TRANSFER AGENT
AND DIVIDEND DISBURSING AGENT
Dean Witter Trust Company
Harborside Financial Center
Plaza Two
Jersey City, New Jersey 07311
INDEPENDENT ACCOUNTANTS
Price Waterhouse
1177 Avenue of the Americas
New York, New York 10036
INVESTMENT MANAGER
Dean Witter InterCapital Inc.
DEAN WITTER
DIVERSIFIED
INCOME TRUST
PROSPECTUS
DECEMBER 30, 1993
<PAGE>
DEAN WITTER
DIVERSIFIED
INCOME
TRUST
STATEMENT OF ADDITIONAL INFORMATION
DECEMBER 30, 1993
===============================================================================
Dean Witter Diversified Income Trust (the "Fund") is an open-end,
diversified management investment company whose primary investment objective is
a high level of current income. As a secondary objective, the Fund seeks to
maximize total return but only to the extent consistent with its primary
objective. The Fund seeks to achieve its investment objectives by equally
allocating its assets among three separate groupings of various types of fixed
income securities. Certain of the securities in which the Fund may invest will
include securities rated Baa/BBB or lower.
A Prospectus for the Fund dated December 30, 1993, which provides the
basic information you should know before investing in the Fund, may be obtained
without charge from the Fund at the address or telephone number listed below or
from the Fund's Distributor, Dean Witter Distributors Inc., or from Dean Witter
Reynolds Inc. at any of its branch offices. This Statement of Additional
Information is not a Prospectus. It contains information in addition to and
more detailed than that set forth in the Prospectus. It is intended to provide
additional information regarding the activities and operations of the Fund, and
should be read in conjunction with the Prospectus.
Dean Witter
Diversified Income Trust
Two World Trade Center
New York, New York 10048
(212) 392-2550
<PAGE>
TABLE OF CONTENTS
===============================================================================
The Fund and its Management....................................... 3
Trustees and Officers............................................. 6
Investment Practices and Policies................................. 9
Investment Restrictions........................................... 27
Portfolio Transactions and Brokerage.............................. 28
The Distributor................................................... 29
Shareholder Services.............................................. 33
Redemptions and Repurchases....................................... 37
Dividends, Distributions and Taxes................................ 39
Performance Information........................................... 41
Description of Shares of the Fund................................. 42
Custodian and Transfer Agent...................................... 42
Independent Accountants........................................... 43
Reports to Shareholders........................................... 43
Legal Counsel..................................................... 43
Experts........................................................... 43
Registration Statement............................................ 43
Financial Statements--October 31, 1993............................ 44
Report of Independent Accountants................................. 53
2
<PAGE>
THE FUND AND ITS MANAGEMENT
===============================================================================
THE FUND
The Fund is a trust of the type commonly known as a "Massachusetts
business trust" and was organized under the laws of the Commonwealth of
Massachusetts on December 20, 1991.
THE INVESTMENT MANAGER
Dean Witter InterCapital Inc. ("InterCapital" or the "Investment
Manager"), a Delaware corporation, whose address is Two World Trade Center, New
York, New York 10048, is the Fund's Investment Manager. InterCapital is a
wholly-owned subsidiary of Dean Witter, Discover & Co. ("DWDC") a Delaware
corporation. In an internal reorganization which took place in January, 1993,
InterCapital assumed the investment advisory, administrative and management
activities previously performed by the InterCapital Division of Dean Witter
Reynolds Inc. ("DWR"), a broker-dealer affiliate of InterCapital. (As used in
this Statement of Additional Information, the terms "InterCapital" and
"Investment Manager" refer to DWR's InterCapital Division prior to the internal
reorganization and to Dean Witter InterCapital Inc. thereafter). The daily
management of the Fund is conducted by or under the direction of officers of
the Fund and of the Investment Manager, subject to review by the Fund's Board
of Trustees. In addition, Trustees of the Fund provide guidance on economic
factors and interest rate trends. Information as to these Trustees and officers
is contained under the caption "Trustees and Officers".
InterCapital is also the investment manager (or investment adviser and
administrator) of the following investment companies: Dean Witter Liquid Asset
Fund Inc., InterCapital Income Securities Inc., InterCapital Insured Municipal
Bond Trust, InterCapital Quality Municipal Investment Trust, InterCapital
Insured Municipal Trust, InterCapital Quality Municipal Income Trust,
InterCapital Insured Municipal Income Trust, InterCapital California Insured
Municipal Income Trust, InterCapital Quality Municipal Securities, InterCapital
California Quality Municipal Securities, InterCapital New York Quality
Municipal Securities, Dean Witter High Yield Securities Inc., Dean Witter Tax-
Free Daily Income Trust, Dean Witter Developing Growth Securities Trust, Dean
Witter Tax-Exempt Securities Trust, Dean Witter Natural Resource Development
Securities Inc., Dean Witter Dividend Growth Securities Inc., Dean Witter
American Value Fund, Dean Witter U.S. Government Money Market Trust, Dean
Witter Variable Investment Series, Dean Witter World Wide Investment Trust,
Dean Witter Select Municipal Reinvestment Fund, Dean Witter U.S. Government
Securities Trust, Dean Witter California Tax-Free Income Fund, Dean Witter
Equity Income Trust, Dean Witter New York Tax-Free Income Fund, Dean Witter-
Convertible Securities Trust, Dean Witter Federal Securities Trust, Dean Witter
Value-Added Market Series, High Income Advantage Trust, High Income Advantage
Trust II, High Income Advantage Trust III, Dean Witter Government Income Trust,
Dean Witter Utilities Fund, Dean Witter California Tax-Free Daily Income Trust,
Dean Witter Strategist Fund, Dean Witter Managed Assets Trust, Dean Witter
World Wide Income Trust, Dean Witter Intermediate Income Securities, Dean
Witter New York Municipal Money Market Trust, Dean Witter Capital Growth
Securities, Dean Witter European Growth Fund Inc., Dean Witter Precious Metals
and Minerals Trust, Dean Witter Global Short-Term Income Fund Inc., Dean Witter
Pacific Growth Fund Inc., Dean Witter Multi-State Municipal Series Trust, Dean
Witter Premier Income Trust, Dean Witter Short-Term U.S. Treasury Trust, Dean
Witter Health Sciences Trust, Dean Witter Retirement Series, Dean Witter
Limited Term Municipal Trust, Dean Witter Short-Term Bond, Dean Witter Global
Dividend Growth Securities, Active Assets Money Trust, Active Assets Tax-Free
Trust, Active Assets California Tax-Free Trust, Active Assets Government
Securities Trust, Municipal Income Trust, Municipal Income Trust II, Municipal
Income Trust III, Municipal Income Opportunities Trust, Municipal Income
Opportunities Trust II, Municipal Income Opportunities Trust III, Prime Income
Trust and Municipal Premium Income Trust. The foregoing investment companies,
together with the Fund, are collectively referred to as the Dean Witter Funds.
In addition, InterCapital serves as manager for the following companies for
which TCW Funds Management, Inc. is the investment adviser: TCW/DW Core Equity
Trust, TCW/DW North American Government Income Trust, TCW/DW Latin American
Growth Fund, TCW/DW Income and Growth Fund, TCW/DW Small Cap Growth Fund,
TCW/DW Balanced Fund, TCW/DW Term Trust 2000, TCW/DW Term Trust 2002 and TCW/DW
Term Trust 2003 (the "TCW/DW Funds"). InterCapital also serves as (i) sub-
adviser to Templeton Global Opportunities Trust, an
3
<PAGE>
open-end investment company; (ii) administrator of The Black Rock Strategic
Term Trust Inc., a closed-end investment company; and (iii) sub-administrator
of Mass Mutual Participation Investors and Templeton Global Governments Income
Trust, closed-end investment companies.
The Investment Manager also serves as an investment adviser for Dean
Witter World Wide Investment Fund, an investment company organized under the
laws of Luxembourg, shares of which are not available for purchase in the
United States or by American citizens outside the United States.
Pursuant to an Investment Management Agreement (the "Agreement") with
the Investment Manager, the Fund has retained the Investment Manager to manage
the investment of the Fund's assets, including the placing of orders for the
purchase and sale of portfolio securities. The Investment Manager obtains and
evaluates such information and advice relating to the economy, securities
markets and specific securities as it considers necessary or useful to
continuously manage the assets of the Fund in a manner consistent with its
investment objective.
Under the terms of the Agreement, in addition to managing the Fund's
investments, the Investment Manager maintains certain of the Fund's books and
records and furnishes, at its own expense, such office space, facilities,
equipment, clerical help, bookkeeping and certain legal services as the Fund
may reasonably require in the conduct of its business, including the
preparation of prospectuses, proxy statements and reports required to be filed
with Federal and state securities commissions (except insofar as the
participation or assistance of independent accountants and attorneys is, in the
opinion of the Investment Manager, necessary or desirable). In addition, the
Investment Manager pays the salaries of all personnel, including officers of
the Fund, who are employees of the Investment Manager. The Investment Manager
also bears the cost of telephone service, heat, light, power and other
utilities provided to the Fund.
Expenses not expressly assumed by the Investment Manager under the
Agreement (see "The Fund and its Management" in the Prospectus), or by the
Distributor of the Fund's shares (see "The Distributor") will be paid by the
Fund. The expenses borne by the Fund include, but are not limited to: expenses
of the Plan of Distribution pursuant to Rule 12b-1(see "The Distributor"),
charges and expenses of any registrar, custodian, stock transfer and dividend
disbursing agent; brokerage commissions; taxes; engraving and printing share
certificates; registration costs of the Fund and its shares under Federal and
state securities laws; the cost and expense of printing, including typesetting,
and distributing prospectuses and statements of additional information of the
Fund and supplements thereto to the Fund's shareholders; all expenses of
shareholders' and Trustees' meetings and of preparing, printing and mailing
proxy statements and reports to shareholders; fees and travel expenses of
Trustees or members of any advisory board or committee who are not employees of
the Investment Manager or any corporate affiliate of the Investment Manager;
all expenses incident to any dividend, withdrawal or redemption options;
charges and expenses of any outside service used for pricing of the Fund's
shares; fees and expenses of legal counsel, including counsel to the Trustees
who are not interested persons of the Fund or of the Investment Manager (not
including compensation or expenses of attorneys who are employees of the
Investment Manager) and independent accountants; membership dues of industry
associations; interest on Fund borrowings; postage; insurance premiums on
property or personnel (including officers and Trustees) of the Fund which inure
to its benefit; extraordinary expenses (including, but not limited to, legal
claims and liabilities and litigation costs and any indemnification relating
thereto); and all other costs of the Fund's operation.
As full compensation for the services and facilities furnished to the
Fund and expenses of the Fund assumed by the Investment Manager, the Fund pays
the Investment Manager monthly compensation calculated daily by applying the
annual rate of 0.40% to the net assets of the Fund, determined as of the close
of each business day. Total operating expenses of the Fund are subject to
applicable limitations under rules and regulations of states where the Fund is
authorized to sell its shares. Therefore, operating expenses are effectively
subject to the most restrictive applicable limitations as the same may be
amended from time to time. Presently, the most restrictive limitation to which
the Fund is subject is as follows: if, in any fiscal year, the Fund's total
operating expenses, exclusive of taxes, interest, brokerage fees, distribution
fees and extraordinary expenses (to the extent permitted by applicable state
securities laws and regulations), exceed 2 1/2% of the first $30,000,000 of
average daily net assets, 2% of the next
4
<PAGE>
$70,000,000 and 1 1/2% of any excess over $100,000,000, the Investment Manager
will reimburse the Fund for the amount of such excess. Such amount, if any,
will be calculated daily and credited on a monthly basis. The Investment
Manager assumed all operating expenses (except the 12b-1 fee and brokerage
fees) and waived the compensation provided for in the Management Agreement
until January 1, 1993. Total compensation accrued to the Investment Manager
under the Agreement (after fee waiver and expense assumption) for the fiscal
year ended October 31, 1993 amounted to $375,426.
The Agreement provides that in the absence of willful misfeasance, bad
faith, gross negligence or reckless disregard of its obligations thereunder,
the Investment Manager is not liable to the Fund or any of its investors for
any act or omission by the Investment Manager or for any losses sustained by
the Fund or its investors. The Agreement in no way restricts the Investment
Manager from acting as investment manager or adviser to others.
The Investment Manager has paid the organizational expenses of the Fund
prior to the offering of the Fund's shares. The Fund has agreed to reimburse
the Investment Manager for such expenses in an amount up to a maximum of
$200,000. The Fund has deferred and is amortizing the organizational expenses
on the straight-line method over a period not to exceed five years from the
date of commencement of the Fund's operations.
The Agreement was initially approved by the Board of Trustees on
October 30, 1992 and by the shareholders of the Fund at a Special Meeting of
Shareholders held on January 12, 1993. The Agreement is substantially identical
to a prior investment management agreement which was initially approved by the
Board of Trustees on January 23, 1992, and by DWR, as the then sole shareholder
of the Fund on February 25, 1992. The Agreement took effect on June 30, 1993
upon the spin-off by Sears, Roebuck and Co. of its remaining shares of DWDC.
The Agreement may be terminated at any time, without penalty, on thirty days'
notice by the Board of Trustees of the Fund, by the holders of a majority, as
defined in the Investment Company Act of 1940, as amended (the "Act"), of the
outstanding shares of the Fund, or by the Investment Manager. The Agreement
will automatically terminate in the event of its assignment (as defined in the
Act). Under its terms, the Agreement will continue in effect until April 30,
1994 and from year to year thereafter, provided continuance of the Agreement is
approved at least annually by the vote of the holders of a majority, as defined
in the Act, of the outstanding shares of the Fund, or by the Board of Trustees
of the Fund; provided that in either event such continuance is approved
annually by the vote of a majority of the Trustees of the Fund who are not
parties to the Agreement or "interested persons" (as defined in the Act) of any
such party, which vote must be cast in person at a meeting called for the
purpose of voting on such approval.
The Fund has acknowledged that the name "Dean Witter" is a property
right of DWR. The Fund has agreed that DWR or its parent company may use or, at
any time, permit others to use, the name "Dean Witter". The Fund has also
agreed that in the event the Agreement is terminated, or if the affiliation
between InterCapital and its parent is terminated, the Fund will eliminate the
name "Dean Witter" from its name if DWR or its parent company shall so request.
5
<PAGE>
TRUSTEES AND OFFICERS
===============================================================================
The Trustees and Executive Officers of the Fund, their principal
business occupations during the last five years and their affiliations, if any,
with InterCapital and with the Dean Witter Funds and the TCW/DW Funds are shown
below.
NAME, POSITION WITH FUND PRINCIPAL OCCUPATION
AND ADDRESS DURING LAST FIVE YEARS
- ------------------------ ----------------------
Jack F. Bennett
Trustee
141 Taconic Road
Greenwich, Connecticut Retired; Director or Trustee of the Dean Witter
Funds; formerly Senior Vice President and
Director of Exxon Corporation (1975-January,
1989) and Under Secretary of the U.S. Treasury
for Monetary Affairs (1974-1975); director of
Philips Electronics N.V., Tandem Computers Inc.
and Massachusetts Mutual Life Insurance Co.;
Director or trustee of various not-for-profit and
business organizations.
Charles A. Fiumefreddo*
Chairman of the Board,
President, Chief Executive
Officer and Trustee
Two World Trade Center
New York, New York Chairman, Chief Executive Officer and Director of
InterCapital and Dean Witter Distributors Inc.;
Executive Vice President and Director of DWR;
Chairman, Director or Trustee, President and
Chief Executive Officer of the Dean Witter Funds;
Chairman, Chief Executive Officer and Trustee of
the TCW/DW Funds; Chairman and Director of Dean
Witter Trust Company; Director and/or officer of
various DWDC subsidiaries; formerly Executive
Vice President and Director of DWDC (until
February, 1993).
Edwin J. Garn
Trustee
2000 Eagle Gate Tower
Salt Lake City, Utah Director or Trustee of the Dean Witter Funds;
formerly United States Senator (R-Utah) (1974-
1992) and Chairman, Senate Banking Committee
(1980-1986); formerly Mayor of Salt Lake City,
Utah (1971-1974); formerly Astronaut, Space
Shuttle Discovery (April 12-19, 1985); Vice
Chairman, Huntsman Chemical Corporation (since
January, 1993); member of the board of various
civic and charitable organizations.
John R. Haire
Trustee
439 East 51st Street
New York, New York Chairman of the Audit Committee and Chairman of
the Committee of the Independent Directors or
Trustees and Director or Trustee of the Dean
Witter Funds; Trustee of the TCW/DW Funds;
formerly President, Council for Aid to Education
(1978-October, 1989), Chairman and Chief
Executive Officer of Anchor Corporation, an
Investment Adviser (1964-1978); Director of
Washington National Corporation (insurance) and
Bowne & Co., Inc. (printing).
Dr. John E. Jeuck
Trustee
70 East Cedar Street
Chicago, Illinois Retired; Director or Trustee of the Dean Witter
Funds; formerly Robert Law professor of Business
Administration, Graduate School of Business,
University of Chicago (until July, 1989);
Business consultant.
6
<PAGE>
NAME, POSITION WITH FUND PRINCIPAL OCCUPATION
AND ADDRESS DURING LAST FIVE YEARS
- ------------------------ ----------------------
Dr. Manuel H. Johnson
Trustee
7521 Old Dominion Drive
MacLean, Virginia Senior Partner, Johnson Smick International,
Inc., a consulting firm; Koch Professor of
International Economics and Director of the
Center for Global Market Studies at George Mason
University (since September, 1990); Director or
Trustee of the Dean Witter Funds; Trustee of the
TCW/DW Funds; Co-Chairman and a founder of the
Group of Seven Council (G7C), an international
economic commission (since September, 1990);
Director of Greenwich Capital Markets, Inc.
(broker-dealer); formerly Vice Chairman of the
Board of Governors of the Federal Reserve System
(February, 1986-August, 1990) and Assistant
Secretary of the U.S. Treasury (1982-1986).
Paul Kolton
Trustee
Nine Hunting Ridge Road
Stamford, Connecticut Director or Trustee of the Dean Witter Funds;
Chairman of the Audit Committee and Chairman of
the Committee of the Independent Trustees and
Trustee of the TCW/DW Funds; formerly Chairman of
the Financial Accounting Standards Advisory
Council and Chairman and Chief Executive Officer
of the American Stock Exchange; Director of UCC
Investors Holding Inc. (Uniroyal Chemical Company
Inc.); Director or trustee of various not-for-
profit organizations.
Michael E. Nugent
Trustee
237 Park Avenue
New York, New York General Partner, Triumph Capital, L.P., a private
investment partnership (since April, 1988);
Director or Trustee of the Dean Witter Funds;
Trustee of the TCW/DW Funds; formerly Vice
President, Bankers Trust Company and BT Capital
Corporation (September, 1984-March, 1988);
Director of various business organizations.
Albert T. Sommers
Trustee
845 Third Avenue
New York, New York Senior Fellow and Economic Counselor (formerly
Senior Vice President and Chief Economist) of the
Conference Board, a non-profit business research
organization; President, Albert T. Sommers, Inc.,
an economic consulting firm; Director or Trustee
of the Dean Witter Funds; formerly Chairman,
Price Advisory Committee of the Council on Wage
and Price Stability (December, 1979-December,
1980); Economic Adviser, The Ford Foundation;
Director of Grow Group, Inc. (chemicals), MSI,
Inc. (medical services) and Westbridge Capital
Inc. (insurance).
Edward R. Telling*
Trustee
Sears Tower
Chicago, Illinois Retired; Director or Trustee of the Dean Witter
Funds; formerly Chairman of the Board of
Directors and Chief Executive Officer (until
December, 1985) and President (from January,
1981-March, 1982 and from February, 1984-August,
1984) of Sears, Roebuck and Co.; formerly
Director of Sears Roeback and Co.
7
<PAGE>
NAME, POSITION WITH FUND PRINCIPAL OCCUPATION
AND ADDRESS DURING LAST FIVE YEARS
- ------------------------ ----------------------
Sheldon Curtis
Vice President, Secretary
and General Counsel
Two World Trade Center
New York, New York Senior Vice President and General Counsel of
InterCapital; Senior Vice President, Assistant
Secretary and Assistant General Counsel of Dean
Witter Distributors Inc.; Senior Vice President
and Secretary of Dean Witter Trust Company (since
October, 1989); Assistant Secretary of DWDC and
DWR; Vice President, Secretary and General
Counsel of the Dean Witter Funds and the TCW/DW
Funds.
Peter M. Avelar
Vice President
Two World Trade Center
New York, New York Senior Vice President of InterCapital (since
April, 1992); Vice President of Various Dean
Witter Funds; formerly Vice President of
InterCapital (December, 1990-April, 1992), First
Vice President of PaineWebber Asset Management
(March, 1989-December, 1990) and Vice President
of Delaware Investment Advisors (June, 1987-
March, 1989).
Rajesh K. Gupta
Vice President
Two World Trade Center
New York, New York Senior Vice President of InterCapital (since
April, 1991); previously Vice President of
InterCapital; Vice President of various Dean
Witter Funds.
Vinh Q. Tran
Vice President
Two World Trade Center
New York, New York Vice President of InterCapital (since February,
1989); formerly Director of International
Investments, Aetna Life and Casualty Co. (June,
1985-February, 1989).
Thomas F. Caloia
Treasurer
Two World Trade Center
New York, New York First Vice President (since May, 1991) and
Assistant Treasurer (since April, 1988) of
InterCapital and Treasurer (since April, 1988) of
the Dean Witter Funds and the TCW/DW Funds;
previously Vice President of InterCapital.
- ----------
* Denotes Trustees who are "interested persons" of the Fund, as defined in the
Act.
In addition, Robert M. Scanlan, President of InterCapital, and David A.
Hughey and Edmund C. Puckhaber, Executive Vice Presidents of InterCapital, are
Vice Presidents of the Fund, and Barry Fink, First Vice President of
InterCapital, and Marilyn K. Cranney, Lawrence S. Lafer, Lou Anne D. McInnis
and Ruth Rossi, Vice Presidents and Assistant General Counsels of InterCapital,
are Assistant Secretaries of the Fund.
The Fund pays each Trustee who is not an employee or retired employee
of the Investment Manager or an affiliated company an annual fee of $1,600
($1,200 after December 31, 1993) plus $50 for each meeting of the Board of
Trustees, of the Audit Committee or the Committee of the Independent Trustees
attended by the Trustee in person (the Fund pays the Chairman of the Audit
Committee an additional annual fee of $1,200 ($1,000 after December 31, 1993)
and pays the Chairman of the Committee of the Independent Trustees an annual
fee of $2,400, in each case inclusive of the Committee meeting fees). The Fund
also reimburses such Trustees for travel and other out-of-pocket expenses
incurred by them in connection with attending such meetings. Trustees and
officers of the Fund who are employed by the Investment Manager or an
affiliated company receive no compensation or expense reimbursement from the
Fund. The Fund has adopted a retirement program (effective January 1, 1994)
under which an Independent Trustee who retires after a minimum required period
of service would be entitled to retirement payments upon reaching the eligible
retirement age (normally, after attaining age 72) based upon length of service
and computed as a percentage of one-fifth of the total compensation
8
<PAGE>
earned by such Trustee for service to the Fund in the five-year period prior to
the date of the Trustee's retirement. No Independent Trustee has retired since
the adoption of the program and no payments by the Fund have been made under
the program to any Trustee. For the fiscal year ended October 31, 1993, the
Fund accrued a total of $22,229 for Trustees' fees and expenses. As of October
31, 1993, the aggregate shares of beneficial interest of the Fund owned by the
Fund's officers and Trustees as a group was less than 1 percent of the Fund's
shares of beneficial interest outstanding.
INVESTMENT PRACTICES AND POLICIES
==============================================================================
U.S. GOVERNMENT SECURITIES
As discussed in the Prospectus, the Fund may invest in, among other
securities, securities issued by the U.S. Government, its agencies or
instrumentalities. Such securities include:
(1) U.S. Treasury bills (maturities of one year or less), U.S.
Treasury notes (maturities of one to ten years) and U.S. Treasury bonds
(generally maturities of greater than ten years), all of which are direct
obligations of the U.S. Government and, as such, are backed by the "full faith
and credit" of the United States.
(2) Securities issued by agencies and instrumentalities of the U.S.
Government which are backed by the full faith and credit of the United States.
Among the agencies and instrumentalities issuing such obligations are the
Federal Housing Administration, the Government National Mortgage Association
("GNMA"), the Department of Housing and Urban Development, the Export-Import
Bank, the Farmers Home Administration, the General Services Administration, the
Maritime Administration and the Small Business Administration. The maturities
of such obligations range from three months to 30 years.
(3) Securities issued by agencies and instrumentalities which are not
backed by the full faith and credit of the United States, but whose issuing
agency or instrumentality has the right to borrow, to meet its obligations,
from an existing line of credit with the U.S. Treasury. Among the agencies and
instrumentalities issuing such obligations are the Tennessee Valley Authority,
the Federal National Mortgage Association ("FNMA"), the Federal Home Loan
Mortgage Corporation ("FHLMC") and the U.S. Postal Service. The U.S. Treasury
has no legal obligation to provide such line of credit and may choose not to do
so.
(4) Securities issued by agencies and instrumentalities which are not
backed by the full faith and credit of the United States, but which are backed
by the credit of the issuing agency or instrumentality. Among the agencies and
instrumentalities issuing such obligations are the Federal Farm Credit System
and the Federal Home Loan Banks.
Neither the value nor the yield of the U.S. Government securities which
may be invested in by the Fund are guaranteed by the U.S. Government. Such
values and yield will fluctuate with changes in prevailing interest rates,
economic factors and fiscal and monetary policies. Generally, as prevailing
interest rates rise, the value of any U.S. Government securities held by the
Fund will fall. Such securities with longer maturities generally tend to
produce higher yields and are subject to greater market fluctuation as a result
of changes in interest rates than debt securities with shorter maturities.
MORTGAGE-BACKED SECURITIES
Certain of the U.S. Government securities in which the Fund may invest,
e.g., certificates issued by GNMA, FNMA and FHLMC, are "mortgage-backed
securities," which 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 timely payment of the principal and interest
on mortgages underlying the certificates, whether or not such amounts are
collected by the issuer on the underlying mortgages. (A pass-through security
is formed when mortgages are pooled together and undivided interests in the
pool or pools are sold. The cash flow from the mortgages is passed through to
the holders of the securities in the form of periodic payments of interest,
principal and prepayments net of a service fee).
9
<PAGE>
The average life of such certificates varies with the maturities of the
underlying mortgage instruments, which may be up to thirty years but which may
include mortgage instruments with maturities of fifteen years, adjustable rate
mortgage instruments, variable rate mortgage instruments, graduated rate
mortgage instruments and/or other types of mortgage instruments. The assumed
average life of mortgages backing the majority of GNMA and FNMA certificates is
twelve years, and of FHLMC certificates is ten years. This average life is
likely to be substantially shorter than the original maturity of the mortgage
pools underlying the certificates, as a pool's duration may be shortened by
unscheduled or early payments of principal on the underlying mortgages. (Such
prepayments occur when the holder of an individual mortgage prepays the
remaining principal before the mortgage's scheduled maturity date.) In periods
of falling interest rates, the rate of prepayment tends to increase thereby
shortening the actual average life of a pool of mortgage-related securities.
Conversely, in periods of rising rates, the rate of prepayment tends to
decrease, thereby lengthening the actual average life of the pool. Prepayment
rates vary widely, and therefore it is not possible to accurately predict the
average life or realized yield of a particular pool.
The occurrence of mortgage prepayments is affected by factors including
the prevailing level of interest rates, general economic conditions, the
location and age of the mortgage and other social and demographic conditions.
Prepayment rates are important because of their effect on the yield and price
of the securities. If the Fund has purchased securities backed by pools
containing mortgages whose yields exceed the prevailing interest rate, any
premium (i.e., a price in excess of principal amount) paid for such securities
may be lost. As a result, the net asset value of shares of the Fund and the
Fund's ability to achieve its investment objectives may be adversely affected
by mortgage prepayments.
GNMA Certificates. Certificates of the Government National Mortgage
Association ("GNMA Certificates") are mortgage-backed securities, which
evidence an undivided interest in a pool or pools of mortgages insured by the
Federal Housing Administration ("FHA") or the Farmers Home Administration or
guaranteed by the Veterans Administration ("VA"). The GNMA Certificates that
the Fund will invest in are the "modified pass-through" type in that GNMA
guarantees the timely payment of monthly installments of principal and interest
due on the mortgage pool whether or not such amounts are collected by the
issuer on the underlying mortgages. The National Housing Act provides that the
full faith and credit of the United States is pledged to the timely payment of
principal and interest by GNMA of the amounts due on the GNMA Certificates.
Additionally, GNMA is empowered to borrow without limitation from the U.S.
Treasury if necessary to make any payments required under its guarantee.
The average life of GNMA Certificates varies with the maturities of the
underlying mortgage instruments some of which have maturities of 30 years. The
average life of the GNMA Certificate is likely to be substantially less than
the original maturity of the underlying mortgage pool because of prepayments or
refinancing of the mortgages or foreclosure. (Due to GNMA guarantee,
foreclosures impose no risk to principal investments.) Statistics indicate that
the average life of the type of mortgages backing the majority of GNMA
Certificates is approximately 12 years and for this reason it is standard
practice to treat GNMA Certificates as 30-year mortgage-backed securities which
prepay fully in the twelfth year.
Yields on pass-through securities are typically quoted by investment
dealers and vendors based on the actual maturities of the underlying
instruments and the associated average life assumption. Historically, actual
average life has been consistent with the 12-year assumption referred to above.
The actual yield of each GNMA Certificate is influenced by the prepayment
experience of the mortgage pool underlying the Certificates. Such prepayments
are passed through to the registered holder of the Certificate along with the
regular monthly payments of principal and interest, which has the effect of
reducing future payments, and consequently the yield. Reinvestment by the Fund
of prepayments may occur at higher or lower interest rates than the original
investment.
FHLMC Certificates. FHLMC is a corporate instrumentality of the United
States created pursuant to the Emergency Home Finance Act of 1970, as amended
(the "FHLMC Act"). FHLMC was established primarily for the purpose of
increasing the availability of mortgage credit for the financing of needed
housing. The principal activity of FHLMC currently consists of the purchase of
first lien, conventional, residential mortgage loans and participation
interests in such mortgage loans and the resale of the mortgage loans so
purchased in the form of mortgage securities, primarily FHLMC Certificates.
10
<PAGE>
FHLMC guarantees to each registered holder of a FHLMC Certificate the
timely payment of interest at the rate provided for by such FHLMC Certificate,
whether or not received. FHLMC also guarantees to each registered holder of a
FHLMC Certificate ultimate collection of all principal of the related mortgage
loans, without any offset or deduction, but does not, generally, guarantee the
timely payment of scheduled principal. FHLMC may remit the amount due on
account of its guarantee of collection of principal at any time after default
on an underlying mortgage loan, but not later than 30 days following (i)
foreclosure sale, (ii) payment of a claim by any mortgage insurer or (iii) the
expiration of any right of redemption, whichever occurs later, but in any event
no later than one year after demand has been made upon the mortgagor for
accelerated payment of principal. The obligations of FHLMC under its guarantee
are obligations solely of FHLMC and are not backed by the full faith and credit
of the U.S. Government. The FHLMC has the right, however, to borrow from an
existing line of credit with the U.S. Treasury in order to meet its
obligations.
FHLMC Certificates represent a pro rata interest in a group of mortgage
loans (a "FHLMC Certificate group") purchased by FHLMC. The mortgage loans
underlying the FHLMC Certificates will consist of fixed rate or adjustable rate
mortgage loans with original terms to maturity of between ten and thirty years,
substantially all of which are secured by first liens on one- to four-family
residential properties or multifamily projects. Each mortgage loan must meet
the applicable standards set forth in the FHLMC Act. A FHLMC Certificate group
may include whole loans, participation interests in whole loans and undivided
interests in whole loans and participations comprising another FHLMC
Certificate group.
FNMA Certificates. The Federal National Mortgage Association ("FNMA")
is a federally chartered and privately owned corporation organized and existing
under the Federal National Mortgage Association Charter Act. FNMA was
originally established in 1938 as a U.S. Government agency to provide
supplemental liquidity to the mortgage market and was transformed into a
stockholder owned and privately managed corporation by legislation enacted in
1968. FNMA provides funds to the mortgage market primarily by purchasing home
mortgage loans from local lenders, thereby replenishing their funds for
additional lending. FNMA acquires funds to purchase home mortgage loans from
many capital market investors that may not ordinarily invest in mortgage loans
directly, thereby expanding the total amount of funds available for housing.
Each FNMA Certificate will entitle the registered holder thereof to
receive amounts representing such holder's pro rata interest in scheduled
principal payments and interest payments (at such FNMA Certificate's pass-
through rate, which is net of any servicing and guarantee fees on the
underlying mortgage loans), and any principal prepayments on the mortgage loans
in the pool represented by such FNMA Certificate and such holder's
proportionate interest in the full principal amount of any foreclosed or
otherwise finally liquidated mortgage loan. The full and timely payment of
principal of and interest on each FNMA Certificate will be guaranteed by FNMA,
which guarantee is not backed by the full faith and credit of the U.S.
Government.
Each FNMA Certificate will represent a pro rata interest in one or more
pools of FHA Loans, VA Loans or conventional mortgage loans (i.e., mortgage
loans that are not insured or guaranteed by any governmental agency) of the
following types: (i) fixed rate level payment mortgage loans; (ii) fixed rate
growing equity mortgage loans; (iii) fixed rate graduated payment mortgage
loans; (iv) variable rate California mortgage loans; (v) other adjustable rate
mortgage loans; and (vi) fixed rate mortgage loans secured by multifamily
projects. FNMA Certificates have an assumed average life similar to GNMA
Certificates.
HIGH YIELD SECURITIES
As discussed in the Prospectus, the Fund will also invest in high
yield, high risk fixed-income securities rated Baa or lower by Moody's
Investors Service Inc. ("Moody's"), or BBB or lower by Standard & Poor's
Corporation ("Standard & Poor's). The ratings of fixed-income securities by
Moody's and Standard & Poor's are a generally accepted barometer of credit
risk. They are, however, subject to certain limitations from an investor's
standpoint.
Such limitations include the following: the rating of an issuer is
heavily weighted by past developments and does not necessarily reflect probable
future conditions; there is frequently a lag between the
11
<PAGE>
time a rating is assigned and the time it is updated; and there may be varying
degrees of difference in credit risk of securities in each rating category. The
Investment Manager will attempt to reduce the overall portfolio credit risk
through diversification and selection of portfolio securities based on
considerations mentioned below.
While the ratings provide a generally useful guide to credit risks,
they do not, nor do they purport to, offer any criteria for evaluating the
interest rate risk. Changes in the general level of interest rates cause
fluctuations in the prices of fixed-income securities already outstanding and
will therefore result in fluctuation in net asset value of the Fund's shares.
The extent of the fluctuation is determined by a complex interaction of a
number of factors. The Investment Manager will evaluate those factors it
considers relevant and will make portfolio changes when it deems it appropriate
in seeking to reduce the risk of depreciation in the value of the Fund's
portfolio. However, in seeking to achieve the Fund's primary objective, there
will be times, such as during periods of rising interest rates, when
depreciation and realization of capital losses on securities in the portfolio
will be unavoidable. Moreover, medium and lower-rated securities and non-rated
securities of comparable quality tend to be subject to wider fluctuations in
yield and market values than higher rated securities. Such fluctuations after a
security is acquired do not affect the cash income received from that security
but are reflected in the net asset value of the Fund's portfolio.
FOREIGN SECURITIES
Foreign investments involve certain risks, including the political or
economic instability of the issuer or of the country of issue, the difficulty
of predicting international trade patterns and the possibility of imposition of
exchange controls. Such securities may also be subject to greater fluctuations
in price than securities of United States corporations or of the United States
Government. In addition, there may be less publicly available information about
a foreign company than about a domestic company. Foreign companies generally
are not subject to uniform accounting, auditing and financial reporting
standards comparable to those applicable to domestic companies. There is
generally less government regulation of stock exchanges, brokers and listed
companies abroad than in the United States, and with respect to certain foreign
countries, there is a possibility of expropriation or confiscatory taxation, or
diplomatic developments which could affect investment in those countries.
Finally, in the event of a default of any such foreign debt obligations, it may
be more difficult for the Fund to obtain or to enforce a judgment against the
issuers of such securities. In addition to the above-mentioned risks,
securities denominated in foreign currency, whether issued by a foreign or a
domestic issuer, may be affected favorably or unfavorably by changes in
currency rates and in exchange control regulations, and costs may be incurred
in connection with conversions between various currencies. It may not be
possible to hedge against the risks of currency fluctuation.
OTHER INVESTMENT POLICIES
Repurchase Agreements. When cash may be available for only a few days,
it may be invested by the Fund in repurchase agreements until such time as it
may otherwise be invested or used for payments of obligations of the Fund. A
repurchase agreement may be viewed as a type of secured lending by the Fund
which typically involves the acquisition by the Fund of government securities
from a selling financial institution such as a bank, savings and loan
association or broker-dealer. The agreement provides that the Fund will sell
back to the institution, and that the institution will repurchase, the
underlying security ("collateral") at a specified price and at a fixed time in
the future, usually not more than seven days from the date of purchase. The
collateral will be maintained in a segregated account and will be marked-to-
market daily to determine whether the full value of the collateral, as
specified in the agreement, is always at least equal to the purchase price plus
accrued interest. If required, additional collateral will be requested from the
counterparty and when received added to the account to maintain full
collateralization. In the event the original seller defaults on its obligations
to repurchase, as a result of its bankruptcy or otherwise, the Fund will seek
to sell the collateral, which action could involve costs or delays. In such
case, the Fund's ability to dispose of the collateral to recover its investment
may be restricted or delayed. The Fund will accrue interest from the
institution until the time when the repurchase is to occur. Although
12
<PAGE>
such date is deemed by the Fund to be the maturity date of a repurchase
agreement, the maturities of securities subject to repurchase agreements are
not subject to any limits and may exceed one year.
While repurchase agreements involve certain risks not associated with
direct investments in debt securities, the Fund follows procedures designed to
minimize such risks. Repurchase agreements will be transacted only with large,
well-capitalized and well-established financial institutions whose financial
condition will be continuously monitored by the management of the Fund subject
to procedures established by the Trustees. The procedures also require that the
collateral underlying the agreement be specified. The Fund does not presently
intend to enter into repurchase agreements so that more than 5% of the Fund's
total assets are subject to such agreements. For the fiscal period ended
October 31, 1993, the Fund did not enter into repurchase agreements in an
amount exceeding 5% of its total assets.
Reverse Repurchase Agreements. The Fund may also use reverse repurchase
agreements for purposes of meeting redemptions or as part of its investment
strategy. Reverse repurchase agreements involve sales by the Fund of portfolio
assets concurrently with an agreement by the Fund to repurchase the same assets
at a later date at a fixed price. Generally, the effect of such a transaction
is that the Fund can recover all or most of the cash invested in the portfolio
securities involved during the term of the reverse repurchase agreement, while
it will be able to keep the interest income associated with those portfolio
securities. Such transactions are only advantageous if the interest cost to the
Fund of the reverse repurchase transaction is less than the cost of obtaining
the cash otherwise. Opportunities to achieve this advantage may not always be
available, and the Fund intends to use the reverse repurchase technique only
when it will be to its advantage to do so. The Fund will establish a segregated
account with its custodian bank in which it will maintain cash or cash
equivalents or other portfolio securities (i.e., U.S. Government securities)
equal in value to its obligations in respect of reverse repurchase agreements.
Reverse repurchase agreements are considered borrowings by the Fund and, in
accordance with legal requirements, the Fund will maintain an asset coverage
(including the proceeds) of at least 300% with respect to all reverse
repurchase agreements. Reverse repurchase agreements may not exceed 10% of the
Fund's total assets. For the fiscal period ended October 31, 1993, the Fund did
not enter into any reverse repurchase agreements.
When-Issued and Delayed Delivery Securities and Forward Commitments. As
discussed in the Prospectus, from time to time, in the ordinary course of
business, the Fund may purchase securities on a when-issued or delayed delivery
basis and may purchase or sell securities on a forward commitment basis. When
such transactions are negotiated, the price is fixed at the time of the
commitment, but delivery and payment can take place a month or more after the
date of the commitment. The securities so purchased are subject to market
fluctuation and no interest accrues to the purchaser during this period. While
the Fund will only purchase securities on a when-issued, delayed delivery or
forward commitment basis with the intention of acquiring the securities, the
Fund may sell the securities before the settlement date, if it is deemed
advisable. At the time the Fund makes the commitment to purchase securities on
a when-issued or delayed delivery basis, the Fund will record the transaction
and thereafter reflect the value, each day, of such security in determining the
net asset value of the Fund. At the time of delivery of the securities, the
value may be more or less than the purchase price. The Fund will also establish
a segregated account with the Fund's custodian bank in which it will
continuously maintain cash or U.S. Government securities or other high grade
debt portfolio securities equal in value to commitments of such when-issued or
delayed delivery securities; subject to the requirement, the Fund may purchase
securities on such basis without limit. An increase in the percentage of the
Fund's assets committed to the purchase of securities on a when-issued or
delayed delivery basis may increase the volatility of the Fund's net asset
value. The Fund's management and the Trustees do not believe that the Fund's
net asset value or income will be adversely affected by its purchase of
securities on such basis. For the fiscal year ended October 31, 1993, the
Fund's investments in securities on a when-issued, delayed delivery or forward
commitment basis did not exceed 5% of the Fund's total assets.
When, As and If Issued Securities. As discussed in the Prospectus, the
Fund may purchase securities on a "when, as and if issued" basis under which
the issuance of the security depends upon the occurrence of a subsequent event,
such as approval of a merger, corporate reorganization, leveraged buyout or
debt restructuring. The commitment for the purchase of any such security will
not be recognized in the portfolio of the Fund until the Investment Manager
determines that issuance of the security
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is probable. At such time, the Fund will record the transaction and, in
determining its net asset value, will reflect the value of the security daily.
At such time, the Fund will also establish a segregated account with its
custodian bank in which it will continuously maintain cash or U.S. Government
securities or other high grade debt portfolio securities equal in value to
recognized commitments for such securities. Settlement of the trade will occur
within five business days of the occurrence of the subsequent event. The value
of the Fund's commitments to purchase the securities of any one issuer,
together with the value of all securities of such issuer owned by the Fund, may
not exceed 5% of the value of the Fund's total assets at the time the initial
commitment to purchase such securities is made (see "Investment Restrictions").
Subject to the foregoing restrictions, the Fund may purchase securities on such
basis without limit. An increase in the percentage of the Fund's assets
committed to the purchase of securities on a "when, as and if issued" basis may
increase the volatility of its net asset value. The Fund's management and the
Trustees do not believe that the net asset value of the Fund will be adversely
affected by its purchase of securities on such basis. The Fund may also sell
securities on a "when, as and if issued" basis provided that the issuance of
the security will result automatically from the exchange or conversion of a
security owned by the Fund at the time of the sale. For the fiscal period ended
October 31, 1993 the Fund did not purchase any securities on a when, as and if
issued basis in an amount exceeding 5% of its total assets.
Lending of Portfolio Securities. Consistent with applicable regulatory
requirements, the Fund may lend its portfolio securities to brokers, dealers
and other financial institutions, provided that such loans are callable at any
time by the Fund (subject to notice provisions described below), and are at all
times secured by cash or appropriate high-grade debt obligations, which are
maintained in a segregated account pursuant to applicable regulations and that
are at least equal to the market value, determined daily, of the loaned
securities. The advantage of such loans is that the Fund continues to receive
the income on the loaned securities while at the same time earning interest or
a portion of the interest on the cash amounts deposited as collateral, which
will be invested in short-term obligations. The Fund will not lend its
portfolio securities if such loans are not permitted by the laws or regulations
of any state in which its shares are qualified for sale and will not lend more
than 25% of the value of its total assets. A loan may be terminated by the
borrower on one business day's notice, or by the Fund on two business days'
notice. If the borrower fails to deliver the loaned securities within two days
after receipt of notice, the Fund could use the collateral to replace the
securities while holding the borrower liable for any excess of replacement cost
over collateral. As with any extensions of credit, there are risks of delay in
recovery and in some cases even loss of rights in the collateral should the
borrower of the securities fail financially. However, these loans of portfolio
securities will be made only to firms deemed by the Fund's management to be
creditworthy and when the income which can be earned from such loans justifies
the attendant risks. Upon termination of the loan, the borrower is required to
return the securities to the Fund. Any gain or loss in the market price during
the loan period would inure to the Fund. The creditworthiness of firms to which
the Fund lends it portfolio securities will be monitored on an ongoing basis by
the Fund's management pursuant to procedures adopted and reviewed, on an
ongoing basis, by the Board of Trustees of the Fund.
When voting or consent rights which accompany loaned securities pass to
the borrower, the Fund will follow the policy of calling the loaned securities,
to be delivered within one day after notice, to permit the exercise of such
rights if the matters involved would have a material effect on the Fund's
investment in such loaned securities. The Fund will pay reasonable finder's,
administrative and custodial fees in connection with a loan of its securities.
The Fund has not to date nor does it presently intend to lend any of its
portfolio securities in the foreseeable future.
Common Stocks. As stated in the Prospectus, consistent with the Fund's
investment objectives, the Fund will invest in common stocks only in certain
circumstances. First, the Fund may purchase common stock which is included in a
unit with fixed-income securities purchased by the Fund. Second, the Fund may
acquire common stock when fixed-income securities owned by the Fund are
converted by the issuer into common stock. Third, the Fund may exercise
warrants attached to fixed-income securities purchased by the Fund. Finally,
the Fund may purchase the common stock of companies involved in takeovers or
recapitalizations where the issuer or a controlling stockholder has offered, or
pursuant to a "going private" transaction is effecting, a transaction involving
the issuance of newly issued fixed-income
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<PAGE>
securities to holders of such common stock. Purchasing the common stock
directly in the last circumstance enables the Fund to acquire the fixed-income
securities directly from the issuer at face value, thereby eliminating the
payment of a third-party dealer mark-up. The maximum percentage of the Fund's
total assets which may be invested in common stocks at any one time is 20%.
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
As discussed in the Prospectus, the Fund may enter into forward foreign
currency exchange contracts ("forward contracts") as a hedge against
fluctuations in future foreign exchange rates. The Fund will conduct its
foreign currency exchange transaction either on a spot (i.e., cash) basis at
the spot rate prevailing in the foreign currency exchange market, or through
entering into forward contracts to purchase or sell foreign currencies. A
forward contract involves an obligation to purchase or sell a specific currency
at a future date, which may be any fixed number of days from the date of the
contract agreed upon by the parties, at a price set at the time of the
contract. These contracts are traded in the interbank market conducted directly
between currency traders (usually large, commercial and investment banks) and
their customers. Such forward contracts will be entered into only with United
States banks and their foreign branches or foreign banks whose assets total $1
billion or more. A forward contract generally has no deposit requirement, and
no commissions are charged at any stage for trades.
When the Fund's Investment Manager believes that the currency of a
particular foreign country may experience a substantial movement against the
U.S. dollar, it may enter into a forward contract to purchase or sell, for a
fixed amount of dollars or other currency, the amount of foreign currency
approximating the value of some or all of the Fund's portfolio securities
denominated in such foreign currency. The Fund will also not enter into such
forward contracts or maintain a net exposure to such contracts where the
consummation of the contracts would obligate the Fund to deliver an amount of
foreign currency in excess of the value of the Fund's portfolio securities or
other assets denominated in that currency. Under normal circumstances,
consideration of the prospect for currency parities will be incorporated into
the longer term investment decisions made with regard to overall
diversification strategies. However, the management of the Fund believes that
it is important to have the flexibility to enter into such forward contracts
when it determines that the best interests of the Fund will be served. The
Fund's custodian bank will place cash, U.S. Government securities or other
appropriate liquid high grade debt securities in a segregated account of the
Fund in an amount equal to the value of the Fund's total assets committed to
the consummation of forward contracts entered into under the circumstances set
forth above. If the value of the securities placed in the segregated account
declines, additional cash or securities will be placed in the account on a
daily basis so that the value of the account will equal the amount of the
Fund's commitments with respect to such contracts.
Where, for example, the Fund is hedging a portfolio position consisting
of foreign fixed-income securities denominated in a foreign currency against
adverse exchange rate moves vis-a-vis the U.S. dollar, at the maturity of the
forward contract for delivery by the Fund of a foreign currency, the Fund may
either sell the portfolio security and make delivery of the foreign currency,
or it may retain the security and terminate its contractual obligation to
deliver the foreign currency by purchasing an "offsetting" contract with the
same currency trader obligating it to purchase, on the same maturity date, the
same amount of the foreign currency. It is impossible to forecast the market
value of portfolio securities at the expiration of the contract. Accordingly,
it may be necessary for the Fund to purchase additional foreign currency on the
spot market (and bear the expense of such purchase) if the market value of the
security is less than the amount of foreign currency the Fund is obligated to
deliver and if a decision is made to sell the security and make delivery of the
foreign currency. Conversely, it may be necessary to sell on the spot market
some of the foreign currency received upon the sale of the portfolio securities
if its market value exceeds the amount of foreign currency the Fund is
obligated to deliver.
If the Fund retains the portfolio securities and engages in an
offsetting transaction, the Fund will incur a gain or loss to the extent that
there has been movement in spot or forward contract prices. If the Fund engages
in an offsetting transaction, it may subsequently enter into a new forward
contract to sell the foreign currency. Should forward prices decline during the
period between the Fund's entering into a forward contract for the sale of a
foreign currency and the date it enters into an offsetting contract for the
purchase of the foreign currency, the Fund will realize a gain to the extent
the price of the currency it has
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<PAGE>
agreed to sell exceeds the price of the currency it has agreed to purchase.
Should forward prices increase, the Fund will suffer a loss to the extent the
price of the currency it has agreed to purchase exceeds the price of the
currency it has agreed to sell.
If the Fund purchases a fixed-income security which is denominated in
U.S. dollars but which will pay out its principal based upon a formula tied to
the exchange rate between the U.S. dollar and a foreign currency, it may hedge
against a decline in the principal value of the security by entering into a
forward contract to sell or purchase an amount of the relevant foreign currency
equal to some or all of the principal value of the security.
At times when the Fund has written a call or put option on a fixed-
income security or the currency in which it is denominated, it may wish to
enter into a forward contract to purchase or sell the foreign currency in which
the security is denominated. A forward contract would, for example, hedge the
risk of the security on which a call currency option has been written declining
in value to a greater extent than the value of the premium received for the
option. The Fund will maintain with its Custodian at all times, cash, U.S.
Government securities or other appropriate high grade debt obligations in a
segregated account equal in value to all forward contract obligations and
option contract obligations entered into in hedge situations such as this.
Although the Fund values its assets daily in terms of U.S. dollars, it
does not intend to convert its holdings of foreign currencies into U.S. dollars
on a daily basis. It will, however, do so from time to time, and investors
should be aware of the costs of currency conversion. Although foreign exchange
dealers do not charge a fee for conversion, they do realize a profit based on
the spread between the prices at which they are buying and selling various
currencies. Thus, a dealer may offer to sell a foreign currency to the Fund at
one rate, while offering a lesser rate of exchange should the Fund desire to
resell that currency to the dealer.
OPTIONS AND FUTURES TRANSACTIONS
The Fund may write covered call options against securities held in its
portfolio and covered put options on eligible portfolio securities and purchase
options of the same series to effect closing transactions, and may hedge
against potential changes in the market value of its investments (or
anticipated investments) by purchasing put and call options on portfolio (or
eligible portfolio) securities (and the currencies in which they are
denominated) and engaging in transactions involving futures contracts and
options on such contracts.
Call and put options on U.S. Treasury notes, bonds and bills and on
various foreign currencies are listed on several U.S. and foreign securities
exchanges and are written in over-the-counter transactions ("OTC Options").
Listed options are issued or guaranteed by the exchange on which they trade or
by a clearing corporation such as the Options Clearing Corporation ("OCC").
Ownership of a listed call option gives the Fund the right to buy from the OCC
(in the U.S.) or other clearing corporation or exchange, the underlying
security or currency covered by the option at the stated exercise price (the
price per unit of the underlying security or currency) by filing an exercise
notice prior to the expiration date of the option. The
writer (seller) of the option would then have the obligation to sell, to the
OCC (in the U.S.) or other clearing corporation or exchange, the underlying
security or currency at that exercise price prior to the expiration date of the
option, regardless of its then current market price. Ownership of a listed put
option would give the Fund the right to sell the underlying security or
currency to the OCC (in the U.S.) or other clearing corporation or exchange at
the stated exercise price. Upon notice of exercise of the put option, the
writer of the option would have the obligation to purchase the underlying
security or currency from the OCC (in the U.S.) or other clearing corporation
or exchange at the exercise price.
Options on Treasury Bonds and Notes. Because trading interest in
options written on Treasury bonds and notes tends to center on the most
recently auctioned issues, the exchanges on which such securities trade will
not continue indefinitely to introduce options with new expirations to replace
expiring options on particular issues. Instead, the expirations introduced at
the commencement of options trading on a particular issue will be allowed to
run their course, with the possible addition of a limited number of new
expirations as the original ones expire. Options trading on each issue of bonds
or notes will thus be phased out as new options are listed on more recent
issues, and options representing a full range of expirations will not
ordinarily be available for every issue on which options are traded.
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<PAGE>
Options on Treasury Bills. Because a deliverable Treasury bill changes
from week to week, writers of Treasury bill calls cannot provide in advance for
their potential exercise settlement obligations by acquiring and holding the
underlying security. However, if the Fund holds a long position in Treasury
bills with a principal amount of the securities deliverable upon exercise of
the option, the position may be hedged from a risk standpoint by the writing of
a call option. For as long as the call option is outstanding, the Fund will
hold the Treasury bills in a segregated account with its Custodian, so that
they will be treated as being covered.
Options on GNMA Certificates. Currently, options on GNMA Certificates
are only traded over-the-counter. Since the remaining principal balance of GNMA
Certificates declines each month as a result of mortgage payments, the Fund, as
a writer of a GNMA call holding GNMA Certificates as "cover" to satisfy its
delivery obligation in the event of exercise, may find that the GNMA
Certificates it holds no longer have a sufficient remaining principal balance
for this purpose. Should this occur, the Fund will purchase additional GNMA
Certificates from the same pool (if obtainable) or replacement GNMA
Certificates in the cash market in order to maintain its cover. A GNMA
Certificate held by the Fund to cover an option position in any but the nearest
expiration month may cease to represent cover for the option in the event of a
decline in the GNMA coupon rate at which new pools are originated under the
FHA/VA loan ceiling in effect at any given time, as such decline may increase
the prepayments made on other mortgage pools. If this should occur, the Fund
will no longer be covered, and the Fund will either enter into a closing
purchase transaction or replace such Certificate with a Certificate which
represents cover. When the Fund closes out its position or replaces such
Certificate, it may realize an unanticipated loss and incur transaction costs.
Options on Foreign Currencies. The Fund may purchase and write options
on foreign currencies for purposes similar to those involved with investing in
forward foreign currency exchange contracts. For example, in order to protect
against declines in the dollar value of portfolio securities which are
denominated in a foreign currency, the Fund may purchase put options on an
amount of such foreign currency equivalent to the current value of the
portfolio securities involved. As a result, the Fund would be enabled to sell
the foreign currency for a fixed amount of U.S. dollars, thereby "locking in"
the dollar value of the portfolio securities (less the amount of the premiums
paid for the options). Conversely, the Fund may purchase call options on
foreign currencies in which securities it anticipates purchasing are
denominated to secure a set U.S. dollar price for such securities and protect
against a decline in the value of the U.S. dollar against such foreign
currency. The Fund may also purchase call and put options to close out written
options positions.
The Fund may also write call options on foreign currency to protect
against potential declines in its portfolio securities which are denominated in
foreign currencies. If the U.S. dollar value of the portfolio securities falls
as a result of a decline in the exchange rate between the foreign currency in
which it is denominated and the U.S. dollar, then a loss to the Fund occasioned
by such value decline would be ameliorated by receipt of the premium on the
option sold. At the same time, however, the Fund gives up the benefit of any
rise in value of the relevant portfolio securities above the exercise price of
the option and, in fact, only receives a benefit from the writing of the option
to the extent that the value of the portfolio securities falls below the price
of the premium received. The Fund may also write options to close out long call
option positions. A put option on a foreign currency would be written by the
Fund for the same reason it would purchase a call option, namely, to hedge
against an increase in the U.S. dollar value of a foreign security which the
Fund anticipates purchasing. Here, the receipt of the premium would offset, to
the extent of the size of the premium, any increased cost to the Fund resulting
from an increase in the U.S. dollar value of the foreign security. However, the
Fund could not benefit from any decline in the cost of the foreign security
which is greater than the price of the premium received. The Fund may also
write options to close out long put and call option positions.
The markets in foreign currency options are relatively new and the
Fund's ability to establish and close out positions on such options is subject
to the maintenance of a liquid secondary market. Although the Fund will not
purchase or write such options unless and until, in the opinion of the
Investment Manager, the market for them has developed sufficiently to ensure
that the risks in connection with such
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<PAGE>
options are not greater than the risks in connection with the underlying
currency, there can be no assurance that a liquid secondary market will exist
for a particular option at any specific time. In addition, options on foreign
currencies are affected by all of those factors which influence foreign
exchange rates and investments generally.
The value of a foreign currency option depends upon the value of the
underlying currency relative to the U.S. dollar. As a result, the price of the
option position may vary with changes in the value of either or both currencies
and have no relationship to the investment merits of a foreign security,
including foreign securities held in a "hedged" investment portfolio. Because
foreign currency transactions occurring in the interbank market involve
substantially larger amounts than those that may be involved in the use of
foreign currency options, investors may be disadvantaged by having to deal in
an odd lot market (generally consisting of transactions of less than $1
million) for the underlying foreign currencies at prices that are less
favorable than for round lots.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis. Quotation
information available is generally representative of very large transactions in
the interbank market and thus may not reflect relatively smaller transactions
(i.e., less than $1 million) where rates may be less favorable. The interbank
market in foreign currencies is a global, around-the-clock market. To the
extent that the U.S. options markets are closed while the markets for the
underlying currencies remain open, significant price and rate movements may
take place in the underlying markets that are not reflected in the options
market.
OTC Options. Exchange-listed options are issued by the OCC (in the
U.S.) or other clearing corporation or exchange which assures that all
transactions in such options are properly executed. OTC options are purchased
from or sold (written) to dealers or financial institutions which have entered
into direct agreements with the Fund. With OTC options, such variables as
expiration date, exercise price and premium will be agreed upon between the
Fund and the transacting dealer, without the intermediation of a third party
such as the OCC. If the transacting dealer fails to make or take delivery of
the securities or amount of foreign currency underlying an option it has
written, in accordance with the terms of that option, the Fund would lose the
premium paid for the option as well as any anticipated benefit of the
transaction. The Fund will engage in OTC option transactions only with member
banks of the Federal Reserve System or primary dealers in U.S. Government
securities or with affiliates of such banks or dealers which have capital of at
least $50 million or whose obligations are guaranteed by an entity having
capital of at least $50 million.
Covered Call Writing. The Fund is permitted to write covered call
options on portfolio securities and the currencies in which they are
denominated, without limit, in order to aid in achieving its investment
objectives. Generally, a call option is "covered" if the Fund owns, or has the
right to acquire, without additional cash consideration (or for additional cash
consideration held for the Fund by its Custodian in a segregated account) the
underlying security (currency) subject to the option except that in the case of
call options on U.S. Treasury bills, the Fund might own U.S. Treasury bills of
a different series from those underlying the call option, but with a principal
amount and value corresponding to the exercise price and a maturity date no
later than that of the security (currency) deliverable under the call option. A
call option is also covered if the Fund holds a call on the same security as
the underlying security (currency) of the written option, where the exercise
price of the call used for coverage is equal to or less than the exercise price
of the call written or greater than the exercise price of the call written if
the mark to market difference is maintained by the Fund in cash, U.S.
Government securities or other high grade debt obligations which the Fund holds
in a segregated account maintained with its Custodian.
The Fund will receive from the purchaser, in return for a call it has
written, a "premium"; i.e., the price of the option. Receipt of these premiums
may better enable the Fund to earn a higher level of current income than it
would earn from holding the underlying securities (currencies) alone. Moreover,
the premium received will offset a portion of the potential loss incurred by
the Fund if the securities (currencies) underlying the option are ultimately
sold (exchanged) by the Fund at a loss. Furthermore, a premium received on a
call written on a foreign currency will ameliorate any potential loss of value
on the portfolio security due to a decline in the value of the currency.
However, during the option period, the
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<PAGE>
covered call writer has, in return for the premium on the option, given up the
opportunity for capital appreciation above the exercise price should the market
price of the underlying security (or the exchange rate of the currency in which
it is denominated) increase, but has retained the risk of loss should the price
of the underlying security (or the exchange rate of the currency in which it is
denominated) decline. The premium received will fluctuate with varying economic
market conditions. If the market value of the portfolio securities (or the
currencies in which they are denominated) upon which call options have been
written increases, the Fund may receive a lower total return from the portion
of its portfolio upon which calls have been written than it would have had such
calls not been written.
As regards listed options and certain OTC options, during the option
period, the Fund may be required, at any time, to deliver the underlying
security (currency) against payment of the exercise price on any calls it has
written (exercise of certain listed and OTC options may be limited to specific
expiration dates). This obligation is terminated upon the expiration of the
option period or at such earlier time when the writer effects a closing
purchase transaction. A closing purchase transaction is accomplished by
purchasing an option of the same series as the option previously written.
However, once the Fund has been assigned an exercise notice, the Fund will be
unable to effect a closing purchase transaction.
Closing purchase transactions are ordinarily effected to realize a
profit on an outstanding call option, to prevent an underlying security
(currency) from being called, to permit the sale of an underlying security (or
the exchange of the underlying currency) or to enable the Fund to write another
call option on the underlying security (currency) with either a different
exercise price or expiration date or both. The Fund may realize a net gain or
loss from a closing purchase transaction depending upon whether the amount of
the premium received on the call option is more or less than the cost of
effecting the closing purchase transaction. Any loss incurred in a closing
purchase transaction may be wholly or partially offset by unrealized
appreciation in the market value of the underlying security (currency).
Conversely, a gain resulting from a closing purchase transaction could be
offset in whole or in part or exceeded by a decline in the market value of the
underlying security (currency).
If a call option expires unexercised, the Fund realizes a gain in the
amount of the premium on the option less the commission paid. Such a gain,
however, may be offset by depreciation in the market value of the underlying
security (currency) during the option period. If a call option is exercised,
the Fund realizes a gain or loss from the sale of the underlying security
(currency) equal to the difference between the purchase price of the underlying
security (currency) and the proceeds of the sale of the security (currency)
plus the premium received on the option less the commission paid.
Options written by the Fund will normally have expiration dates of up
to eighteen months from the date written. The exercise price of a call option
may be below, equal to or above the current market value of the underlying
security at the time the option is written. See "Risks of Options and Futures
Transactions," below.
Covered Put Writing. As stated in the Prospectus, as a writer of a
covered put option, the Fund incurs an obligation to buy the security
underlying the option from the purchaser of the put, at the option's exercise
price at any time during the option period, at the purchaser's election
(certain listed and OTC put options written by the Fund will be exercisable by
the purchaser on a specific date). A put is "covered" if, at all times, the
Fund maintains, in a segregated account maintained on its behalf at the Fund's
Custodian, cash, U.S. Government securities or other high grade obligations in
an amount equal to at least the exercise price of the option, at all times
during the option period. Similarly, a short put position could be covered by
the Fund by its purchase of a put option on the same security (currency) as the
underlying security of the written option, where the exercise price of the
purchased option is equal to or more than the exercise price of the put written
or less than the exercise price of the put written if the marked to market
difference is maintained by the Fund in cash, U.S. Government securities or
other high grade debt obligations which the Fund holds in a segregated account
maintained at its Custodian. In writing puts, the Fund assumes the risk of loss
should the market value of the underlying security (currency) decline below the
exercise price of the option (any loss being decreased by the receipt of the
premium on the option written). In the case of listed options, during the
option period, the Fund may be required, at any time, to make payment of the
exercise price against delivery of the underlying security (currency). The
operation of and limitations on covered put options in other respects are
substantially identical to those of call options.
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The Fund will write put options for three purposes: (1) to receive the
income derived from the premiums paid by purchasers; (2) when the Investment
Manager wishes to purchase the security (or a security denominated in the
currency underlying the option) underlying the option at a price lower than its
current market price, in which case it will write the covered put at an
exercise price reflecting the lower purchase price sought; and (3) to close out
a long put option position. The potential gain on a covered put option is
limited to the premium received on the option (less the commissions paid on the
transaction) while the potential loss equals the differences between the
exercise price of the option and the current market price of the underlying
securities (currencies) when the put is exercised, offset by the premium
received (less the commissions paid on the transaction).
Purchasing Call and Put Options. The Fund may purchase listed and OTC
call and put options in amounts equalling up to 5% of its total assets. The
Fund may purchase a call option in order to close out a covered call position
(see "Covered Call Writing" above), to protect against an increase in price of
a security it anticipates purchasing or, in the case of a call option on
foreign currency, to hedge against an adverse exchange rate move of the
currency in which the security it anticipates purchasing is denominated vis-a-
vis the currency in which the exercise price is denominated. The purchase of
the call option to effect a closing transaction on a call written over-the-
counter may be listed or an OTC option. In either case, the call purchased is
likely to be on the same securities (currencies) and have the same terms as the
written option. If purchased over-the-counter, the option would generally be
acquired from the dealer or financial institution which purchased the call
written by the Fund.
The Fund may purchase put options on securities (currencies) which it
holds in its portfolio to protect itself against a decline in the value of the
security and to close out written put option positions. If the value of the
underlying security (currency) were to fall below the exercise price of the put
purchased in an amount greater than the premium paid for the option, the Fund
would incur no additional loss. In addition, the Fund may sell a put option
which it has previously purchased prior to the sale of the securities
(currencies) underlying such option. Such a sale would result in a net gain or
loss depending on whether the amount received on the sale is more or less than
the premium and other transaction costs paid on the put option which is sold.
And such gain or loss could be offset in whole or in part by a change in the
market value of the underlying security (currency). If a put option purchased
by the Fund expired without being sold or exercised, the premium would be lost.
Risks of Options Transactions. During the option period, the covered
call writer has, in return for the premium on the option, given up the
opportunity for capital appreciation above the exercise price should the market
price of the underlying security (or the value of its denominated currency)
increase, but has retained the risk of loss should the price of the underlying
security (or the value of its denominated currency) decline. The writer has no
control over the time when it may be required to fulfill its obligation as a
writer of the option. Once an option writer has received an exercise notice, it
cannot effect a closing purchase transaction in order to terminate its
obligation under the option and must deliver or receive the underlying
securities at the exercise price.
Prior to exercise or expiration, an option position can only be
terminated by entering into a closing purchase or sale transaction. If the
covered call option writer is unable to effect a closing purchase transaction
or to purchase an offsetting OTC option, it cannot sell the underlying security
until the option expires or the option is exercised. Accordingly, a covered
call option writer may not be able to sell an underlying security at a time
when it might otherwise be advantageous to do so. A secured put option writer
who is unable to effect a closing purchase transaction or to purchase an
offsetting OTC option would continue to bear the risk of decline in the market
price of the underlying security until the option expires or is exercised. In
addition, a secured put writer would be unable to utilize the amount held in
cash or U.S. Government or other high grade short-term obligations securities
as security for the put option for other investment purposes until the exercise
or expiration of the option.
The Fund's ability to close out its position as a writer of an option
is dependent upon the existence of a liquid secondary market on Option
Exchanges. There is no assurance that such a market will exist, particularly in
the case of OTC options, as such options will generally only be closed out by
entering into a closing purchase transaction with the purchasing dealer.
However, the Fund may be able to purchase
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an offsetting option which does not close out its position as a writer but
constitutes an asset of equal value to the obligation under the option written.
If the Fund is not able to either enter into a closing purchase transaction or
purchase an offsetting position, it will be required to maintain the securities
subject to the call, or the collateral underlying the put, even though it might
not be advantageous to do so, until a closing transaction can be entered into
(or the option is exercised or expires).
Among the possible reasons for the absence of a liquid secondary market
on an Exchange are: (i) insufficient trading interest in certain options; (ii)
restrictions on transactions imposed by an Exchange; (iii) trading halts,
suspensions or other restrictions imposed with respect to particular classes or
series of options or underlying securities; (iv) interruption of the normal
operations on an Exchange; (v) inadequacy of the facilities of an Exchange or
the Options Clearing Corporation ("OCC") to handle current trading volume; or
(vi) a decision by one or more Exchanges to discontinue the trading of options
(or a particular class or series of options), in which event the secondary
market on that Exchange (or in that class or series of options) would cease to
exist, although outstanding options on that Exchange that had been issued by
the OCC as a result of trades on that Exchange would generally continue to be
exercisable in accordance with their terms.
In the event of the bankruptcy of a broker through which the Fund
engages in transactions in options, the Fund could experience delays and/or
losses in liquidating open positions purchased or sold through the broker
and/or incur a loss of all or part of its margin deposits with the broker.
Similarly, in the event of the bankruptcy of the writer of an OTC option
purchased by the Fund, the Fund could experience a loss of all or part of the
value of the option. Transactions are entered into by the Fund only with
brokers or financial institutions deemed creditworthy by the Fund's management.
Each of the Exchanges has established limitations governing the maximum
number of options on the same underlying security or futures contract (whether
or nor covered) which may be written by a single investor, whether acting alone
or in concert with others (regardless of whether such options are written on
the same or different Exchanges or are held or written on one or more accounts
or through one or more brokers). An Exchange may order the liquidation of
positions found to be in violation of these limits and it may impose other
sanctions or restrictions. These position limits may restrict the number of
listed options which the Fund may write.
The hours of trading for options may not conform to the hours during
which the underlying securities are traded. To the extent that the option
markets close before the markets for the underlying securities, significant
price and rate movements can take place in the underlying market that cannot be
reflected in the option markets.
The extent to which the Fund may enter into transactions involving
options may be limited by the Internal Revenue Code's requirements for
qualification as a regulated investment company and the Fund's intention to
qualify as such (see "Dividends, Distributions and Taxes" in the Prospectus).
Futures Contracts and Options On Futures. The Fund may invest in
financial futures contracts ("futures contracts") and related options thereon.
These futures contracts and related options thereon will be used only as a
hedge against anticipated interest rate changes. A futures contract sale
creates an obligation by the Fund, as seller, to deliver the specific type of
instrument called for in the contract at a specified future time for a
specified price. A futures contract purchase would create an obligation by the
Fund, as purchaser, to take delivery of the specific type of financial
instrument at a specified future time at a specified price. The specific
securities delivered or taken, respectively, at settlement date, would not be
determined until or near that date. The determination would be in accordance
with the rules of the exchange on which the futures contract sale or purchase
was effected.
Although the terms of futures contracts specify actual delivery or
receipt of securities, in most instances the contracts are closed out before
the settlement date without the making or taking of delivery of the securities.
Closing out of a futures contract is usually effected by entering into an
offsetting transaction. An offsetting transaction for a futures contract sale
is effected by the Fund entering into a futures contract purchase for the same
aggregate amount of the specific type of financial instrument and same delivery
date. If the price in the sale exceeds the price in the offsetting purchase,
the Fund is immediately paid the difference and thus realizes a gain. If the
offsetting purchase price exceeds the sale price, the
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Fund pays the difference and realizes a loss. Similarly, the closing out of a
futures contract purchase is effected by the Fund entering into a futures
contract sale. If the offsetting sale price exceeds the purchase price, the
Fund realizes a gain, and if the offsetting sale price is less than the
purchase price, the Fund realizes a loss.
Unlike a futures contract, which requires the parties to buy and sell a
security on a set date, an option on a futures contract entitles its holder to
decide on or before a future date whether to enter into such a contract. If the
holder decides not to enter into the contract, the premium paid for the
contract is lost. Since the price of the option is fixed at the point of sale,
there are no daily payments of cash to reflect the change in the value of the
underlying contract, as discussed below for futures contracts. The value of the
option does change and is reflected in the net asset value of the Fund.
The Fund is required to maintain margin deposits with brokerage firms
through which it effects futures contracts and options thereon. The initial
margin requirements vary according to the type of the underlying security. In
addition, due to current industry practice, daily variations in gains and
losses on open contracts are required to be reflected in cash in the form of
variation margin payments. The Fund may be required to make additional margin
payments during the term of the contract.
Financial futures contracts are traded in an auction environment on the
floors of several Exchanges--principally, the Chicago Board of Trade, the
Chicago Mercantile Exchange and the New York Futures Exchange. Each Exchange
guarantees performance under contract provisions through a clearing
corporation, a nonprofit organization managed by the Exchange membership which
is also responsible for handling daily accounting of deposits or withdrawals of
margin.
Interest Rate Futures Contracts. As stated in the Prospectus, the Fund
may purchase and sell interest rate, currency, and index futures contracts
("futures contracts"), that are traded on U.S. and foreign commodity exchanges,
on such underlying securities as U.S. Treasury bonds, notes and bills and/or
any foreign government fixed-income security ("interest rate" futures), on
various currencies ("currency futures") and on such indexes of U.S. and foreign
securities as may exist or come into being ("index" futures).
The Fund will purchase or sell interest rate futures contracts for the
purpose of hedging some or all of the value of its portfolio securities (or
anticipated portfolio securities) against changes in prevailing interest rates.
If the Investment Manager anticipates that interest rates may rise and
concomitantly, the price of certain of its portfolio securities fall, the Fund
may sell an interest rate futures contract. If declining interest rates are
anticipated, the Fund may purchase an interest rate futures contract to protect
against a potential increase in the price of securities the Fund intends to
purchase. Subsequently, appropriate securities may be purchased by the Fund in
an orderly fashion; as securities are purchased, corresponding futures
positions would be terminated by offsetting sales of contracts.
The Fund will purchase or sell index futures contracts for the purpose
of hedging some or all of its portfolio (or anticipated portfolio) securities
against changes in their prices. If the Investment Manager anticipates that the
prices of securities held by the Fund may fall, the Fund may sell an index
futures contract. Conversely, if the Fund wishes to hedge against anticipated
price rises in those securities which the Fund intends to purchase, the Fund
may purchase an index futures contract.
The Fund will purchase or sell currency futures on currencies in which
its portfolio securities (or anticipated portfolio securities) are denominated
for the purposes of hedging against anticipated changes in currency exchange
rates. The Fund will enter into currency futures contracts for the same reasons
as set forth above for entering into forward foreign currency contracts;
namely, to "lock-in" the value of a security purchased or sold in a given
currency vis-a-vis a different currency or to hedge against an adverse currency
exchange rate movement of a portfolio security's (or anticipated portfolio
security's) denominated currency vis-a-vis a different currency.
In addition to the above, interest rate, index and currency futures
will be bought or sold in order to close out a short or long position
maintained by the Fund in a corresponding futures contract.
Although most interest rate futures contracts call for actual delivery
or acceptance of securities, the contracts usually are closed out before the
settlement date without the making or taking of delivery. A
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<PAGE>
futures contract sale is closed out by effecting a futures contract purchase
for the same aggregate amount of the specific type of security (currency) and
the same delivery date. If the sale price exceeds the offsetting purchase
price, the seller would be paid the difference and would realize a gain. If the
offsetting purchase price exceeds the sale price, the seller would pay the
difference and would realize a loss. Similarly, a futures contract purchase is
closed out by effecting a futures contract sale for the same aggregate amount
of the specific type of security (currency) and the same delivery date. If the
offsetting sale price exceeds the purchase price, the purchaser would realize a
gain, whereas if the purchase price exceeds the offsetting sale price, the
purchaser would realize a loss. There is no assurance that the Fund will be
able to enter into a closing transaction.
When the Fund enters into an interest rate futures contract, it is
initially required to deposit with the Fund's Custodian, in a segregated
account in the name of the broker performing the transaction, an "initial
margin" of cash or U.S. Government securities or other high grade short-term
obligations equal to approximately 2% of the contract amount. Initial margin
requirements are established by the Exchanges on which futures contracts trade
and may, from time to time, change. (In addition, brokers may establish margin
deposit requirements in excess of those required by the Exchanges.
Initial margin in futures transactions is different from margin in
securities transactions in that initial margin does not involve the borrowing
of funds by a brokers' client but is, rather, a good faith deposit on the
futures contract which will be returned to the Fund upon the proper termination
of the futures contract. The margin deposits made are marked to market daily
and the Fund may be required to make subsequent deposits of cash or U.S.
Government securities called "variation margin", with the Fund's futures
contract clearing broker, which are reflective of price fluctuations in the
futures contract. Currently, interest rate futures contracts can be purchased
on debt securities such as U.S. Treasury Bills and Bonds, U.S. Treasury Notes
with Maturities between 6 1/2 and 10 years, GNMA Certificates and Bank
Certificates of Deposit.
Additionally, the Fund may invest in Mortgage-Backed Securities, such
as floating rate CMOs or adjustable rate Mortgage-Backed Securities, which have
interest rates subject to periodic adjustment based on changes to a designated
index. One index which may serve as such a benchmark is the London Interbank
Offered Rate, or LIBOR. In order for the Fund to hedge its exposure to
fluctuations in short-term interest rates for its portfolio securities subject
to the LIBOR rate, the Fund may purchase or sell futures contracts on U.S.
dollar denominated Eurodollar instruments linked to the LIBOR rate.
Currency Futures. Generally, foreign currency futures provide for the
delivery of a specified amount of a given currency, on the exercise date, for a
set exercise price denominated in U.S. dollars or other currency. Foreign
currency futures contracts would be entered into for the same reason and under
the same circumstances as forward foreign currency exchange contracts. The
Investment Manager will assess such factors as cost spreads, liquidity and
transaction costs in determining whether to utilize futures contracts or
forward contracts in its foreign currency transactions and hedging strategy.
Currently, currency futures exist for, among other foreign currencies, the
Japanese yen, West German marks, Canadian dollars, British pounds, Swiss francs
and European currency unit.
Purchasers and sellers of foreign currency futures contracts are
subject to the same risks that apply to the buying and selling of futures
generally. In addition, there are risks associated with foreign currency
futures contracts and their use as a hedging device similar to those associated
with options on foreign currencies described above. Further, settlement of a
foreign currency futures contract must occur within the country issuing the
underlying currency. Thus, the Fund must accept or make delivery of the
underlying foreign currency in accordance with any U.S. or foreign restrictions
or regulations regarding the maintenance of foreign banking arrangements by
U.S. residents and may be required to pay any fees, taxes or charges associated
with such delivery which are assessed in the issuing country.
Options on foreign currency futures contracts may involve certain
additional risks. Trading options on foreign currency futures contracts is
relatively new. The ability to establish and close out positions on such
options is subject to the maintenance of a liquid secondary market. To reduce
this risk, the Fund will not purchase or write options on foreign currency
futures contracts unless and until, in the Investment Manager's opinion, the
market for such options has developed sufficiently that the risks in connection
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<PAGE>
with such options are not greater than the risks in connection with
transactions in the underlying foreign currency futures contracts.
Index Futures Contracts. As discussed in the Prospectus, the Fund may
invest in index futures contracts. An index futures contract sale creates an
obligation by the Fund, as seller, to deliver cash at a specified future time.
An index futures contract purchase would create an obligation by the Fund, as
purchaser, to take delivery of cash at a specified future time. Futures
contracts on indexes do not require the physical delivery of securities, but
provide for a final cash settlement on the expiration date which reflects
accumulated profits and losses credited or debited to each party's account.
The Fund is required to maintain margin deposits with brokerage firms
through which it effects index futures contracts in a manner similar to that
described above for interest rate futures contracts. Currently, the initial
margin requirements range from 3% to 10% of the contract amount for index
futures. In addition, due to current industry practice, daily variations in
gains and losses on open contracts are required to be reflected in cash in the
form of variation margin payments. The Fund may be required to make additional
margin payments during the term of the contract.
At any time prior to expiration of the futures contract, the Fund may
elect to close the position by taking an opposite position which will operate
to terminate the Fund's position in the futures contract. A final determination
of variation margin is then made, additional cash is required to be paid by or
released to the Fund and the Fund realizes a loss or gain.
Options on Futures Contracts. The Fund may purchase and write call and
put options on futures contracts which are traded on an exchange and enter into
closing transactions with respect to such options to terminate an existing
position. An option on a futures contract gives the purchaser the right (in
return for the premium paid) to assume a position in a futures contract (a long
position if the option is a call and a short position if the option is a put)
at a specified exercise price at any time during the term of the option. Upon
exercise of the option, the delivery of the futures position by the writer of
the option to the holder of the option is accompanied by delivery of the
accumulated balance in the writer's futures margin account, which represents
the amount by which the market price of the futures contract at the time of
exercise exceeds, in the case of a call, or is less than, in the case of a put,
the exercise price of the option on the futures contract.
The Fund will purchase and write options on futures contracts for
identical purposes to those set forth above for the purchase of a futures
contract (purchase of a call option or sale of a put option) and the sale of a
futures contract (purchase of a put option or sale of a call option), or to
close out a long or short position in futures contracts. If, for example, the
Investment Manager wished to protect against an increase in interest rates and
the resulting negative impact on the value of a portion of its fixed-income
portfolio, it might write a call option on an interest rate futures contract,
the underlying security of which correlates with the portion of the portfolio
the Investment Manager seeks to hedge. Any premiums received in the writing of
options on futures contracts may, of course, provide a further hedge against
losses resulting from price declines in portions of the Fund's portfolio.
Limitations on Futures Contracts and Options on Futures. The Fund may
not enter into futures contracts or purchase related options thereon if,
immediately thereafter, the amount committed to margin plus the amount paid for
premiums for unexpired options on futures contracts exceeds 5% of the value of
the Fund's total assets, after taking into account unrealized gains and
unrealized losses on such contracts it has entered into, provided, however,
that in the case of an option that is in-the-money (the exercise price of the
call (put) option is less (more) than the market price of the underlying
security) at the time of purchase, the in-the-money amount may be excluded in
calculating the 5%. However, there is no overall limitation on the percentage
of the Fund's assets which may be subject to a hedge position. In addition, in
accordance with the regulations of the Commodity Futures Trading Commission
("CFTC") under which the Fund is exempted from registration as a commodity pool
operator, the Fund may only enter into futures contracts and options on futures
contracts transactions for purposes of hedging a part or all of its portfolio.
If the CFTC changes its regulations so that the Fund would be permitted to
write options on futures contracts for purposes other than hedging the Fund's
investments without CFTC registration, the Fund may engage in such transactions
for those purposes. Except as described above, there are no other limitations
on the use of futures and options thereon by the Fund.
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<PAGE>
The writer of an option on a futures contract is required to deposit
initial and variation margin pursuant to requirements similar to those
applicable to futures contracts. Premiums received from the writing of an
option on a futures contract are included in initial margin deposits.
Risks of Transactions in Futures Contracts and Related Options. As
stated in the Prospectus, the Fund may sell a futures contract to protect
against the decline in the value of securities (or the currency in which they
are denominated) held by the Fund. However, it is possible that the futures
market may advance and the value of securities (or the currency in which they
are denominated) held in the portfolio of the Fund may decline. If this
occurred, the Fund would lose money on the futures contract and also experience
a decline in value of its portfolio securities. However, while this could occur
for a very brief period or to a very small degree, over time the value of a
diversified portfolio will tend to move in the same direction as the futures
contracts.
If the Fund purchases a futures contract to hedge against the increase
in value of securities it intends to buy (or the currency in which they are
denominated), and the value of such securities (currencies) decreases, then the
Fund may determine not to invest in the securities as planned and will realize
a loss on the futures contract that is not offset by a reduction in the price
of the securities.
In order to assure that the Fund is entering into transactions in
futures contracts for hedging purposes as defined by the Commodity Futures
Trading Commission either: 1) a substantial majority (i.e., approximately 75%)
of all anticipatory hedge transactions (transactions in which the Fund does not
own at the time of the transaction, but expects to acquire, the securities
underlying the relevant futures contract) involving the purchase of futures
contracts will be completed by the purchase of securities which are the subject
of the hedge or 2) the underlying value of all long positions in futures
contracts will not exceed the total value of a) all short-term debt obligations
held by the Fund; b) cash held by the Fund; c) cash proceeds due to the Fund on
investments within thirty days; d) the margin deposited on the contracts; and
e) any unrealized appreciation in the value of the contracts.
If the Fund has sold a call option on a futures contract, it will cover
this position by holding, in a segregated account maintained at its Custodian,
cash, U.S. Government securities or other high grade debt obligations equal in
value (when added to any initial or variation margin on deposit) to the market
value of the securities (currencies) underlying the futures contract or the
exercise price of the option. Such a position may also be covered by owning the
securities (currencies) underlying the futures contract, or by holding a call
option permitting the Fund to purchase the same contract at a price no higher
than the price at which the short position was established.
In addition, if the Fund holds a long position in a futures contract it
will hold cash, U.S. Government securities or other high grade debt obligations
equal to the purchase price of the contract (less the amount of initial or
variation margin on deposit) in a segregated account maintained for the Fund by
its Custodian. Alternatively, the Fund could cover its long position by
purchasing a put option on the same futures contract with an exercise price as
high as or higher than the price of the contract held by the Fund.
Exchanges limit the amount by which the price of a futures contract may
move on any day. If the price moves equal the daily limit on successive days,
then it may prove impossible to liquidate a futures position until the daily
limit moves have ceased. In the event of adverse price movements, the Fund
would continue to be required to make daily cash payments of variation margin
on open futures positions. In such situations, if the Fund has insufficient
cash, it may have to sell portfolio securities to meet daily variation margin
requirements at a time when it may be disadvantageous to do so. In addition,
the Fund may be required to take or make delivery of the instruments underlying
interest rate futures contracts it holds at a time when it is disadvantageous
to do so. The inability to close out options and futures positions could also
have an adverse impact on the Fund's ability to effectively hedge its
portfolio.
Futures contracts and options thereon which are purchased or sold on
foreign commodities exchanges may have greater price volatility than their U.S.
counterparts. Furthermore, foreign commodities exchanges may be less regulated
and under less governmental scrutiny than U.S. exchanges. Brokerage
commissions, clearing costs and other transaction costs may be higher on
foreign exchanges. Greater margin requirements may limit the Fund's ability to
enter into certain commodity transactions on
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<PAGE>
foreign exchanges. Moreover, differences in clearance and delivery requirements
on foreign exchanges may occasion delays in the settlement of the Fund's
transactions effected on foreign exchanges.
In the event of the bankruptcy of a broker through which the Fund
engages in transactions in futures or options thereon, the Fund could
experience delays and/or losses in liquidating open positions purchased or sold
through the broker and/or incur a loss of all or part of its margin deposits
with the broker. Similarly, in the event of the bankruptcy of the writer of an
OTC option purchased by the Fund, the Fund could experience a loss of all or
part of the value of the option. Transactions are entered into by the Fund only
with brokers or financial institutions deemed creditworthy by the Investment
Manager.
While the futures contracts and options transactions to be engaged in
by the Fund for the purpose of hedging the Fund's portfolio securities are not
speculative in nature, there are risks inherent in the use of such
instruments. One such risk which may arise in employing futures contracts to
protect against the price volatility of portfolio securities (and the
currencies in which they are denominated) is that the prices of securities and
indexes subject to futures contracts (and thereby the futures contract prices)
may correlate imperfectly with the behavior of the cash prices of the Fund's
portfolio securities (and the currencies in which they are denominated).
Another such risk is that prices of interest rate futures contracts may not
move in tandem with the changes in prevailing interest rates against which the
Fund seeks a hedge. A correlation may also be distorted by the fact that the
futures market is dominated by short-term traders seeking to profit from the
difference between a contract or security price objective and their cost of
borrowed funds. Such distortions are generally minor and would diminish as the
contract approached maturity.
There may exist an imperfect correlation between the price movements of
futures contracts purchased by the Fund and the movements in the prices of the
securities (currencies) which are the subject of the hedge. If participants in
the futures market elect to close out their contracts through offsetting
transactions rather than meet margin deposit requirements, distortions in the
normal relationship between the debt securities or currency markets and futures
markets could result. Price distortions could also result if investors in
futures contracts opt to make or take delivery of underlying securities rather
than engage in closing transactions due to the resultant reduction in the
liquidity of the futures market. In addition, due to the fact that, from the
point of view of speculators, the deposit requirements in the futures markets
are less onerous than margin requirements in the cash market, increased
participation by speculators in the futures market could cause temporary price
distortions. Due to the possibility of price distortions in the futures market
and because of the imperfect correlation between movements in the prices of
securities and movements in the prices of futures contracts, a correct forecast
of interest rate trends may still not result in a successful hedging
transaction.
There is no assurance that a liquid secondary market will exist for
futures contracts and related options in which the Fund may invest. In the
event a liquid market does not exist, it may not be possible to close out a
futures position, and in the event of adverse price movements, the Fund would
continue to be required to make daily cash payments of variation margin. In
addition, limitations imposed by an exchange or board of trade on which futures
contracts are traded may compel or prevent the Fund from closing out a contract
which may result in reduced gain or increased loss to the Fund. The absence of
a liquid market in futures contracts might cause the Fund to make or take
delivery of the underlying securities (currencies) at a time when it may be
disadvantageous to do so.
The extent to which the Fund may enter into transactions involving
futures contracts and options thereon may be limited by the Internal Revenue
Code's requirements for qualification as a regulated investment company and the
Fund's intention to qualify as such (see "Dividends, Distributions and Taxes"
in the Prospectus).
Compared to the purchase or sale of futures contracts, the purchase of
call or put options on futures contracts involves less potential risk to the
Fund because the maximum amount at risk is the premium paid for the options
(plus transaction costs). However, there may be circumstances when the purchase
of a call or put option on a futures contract would result in a loss to the
Fund notwithstanding that the purchase or sale of a futures contract would not
result in a loss, as in the instance where there is no movement in the prices
of the futures contract or underlying securities (currencies).
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The Investment Manager has substantial experience in the use of the
investment techniques described above under the heading "Options and Futures
Transactions," which techniques require skills different from those needed to
select the portfolio securities underlying various options and futures
contracts.
PORTFOLIO TURNOVER
The Fund may sell portfolio securities without regard to the length of
time they have been held whenever such sale will, in the Investment Manager's
opinion, strengthen the Fund's position and contribute to its investment
objective. As a result, the Fund's portfolio turnover rate may exceed 100%. A
100% turnover rate would occur, for example, if 100% of the securities held in
the Fund's portfolio (excluding all securities whose maturities at acquisition
were one year or less) were sold and replaced within one year. During the
fiscal period April 9, 1992 through October 31, 1992 and during the fiscal
year ended October 31, 1993 the Fund's portfolio turnover rates were 37% and
117%, respectively.
INVESTMENT RESTRICTIONS
===============================================================================
In addition to the investment restrictions enumerated in the Prospectus, the
investment restrictions listed below have been adopted by the Fund as
fundamental policies, except as otherwise indicated. Under the Act, a
fundamental policy may not be changed without the vote of a majority of the
outstanding voting securities of the Fund, as defined in the Act. Such a
majority is defined as the lesser of (a) 67% or more of the shares present at a
meeting of shareholders, if the holders of 50% of the outstanding shares of the
Fund are present or represented by proxy or (b) more than 50% of the
outstanding shares of the Fund.
The Fund may not:
1. Purchase or sell real estate or interests therein, although the Fund
may purchase securities of issuers which engage in real estate operations and
securities secured by real estate or interests therein.
2. Purchase oil, gas or other mineral leases, rights or royalty
contracts or exploration or development programs, except that the Fund may
invest in the securities of companies which operate, invest in, or sponsor such
programs.
3. Purchase securities of other investment companies, except in
connection with a merger, consolidation, reorganization or acquisition of
assets. For this purpose, Mortgage-Backed Securities and Asset-Backed
Securities are not deemed to be investment companies.
4. Issue senior securities as defined in the Act except insofar as the Fund
may be deemed to have issued a senior security by reason of (a) entering into
any repurchase or reverse repurchase agreement; (b) purchasing any securities
on a when-issued or delayed delivery basis; (c) purchasing or selling futures
contracts, forward foreign exchange contracts or options; (d) borrowing money
in accordance with restrictions described above; or (e) lending portfolio
securities.
5. Make loans of money or securities, except: (a) by the purchase of
publicly distributed debt obligations in which the Fund may invest consistent
with its investment objectives and policies; (b) by investment in repurchase or
reverse repurchase agreements; or (c) by lending its portfolio securities.
6. Engage in the underwriting of securities, except insofar as the Fund
may be deemed an underwriter under the Securities Act of 1933 in disposing of a
portfolio security.
7. Invest for the purpose of exercising control or management of any
other issuer.
8. Purchase or sell commodities or commodities contracts except that
the Fund may purchase or write interest rate, currency and stock and bond index
futures contracts and related options thereon.
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9. Pledge its assets or assign or otherwise encumber them except to
secure permitted borrowings. (For the purpose of this restriction, collateral
arrangements with respect to the writing of options and collateral arrangements
with respect to initial or variation margin for futures are not deemed to be
pledges of assets.)
10. Purchase securities on margin (but the Fund may obtain short-term
loans as are necessary for the clearance of transactions). The deposit or
payment by the Fund of initial or variation margin in connection with futures
contracts or related options thereon is not considered the purchase of a
security on margin.
11. Invest in securities of any company if, to the knowledge of the
Fund, any officer or trustee of the Fund or of the Investment Manager owns more
than 1/2 of 1% of the outstanding securities of such company, and such officers
and directors who own more than 1/2 of 1% own in the aggregate more than 5% of
the outstanding securities of such company; and
12. Invest more than 5% of its net assets in warrants (valued at the
lower of cost or market), including not more than 2% of such assets which are
not listed on the New York or American Stock Exchange. However, warrants
acquired by the Fund in units or attached to other securities may be deemed to
be without value.
13. Make short sales of securities.
If a percentage restriction is adhered to at the time of investment, a
later increase or decrease in percentage resulting from a change in values of
portfolio securities or amount of total or net assets will not be considered a
violation of any of the foregoing restrictions.
PORTFOLIO TRANSACTIONS AND BROKERAGE
===============================================================================
Subject to the general supervision of the Board of Trustees, the
Investment Manager is responsible for decisions to buy and sell securities for
the Fund, the selection of brokers and dealers to effect the transactions, and
the negotiation of brokerage commissions, if any. Purchases and sales of
securities on a stock exchange are effected through brokers who charge a
commission for their services. The Fund expects that the primary market for the
securities in which it intends to invest will generally be the over-the-counter
market. In the over-the-counter market, securities are generally traded on a
"net" basis with dealers acting as principal for their own accounts without a
stated commission, although the price of the security usually includes a profit
to the dealer. The Fund expects that securities will be purchased at times in
underwritten offerings where the price includes a fixed amount of compensation,
generally referred to as the underwriter's concession or discount. Options and
futures transactions will usually be effected through a broker and a commission
will be charged. On occasion, the Fund may also purchase certain money market
instruments directly from an issuer, in which case no commissions or discounts
are paid. During the fiscal period ended October 31, 1992 and during the fiscal
year ended October 31, 1993, the Fund did not pay any brokerage commissions.
The Investment Manager currently serves as investment manager to a
number of clients, including other investment companies, and may in the future
act as investment manager or adviser to others. It is the practice of the
Investment Manager to cause purchase and sale transactions to be allocated
among the Fund and others whose assets it manages in such manner as it deems
equitable. In making such allocations among the Fund and other client accounts,
the main factors considered are the respective investment objectives, the
relative size of portfolio holdings of the same or comparable securities, the
availability of cash for investment, the size of investment commitments
generally held and the opinions of the persons responsible for managing the
portfolios of the Fund and other client accounts.
The policy of the Fund regarding purchases and sales of securities for
its portfolio is that primary consideration will be given to obtaining the most
favorable prices and efficient executions of transactions. Consistent with this
policy, when securities transactions are effected on a stock exchange, the
Fund's policy is to pay commissions which are considered fair and reasonable
without necessarily determining that the lowest possible commissions are paid
in all circumstances. The Fund believes that a requirement always to seek the
lowest possible commission cost could impede effective portfolio management
28
<PAGE>
and preclude the Fund and the Investment Manager from obtaining a high quality
of brokerage and research services. In seeking to determine the reasonableness
of brokerage commissions paid in any transaction, the Investment Manager
relies upon its experience and knowledge regarding commissions generally
charged by various brokers and on its judgment in evaluating the brokerage and
research services received from the broker effecting the transaction. Such
determinations are necessarily subjective and imprecise, as in most cases an
exact dollar value for those services is not ascertainable.
The Fund anticipates that certain of its transactions involving foreign
securities will be effected on securities exchanges. Fixed commissions on such
transactions are generally higher than negotiated commissions on domestic
transactions. There is also generally less government supervision and
regulation of foreign securities exchanges and brokers than in the United
States.
In seeking to implement the Fund's policies, the Investment Manager
effects transactions with those brokers and dealers who the Investment Manager
believes provide the most favorable prices and are capable of providing
efficient executions. If the Investment Manager believes such prices and
executions are obtainable from more than one broker or dealer, it may give
consideration to placing portfolio transactions with those brokers and dealers
who also furnish research and other services to the Fund or the Investment
Manager. Such services may include, but are not limited to, any one or more of
the following: information as to the availability of securities for purchase or
sale; statistical or factual information or opinions pertaining to investment;
wire services; and appraisals or evaluations of portfolio securities. The Fund
will not purchase at a higher price or sell at a lower price in connection with
transactions effected with a dealer, acting as principal, who furnishes
research services to the Fund than would be the case if no weight were given by
the Fund to the dealer's furnishing of such services. During the fiscal year
ended October 31, 1993, the Fund did not direct the payment of any brokerage
commissions because of research services provided.
The information and services received by the Investment Manager from
brokers and dealers may be of benefit to the Investment Manager in the
management of accounts of some of its other clients and may not in all cases
benefit the Fund directly. While the receipt of such information and services
is useful in varying degrees and would generally reduce the amount of research
or services otherwise performed by the Investment Manager and thereby reduce
its expenses, it is of indeterminable value and the management fee paid to the
Investment Manager is not reduced by any amount that may be attributable to the
value of such services.
Pursuant to an order of the Securities and Exchange Commission, the
Fund may effect principal transactions in certain money market instruments with
DWR. The Fund will limit its transactions with DWR to U.S. Government and
Government Agency Securities, Bank Money Instruments (i.e., Certificates of
Deposit and Bankers' Acceptances) and Commercial Paper. Such transactions will
be effected with DWR only when the price available from DWR is better than that
available from other dealers.
Consistent with the policy described above, brokerage transactions in
securities listed on exchanges or admitted to unlisted trading privileges may
be effected through DWR. In order for DWR to effect any portfolio transactions
for the Fund, the commissions, fees or other remuneration received by DWR must
be reasonable and fair compared to the commissions, fees or other remuneration
paid to other brokers in connection with comparable transactions involving
similar securities being purchased or sold on an exchange during a comparable
period of time. This standard would allow DWR to receive no more than the
remuneration which would be expected to be received by an unaffiliated broker
in a commensurate arm's-length transaction. Furthermore, the Trustees of the
Fund, including a majority of the Trustees who are not "interested" persons of
the Fund, as defined in the Act, have adopted procedures which are reasonably
designed to provide that any commissions, fees or other remuneration paid to
DWR are consistent with the foregoing standard. During the fiscal period ended
October 31, 1993 the Fund did not pay any brokerage commissions to DWR.
THE DISTRIBUTOR
===============================================================================
As discussed in the Prospectus, shares of the Fund are distributed
exclusively by Dean Witter Distributors Inc. (the "Distributor"). The
Distributor has entered into a selected dealer agreement with
29
<PAGE>
DWR, which through its own sales organization sells shares of the Fund. In
addition, the Distributor may enter into selected dealer agreements with other
selected broker-dealers. The Distributor, a Delaware corporation, is a wholly-
owned subsidiary of DWDC. The Trustees of the Fund, including a majority of the
Trustees who are not, and were not at the time they voted, interested persons
of the Fund, as defined in the Act (the "Independent Trustees"), approved, at
their meeting held on October 30, 1992, the current Distribution Agreement
appointing the Distributor as exclusive distributor of the Fund's shares and
providing for the Distributor to bear distribution expenses not borne by the
Fund. The current Distribution Agreement is substantially identical to the
Fund's previous distribution agreements. The Distribution Agreements took
effect on June 30, 1993 upon the spin-off by Sears, Roebuck and Co. of its
remaining shares of DWDC. By its terms, the Distribution Agreement will
continue in effect until April 30, 1994 and from year to year thereafter if
approved by the Board.
The Distributor bears all expenses it may incur in providing services
under the Distribution Agreement. Such expenses include the payment of
commissions for sales of the Fund's shares and incentive compensation to
account executives. The Distributor also pays certain expenses in connection
with the distribution of the Fund's shares, including the costs of preparing,
printing and distributing advertising or promotional materials, and the costs
of printing and distributing prospectuses and supplements thereto to
prospective shareholders. The Fund bears the costs of initial typesetting,
printing and distribution of prospectuses and supplements thereto to
shareholders. The Fund bears the costs of registering the Fund and its shares
under federal and state securities laws. The Fund and the Distributor have
agreed to indemnify each other against certain liabilities, including
liabilities under the Securities Act of 1933, as amended. Under the
Distribution Agreement, the Distributor uses its best efforts in rendering
services to the Fund, but in the absence of willful misfeasance, bad faith,
gross negligence or reckless disregard of its obligations, the Distributor is
not liable to the Fund or any of its shareholders for any error of judgment or
mistake of law or for any act or omission or for any losses sustained by the
Fund or its shareholders.
PLAN OF DISTRIBUTION
The Fund has adopted a Plan of Distribution pursuant to Rule 12b-1 under
the Act (the "Plan") pursuant to which the Fund pays the Distributor
compensation accrued daily and payable monthly at the annual rate of 0.85% of
the lesser of: (a) the average daily aggregate gross sales of the Fund's shares
since the inception of the Fund (not including reinvestment of dividends or
distributions), less the average daily aggregate net asset value of the Fund's
shares redeemed since the Fund's inception upon which a contingent deferred
sales charge has been imposed or waived, or (b) the Fund's average daily net
assets. The Distributor also receives the proceeds of contingent deferred sales
charges imposed on certain redemptions of shares, which are separate and apart
from payments made pursuant to the Plan. (see "Redemptions and Repurchases--
Contingent Deferred Sales Charge" in the Prospectus). The Distributor has
informed the Fund and it and/or DWR received approximately $152,000 and $9,548
in contingent deferred sales charges for the fiscal year ended October 31, 1993
and for the fiscal period April 9, 1992 (commencement of operations) through
October 31, 1992, respectively.
The Distributor has informed the Fund that a portion of the fees payable by
the Fund each year pursuant to the Plan equal to 0.20% of the Fund's average
daily net assets is characterized as a "service fee" under the Rules of Fair
Practice of the National Association of Securities Dealers, Inc. (of which the
Distributor is a member). Such portion of the fee is a payment made for
personal service and/or the maintenance of shareholder accounts. The remaining
portion of the Plan fees payable by the Fund is characterized as an "asset-
based sales charge" as such is defined by the aforementioned Rules of Fair
Practice.
Under its terms, the Plan has an initial term ending April 30, 1992, and
provides that it will remain in effect from year to year thereafter, provided
such continuance is approved annually by a vote of the Trustees, including a
majority of the Trustees who are not "interested persons" of the Fund (as
defined in the Act) and who have no direct or indirect financial interest in
the operation of the Plan (the "Independent 12b-1 Trustees"). The Plan was
initially adopted on January 23, 1992 at a meeting of the Trustees called for
the purpose of voting on such Plan. In determining to approve the Plan, the
Trustees of the Fund, including each of the Independent 12b-1 Trustees,
concluded that the Plan would be in the best interest of the Fund and would
have a reasonable likelihood of benefiting the Fund and its shareholders.
30
<PAGE>
The Plan was approved by DWR, as the then sole shareholder of the Fund, on
February 25, 1992 and by the shareholders of the Fund at a Special Meeting of
Shareholders held on January 12, 1993.
At their meeting held on October 30, 1992, the Trustees of the Fund,
including all of the Independent 12b-1 Trustees, approved certain amendments to
the Plan which took effect in January, 1993 and were designed to reflect the
fact that upon reorganization described above, the share distribution
activities theretofore performed for the Fund by DWR were assumed by the
Distributor and DWR's sales activities are now being performed pursuant to the
terms of a selected dealer agreement between the Distributor and DWR. The
amendments provide that payments under the Plan will be made to the Distributor
rather than to DWR as before the Amendment and that the Distributor in turn is
authorized to make payments to DWR or other selected broker-dealers (or direct
that the Fund pay such entities directly). The Distributor is also authorized
to retain part of such fee as compensation for its own distribution-related
expenses.
The Plan was adopted in order to permit the implementation of the Fund's
method of distribution. Under this distribution method, shares of the Fund are
sold without a sales load being deducted at the time of purchase, so that the
full amount of an investor's purchase payment will be invested in shares
without any deduction for sales charges. Shares of the Fund may be subject to a
contingent deferred sales charge, payable to the Distributor, if redeemed
during the six years after their purchase. DWR compensates its account
executives by paying them, from its own funds, commissions for the sale of the
Fund's shares, currently a gross sales credit of up to 4% of the amount sold
and an annual residual commission of up to .20 of 1% of the current value (not
including reinvested dividends or distributions) of the amount sold. The gross
sales credit is a charge which reflects commissions paid by DWR to its account
executives and DWR's Fund associated distribution-related expenses, including
sales compensation, and overhead. The distribution fee that the Distributor
receives from the Fund under the Plan, in effect, offsets distribution expenses
incurred under the Plan on behalf of the Fund's opportunity costs, such as the
gross sales credit and an assumed interest charge thereon ("carrying charge").
In the Distributor's reporting of the distribution expenses to the Fund, such
assumed interest (computed at the "broker's call rate") is calculated on the
gross sales credit as it is reduced by amounts received by the Distributor
under the Plan and any contingent deferred sales charge received by the
Distributor upon redemption of shares of the Fund. No other interest charge is
included as a distribution expense in the Distributor's calculation of its
distribution costs for this purpose. The broker's call rate is the interest
rate charged to securities brokers on loans secured by exchange-listed
securities.
The Fund accrued $882,934 to the Distributor and DWR, pursuant to the
Plan, for the fiscal year ended October 31, 1993. This is an accrual at an
annual rate of 0.85% of the average daily net assets of the Fund and was
calculated pursuant to clause (b) of the compensation formula under the Plan.
The Fund paid 100% of the $882,934 accrued under the Plan for the fiscal year
ended October 31, 1993, to the Distributor and DWR. The Distributor and DWR
estimate that they have spent, pursuant to the Plan, $5,830,332 on behalf of
the Fund since the inception of the Plan. It is estimated that this amount was
spent in approximately the following ways: (i) 7.72% ($449,874)--advertising
and promotional expenses; (ii) 0.57% ($33,246)--printing of prospectuses for
distribution to other than current shareholders; and (iii) 91.71%
($5,347,212)--other expenses, including the gross sales credit and the carrying
charge, of which 1.87% ($99,745) represents carrying charges, 39.25%
($2,098,987) represents commission credits to DWR branch offices for payments
of commissions to account executives and 58.88% ($3,148,480) represents
overhead and other branch office distribution-related expenses. The term
"overhead and other branch office distribution-related expenses" represents (a)
the expenses of operating DWR's branch offices in connection with the sale of
Fund shares, including lease costs, the salaries and employee benefits of
operations and sales support personnel, utility costs, communications costs and
the costs of stationery and supplies; (b) the costs of client sales seminars;
(d) travel expenses of mutual fund sales coordinators to promote the sale of
Fund shares; and (d) other expenses relating to branch promotion of Fund share
sales.
At any given time, the expenses in distributing shares of the Fund
which may be more or less than the total of (i) the payments made by the Fund
pursuant to the Plan and (ii) the proceeds of contingent deferred sales charges
paid by investors upon redemption of shares. The Distributor has advised the
Fund that such excess amount, including the carrying charge designed to
approximate the opportunity costs incurred by DWR which arise from it having
advanced monies without having received the amount
31
<PAGE>
of any sales charges imposed at the time of sale of the Fund's shares, totalled
$4,663,472 at October 31, 1993. Because there is no requirement under the Plan
that the Distributor be reimbursed for all its expenses or any requirement that
the Plan be continued from year to year, this excess amount does not constitute
a liability of the Fund. Although there is no legal obligation for the Fund to
pay expenses incurred in excess of payments made to the Distributor under the
Plan, and the proceeds of contingent deferred sales charges paid by investors
upon redemption of shares, if for any reason the Plan is terminated, the
Trustees will consider at that time the manner in which to treat such expenses.
Any cumulative expenses incurred, but not yet recovered through distribution
fees or contingent deferred sales charges, may or may not be recovered through
future distribution fees or contingent deferred sales charges.
No interested person of the Fund nor any Trustee of the Fund who is not
an interested person of the Fund, as defined in the Act, has any direct or
indirect financial interest in the operation of the Plan except to the extent
that the Distributor, InterCapital, DWR or certain of their employees may be
deemed to have such an interest as a result of benefits derived from the
successful operation of the Plan or as a result of receiving a portion of the
amounts expended thereunder by the Fund.
Under its terms, the Plan continued until April 30, 1992 and provides
that it will remain in effect from year to year thereafter, provided such
continuance is approved annually by a vote of the Trustees in the manner
described above. The most recent continuance of the Plan for one year, until
April 30, 1994, was approved by the Trustees of the Fund, including a majority
of the Independent 12b-1 Trustees, at a meeting held on April 28, 1993. At that
meeting, the Trustees, including a majority of the Independent 12b-1 Trustees,
also approved certain technical amendments to the Plan in connection with
recent amendments adopted by the National Association of Securities Dealers,
Inc. to its Rules of Fair Practice. Prior to approving the continuation of the
Plan, the Trustees requested and received from the Distributor and reviewed all
the information which they deemed necessary to arrive at an informed
determination. In making their determination to continue the Plan, the Trustees
considered: (1) the Fund's experience under the Plan and whether such
experience indicates that the Plan is operating as anticipated; (2) the
benefits the Fund had obtained, was obtaining and would be likely to obtain
under the Plan; and (3) what services had been provided and were continuing to
be provided under the Plan to the Fund and its shareholders. Based upon their
review, the Trustees of the Fund, including each of the Independent 12b-1
Trustees, determined that continuation of the Plan would be in the best
interest of the Fund and would have a reasonable likelihood of continuing to
benefit the Fund and its shareholders. In the Trustees' quarterly review of the
Plan, they will consider its continued appropriateness and the level of
compensation provided therein.
The Plan may not be amended to increase materially the amount to be
spent for the services described therein without approval by the shareholders
of the Fund, and all material amendments to the Plan must also be approved by
the Trustees in the manner described above. The Plan may be terminated at any
time, without payment of any penalty, by vote of a majority of the Independent
12b-1 Trustees or by a vote of a majority of the outstanding voting securities
of the Fund (as defined in the Act) on not more than thirty days' written
notice to any other party to the Plan. The Plan will automatically terminate in
the event of its assignment (as defined in the Act). So long as the Plan is in
effect, the election and nomination of Independent 12b-1 Trustees shall be
committed to the discretion of the Independent 12b-1 Trustees.
DETERMINATION OF NET ASSET VALUE
As stated in the Prospectus, short-term securities with remaining
maturities of sixty days or less at the time of purchase are valued at
amortized cost, unless the Trustees determine such does not reflect the
securities' market value, in which case these securities will be valued at
their fair value as determined by the Trustees. Other short-term debt
securities will be valued on a mark-to-market basis until such time as they
reach a remaining maturity of sixty days, whereupon they will be valued at
amortized cost using their value on the 61st day unless the Trustees determine
such does not reflect the securities' market value, in which case these
securities will be valued at their fair value as determined by the Trustees.
Listed options on debt securities are valued at the latest sale price on the
exchange on which they are listed unless no sales of such options have taken
place that day, in which case they will be valued at the mean between their
latest bid and asked prices. Unlisted options on debt securities and all
options on
32
<PAGE>
equity securities are valued at the mean between their latest bid and asked
prices. Futures are valued at the latest sale price on the commodities exchange
on which they trade unless the Trustees determine such price does not reflect
their market value, in which case they will be valued at their fair value as
determined by the Trustees. All other securities and other assets are valued at
their fair value as determined in good faith under procedures established by
and under the supervision of the Trustees.
The net asset value per share of the Fund is determined at 4:00 p.m.,
New York time, on each day the New York Stock Exchange is open, by taking the
value of all the assets of the Fund, subtracting all liabilities, dividing by
the number of shares outstanding and adjusting the result to the nearest cent.
The New York Stock Exchange currently observes the following holidays: New
Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving Day and Christmas Day.
SHAREHOLDER SERVICES
===============================================================================
Upon the purchase of shares of the Fund, a Shareholder Investment
Account is opened for the investor on the books of the Fund, maintained by the
Fund's Transfer Agent, Dean Witter Trust Company (the "Transfer Agent"). This
is an open account in which shares owned by the investor are credited by the
Transfer Agent in lieu of issuance of a share certificate. If a share
certficate is desired, it must be requested in writing for each transaction.
Certificates are issued only for full shares and may be redeposited in the
account at any time. There is no charge to the investor for issuance of a
certificate. Whenever a transaction takes place in the Shareholder Investment
Account, the shareholder will be mailed a confirmation of the transaction from
the Fund or from DWR or other selected broker-dealer.
Automatic Investment of Dividends and Distributions. As stated in the
Prospectus, all income dividends and capital gains distributions are
automatically paid in full and fractional shares of the Fund, unless the
shareholder requests that they be paid in cash. Each purchase of shares of the
Fund is made upon the condition that the Transfer Agent is thereby
automatically appointed as agent of the investor to receive all dividends and
capital gains distributions on shares owned by the investor. Such dividends and
distributions will be paid, at the net asset value per share, in shares of the
Fund (or in cash if the shareholder so requests) as of the close of business on
the record date. At any time an investor may request the Transfer Agent, in
writing, to have subsequent dividends and/or capital gains distributions paid
to him or her in cash rather than shares. To assure sufficient time to process
the change, such request should be received by the Transfer Agent at least five
business days prior to the record date of the dividend or distribution. In the
case of recently purchased shares for which registration instructions have not
been received on the record date, cash payments will be made to DWR or other
selected broker-dealer, and will be forwarded to the shareholder, upon the
receipt of proper instructions.
Targeted DividendsSM In states where it is legally permissible,
shareholders may also have all income dividends and capital gains distributions
automatically invested in shares of an open-end Dean Witter Fund other than
Dean Witter Diversified Income Trust. Such investment will be made as described
above for automatic investment in shares of the Fund, at the net asset value
per share of the selected Dean Witter Fund as of the close of business on the
payment date of the dividend or distribution and will begin to earn dividends,
if any, in the selected Dean Witter Fund the next business day. To participate
in the Targeted Dividends program, shareholders should contact their DWR or
other selected broker-dealer account executive or the Transfer Agent.
Shareholders of the Fund must be shareholders of the Dean Witter Fund targeted
to receive investments from dividends at the time they enter the Targeted
Dividends program. Investors should review the prospectus of the targeted Dean
Witter Fund before entering the program.
EasyInvest.SM Shareholders may subscribe to EasyInvest, an automatic
purchase plan which provides for any amount from $100 to $5,000 to be
transferred automatically from a checking or savings account, on a semi-
monthly, monthly or quarterly basis, to the Transfer Agent for investment in
shares of the Fund. Shares purchased through EasyInvest will be added to the
shareholder's existing account at the net asset value calculated the same
business day the transfer of funds is effected. For further information or to
subscribe to EasyInvest, shareholders should contact their DWR or other
selected broker-dealer account executive or the Transfer Agent.
33
<PAGE>
Investment of Distributions Received in Cash. Any shareholder who receives
a cash payment representing a dividend or distribution may invest such dividend
or distribution at net asset value, without the imposition of a contingent
deferred sales charge upon redemption, by returning the check or the proceeds
to the Transfer Agent within thirty days after the payment date. If the
shareholder returns the proceeds of a dividend or distribution, such funds must
be accompanied by a signed statement indicating that the proceeds constitute a
dividend or distribution to be invested. Such investment will be made at the
net asset value per share next determined after receipt of the check or the
proceeds by the Transfer Agent.
Direct Investments through Transfer Agent. A shareholder may make
additional investments in Fund shares at any time by sending a check in any
amount, not less than $100, payable to Dean Witter Diversified Income Trust,
directly to the Fund's Transfer Agent. Such amounts will be applied to the
purchase of Fund shares at the net asset value per share next determined after
receipt of the check or purchase payment by the Transfer Agent. The shares so
purchased will be credited to the investor's account.
Systematic Withdrawal Plan. As discussed in the Prospectus, a systematic
withdrawal plan ("Withdrawal Plan") is available for shareholders who own or
purchase shares of the Fund having a minimum value of $10,000 based upon the
then current net asset value. The Withdrawal Plan provides for monthly or
quarterly (March, June, September and December) checks in any dollar amount,
not less than $25, or in any whole percentage of the account balance, on an
annualized basis. Any applicable contingent deferred sales charge will be
imposed on shares redeemed under the Withdrawal Plan (see "Redemptions and
Repurchases--Contingent Deferred Sales Charge"). Therefore, any shareholder
participating in the Withdrawal Plan will have sufficient shares redeemed from
his or her account so that the proceeds (net of any applicable contingent
deferred sales charge) to the shareholder will be the designated monthly or
quarterly amount.
Dividends and capital gains distributions on shares held under the
Systematic Withdrawal Plan will be invested in additional full and fractional
shares at net asset value (without a sales charge). Shares will be credited to
an open account for the investor by the Transfer Agent; no share certificates
will be issued. A shareholder is entitled to a share certificate upon written
request to the Transfer Agent, although in that event the shareholder's
Systematic Withdrawal Plan will be terminated.
The Transfer Agent acts as agent for the shareholder in tendering to the
Fund for redemption sufficient full and fractional shares to provide the amount
of the periodic withdrawal payment designated in the application. The shares
will be redeemed at their net asset value determined, at the shareholder's
option, on the tenth or twenty-fifth day (or next following business day) of
the relevant month or quarter and normally a check for the proceeds will be
mailed by the Transfer Agent or amounts credited to a shareholder's DWR or
other selected broker-dealer brokerage account, within five business days after
the date of redemption. The Withdrawal Plan may be terminated at any time by
the Fund.
Withdrawal Plan payments should not be considered as dividends, yields or
income. If periodic withdrawal plan payments continously exceed net investment
income and net capital gains, the shareholder's original investment will be
correspondingly reduced and ultimately exhausted.
Each withdrawal constitutes a redemption of shares and any gain or loss
realized must be recognized for federal income tax purposes. Although the
shareholder may make additional investments of $2,500 or more under the
Withdrawal Plan, withdrawals made concurrently with purchases of additional
shares may be inadvisable because of the contingent deferred sales charge
applicable to the redemption of shares purchased during the preceding six years
(see "Redemption and Repurchases-Contingent Deferred Sales Charge").
Any shareholder who wishes to have payments under the Withdrawal Plan made
to a third party or sent to an address other than the one listed on the account
must send complete written instructions to the Transfer Agent to enroll in the
Withdrawal Plan. The shareholder's signature on such instructions must be
guaranteed by an eligible guarantor acceptable to the Transfer Agent
(shareholders should contact the Transfer Agent for a determination as to
whether a particular institution is such an eligible guarantor). A shareholder
may, at any time, change the amount and interval of withdrawal payments through
34
<PAGE>
his or her account executive or by written notification to the Transfer Agent.
In addition, the party and/or the address to which checks are mailed may be
changed by written notification to the Transfer Agent, with signature
guarantees required in the manner described above. The shareholder may also
terminate the Withdrawal Plan at any time by written notice to the Transfer
Agent. In the event of such termination, the account will be continued as a
regular shareholder investment account. The shareholder may also redeem all or
part of the shares held in the Withdrawal Plan account (see "Redemptions and
Repurchases" in the Prospectus) at any time.
EXCHANGE PRIVILEGE
As discussed in the Prospectus, the Fund makes available to its
shareholders an Exchange Privilege whereby shareholders of the Fund may
exchange their shares for shares of other Dean Witter Funds sold with a
contingent deferred sales charge ("CDSC funds"), and for shares of Dean Witter
Short-Term U.S. Treasury Trust, Dean Witter Limited Term Municipal Trust, Dean
Witter Short-Term Bond Fund and five Dean Witter Funds which are money market
funds (the foregoing eight non-CDSC funds are hereinafter referred to as the
"Exchange Funds"). Exchanges may be made after the shares of the Fund acquired
by purchase (not by exchange or dividend reinvestment) have been held for
thirty days. There is no waiting period for exchanges of shares acquired by
exchange or dividend reinvestment. An exchange will be treated for federal
income tax purposes the same as a repurchase or redemption of shares, on which
the shareholder may realize a capital gain or loss.
Any new account established through the Exchange Privilege will have the
same registration and cash dividend or dividend reinvestment plan as the
present account, unless the Transfer Agent receives written notification to
the contrary. For telephone exchanges, the exact registration of the existing
account and the account number must be provided.
Any shares held in certificate form cannot be exchanged but must be
forwarded to the Transfer Agent and deposited into the shareholder's account
before being eligible for exchange. (Certificates mailed in for deposit should
not be endorsed.)
As described below, and in the Prospectus under the captions "Exchange
Privilege" and "Contingent Deferred Sales Charge", a contingent deferred sales
charge ("CDSC") may be imposed upon a redemption, depending on a number of
factors, including the number of years from the time of purchase until the time
of redemption or exchange ("holding period"). When shares of the Fund or any
other CDSC fund are exchanged for shares of an Exchange Fund, the exchange is
executed at no charge to the shareholder, without the imposition of the CDSC at
the time of the exchange. During the period of time the shareholder remains in
the Exchange Fund (calculated from the last day of the month in which the
Exchange Fund shares were acquired), the holding period or "year since purchase
payment made" is frozen. When shares are redeemed out of the Exchange Fund,
they will be subject to a CDSC which would be based upon the period of time the
shareholder held shares in a CDSC fund. However, in the case of shares
exchanged into an Exchange Fund on or after April 23, 1990, upon a redemption
of shares which results in a CDSC being imposed, a credit (not to exceed the
amount of the CDSC) will be given in an amount equal to the Exchange Fund 12b-1
distribution fees incurred on or after that date which are attributable to
those shares. Shareholders acquiring shares of an Exchange Fund pursuant to
this exchange privilege may exchange those shares back into a CDSC fund from
the Exchange Fund, with no CDSC being imposed on such exchange. The holding
period previously frozen when shares were first exchanged for shares of the
Exchange Fund resumes on the last day of the month in which shares of a CDSC
fund are reacquired. A CDSC is imposed only upon an ultimate redemption, based
upon the time (calculated as described above) the shareholder was invested in a
CDSC fund.
In addition, shares of the Fund may be acquired in exchange for shares
of Dean Witter Funds sold with a front-end sales charge ("FESC funds"), but
shares of the Fund, however acquired, may not be exchanged for shares of FESC
funds. Shares of a CDSC fund acquired in exchange for shares of an FESC fund
(or in exchange for shares of other Dean Witter Funds for which shares of an
FESC fund have been exchanged) are not subject to any CDSC upon their
redemption.
When shares initially purchased in a CDSC fund are exchanged for shares
of another CDSC fund or for shares of an Exchange Fund, the date of purchase of
the shares of the fund exchanged into, for
35
<PAGE>
purposes of the CDSC upon redemption, will be the last day of the month in
which the shares being exchanged were originally purchased. In allocating the
purchase payments between funds for purposes of the CDSC, the amount which
represents the current net asset value of shares at the time of the exchange
which were (i) purchased more than three or six years (depending on the CDSC
schedule applicable to the shares) prior to the exchange, (ii) originally
acquired through reinvestment of dividends or distributions and (iii) acquired
in exchange for shares of FESC funds, or for shares of other Dean Witter Funds
for which shares of FESC funds have been exchanged (all such shares called
"Free Shares"), will be exchanged first. Shares of Dean Witter American Value
Fund acquired prior to April 30, 1984, shares of Dean Witter Dividend Growth
Securities Inc. and Dean Witter Natural Resource Development Securities Inc.
acquired prior to July 2, 1984, and shares of Dean Witter Strategist Fund
acquired prior to November 8, 1989 are also considered Free Shares and will be
the first Free Shares to be exchanged. After an exchange, all dividends earned
on shares in an Exchange Fund will be considered Free Shares. If the exchanged
amount exceeds the value of such Free Shares, an exchange is made, on a block-
by-block basis, of non-Free Shares held for the longest period of time (except
that if shares held for identical periods of time but subject to different CDSC
schedules are held in the same Exchange Privilege Account, the shares of that
block that are subject to a lower CDSC rate will be exchanged prior to the
shares of that block that are subject to a higher CDSC rate). Shares equal to
any appreciation in the value of non-Free Shares exchanged will be treated as
Free Shares, and the amount of the purchase payments for the non-Free Shares of
the fund exchanged into will be equal to the lesser of (a) the purchase
payments for, or (b) the current net asset value of, the exchanged non-Free
Shares. If an exchange between funds would result in exchange of only part of a
particular block of non-Free Shares, then shares equal to any appreciation in
the value of the block (up to the amount of the exchange) will be treated as
Free Shares and exchanged first, and the purchase payment for that block will
be allocated on a pro rata basis between the non-Free Shares of that block to
be retained and the non-Free Shares to be exchanged. The prorated amount of
such purchase payment attributable to the retained non-Free Shares will remain
as the purchase payment for such shares, and the amount of purchase payment for
the exchanged non-Free Shares will be equal to the lesser of (a) the prorated
amount of the purchase payment for, or (b) the current net asset value of,
those exchanged non-Free Shares. Based upon the procedures described in the
CDSC fund Prospectus under the caption "Contingent Deferred Sales Charge", any
applicable CDSC will be imposed upon the ultimate redemption of shares of any
fund, regardless of the number of exchanges since those shares were originally
purchased.
The Transfer Agent acts as agent for shareholders of the Fund in
effecting redemptions of Fund shares and in applying the proceeds to the
purchase of other fund shares. In the absence of negligence on its part,
neither the Transfer Agent nor the Fund shall be liable for any redemption of
Fund shares caused by unauthorized telephone or telegraph instructions.
Accordingly, in such event, the investor shall bear the risk of loss. The staff
of the Securities and Exchange Commission is currently considering the
propriety of such a policy.
With respect to the repurchase of shares of the Fund, the application
of proceeds to the purchase of new shares in the Fund or any other of the funds
and the general administration of the Exchange Privilege, the Transfer Agent
acts as agent for the Distributor and for the shareholder's selected broker-
dealer, if any, in the performance of such functions. With respect to
exchanges, redemptions or repurchases, the Transfer Agent shall be liable for
its own negligence and not for the default or negligence of its correspondents
or for losses in transit. The Fund shall not be liable for any default or
negligence of the Transfer Agent, the Distributor or any selected broker-
dealer.
The Distributor and any selected broker-dealer have authorized and
appointed the Transfer Agent to act as their agent in connection with the
application of proceeds of any redemption of Fund shares to the purchase of the
shares of any other fund and the general administration of the Exchange
Privilege. No commission or discounts will be paid to the Distributor or any
selected broker-dealer for any transactions pursuant to this Exchange
Privilege.
Exchanges are subject to the minimum investment requirement and any
other conditions imposed by each fund. (The minimum initial investment is
$5,000 for Dean Witter Liquid Asset Fund Inc., Dean Witter Tax-Free Daily
Income Trust, Dean Witter California Tax-Free Daily Income Trust, and Dean
Witter New York Municipal Money Market Trust, although those funds may, at
their discretion, accept
36
<PAGE>
initial investments of as low as $1,000. The minimum initial investment for
Dean Witter Short-Term U.S. Treasury Trust is $10,000 although that Fund, in
its discretion, may accept initial purchases of as low as $5,000. The minimum
initial investment for all other Dean Witter Funds for which the Exchange
Privilege is available is $1,000.) Upon exchange into an Exchange Fund, the
shares of that fund will be held in a special Exchange Privilege Account
separately from accounts of those shareholders who have acquired their shares
directly from that fund. As a result, certain services normally available to
shareholders of those funds, including the check writing feature, will not be
available for funds held in that account.
The Fund and each of the other Dean Witter Funds may limit the number
of times this Exchange Privilege may be exercised by any investor within a
specified period of time. Also, the Exchange Privilege may be terminated or
revised at any time by the Fund and/or any of the Dean Witter Funds for which
shares of the Fund have been exchanged, upon such notice as may be required by
applicable regulatory agencies (presently sixty days' prior written notice for
termination or material revision), provided that six months' prior written
notice of termination will be given to the shareholders who hold shares of the
Exchange Funds pursuant to this Exchange Privilege, and provided further that
the Exchange Privilege may be terminated or materially revised at times (a)
when the New York Stock Exchange is closed for other than customary weekends
and holidays, (b) when trading on that Exchange is restricted, (c) when an
emergency exists as a result of which disposal by the Fund of securities owned
by it is not reasonably practicable or it is not reasonably practicable for the
Fund fairly to determine the value of its net assets, (d) during any other
period when the Securities and Exchange Commission by order so permits
(provided that applicable rules and regulations of the Securities and Exchange
Commission shall govern as to whether the conditions prescribed in (b) or (c)
exist), or (e), if the Fund would be unable to invest amounts effectively in
accordance with its investment objective(s), policies and restrictions.
The current prospectus for each fund describes its investment
objective(s) and policies, and shareholders should obtain a copy and examine it
carefully before investing. An exchange will be treated for federal income tax
purposes the same as a repurchase or redemption of shares, on which the
shareholder may realize a capital gain or loss. However, the ability to deduct
capital losses on an exchange may be limited in situations where there is an
exchange of shares within ninety days after the shares are purchased. The
Exchange Privilege is only available in states where an exchange may legally be
made.
For further information regarding the Exchange Privilege, shareholders
should contact their DWR or other selected broker-dealer account executive or
the Transfer Agent.
REDEMPTIONS AND REPURCHASES
===============================================================================
Redemption. As stated in the Prospectus, shares of the Fund can be
redeemed for cash at any time at the net asset value per share next determined;
however, such redemption proceeds may be reduced by the amount of any
applicable contingent deferred sales charges (see below). If shares are held in
a shareholder's account without a share certificate, a written request for
redemption to the Fund's Transfer Agent at P.O. Box 983, Jersey City, NJ 07303
is required. If certificates are held by the shareholder, the shares may be
redeemed by surrendering the certificates with a written request for
redemption. The share certificate, or an accompanying stock power, and the
request for redemption, must be signed by the shareholder or shareholders
exactly as the shares are registered. Each request for redemption, whether or
not accompanied by a share certificate, must be sent to the Fund's Transfer
Agent, which will redeem the shares at their net asset value next computed (see
"Purchase of Fund Shares" in the Prospectus) after it receives the request, and
certificate, if any, in good order. Any redemption request received after such
computation will be redeemed at the next determined net asset value. The term
"good order" means that the share certificate, if any, and request for
redemption are properly signed, accompanied by any documentation required by
the Transfer Agent, and bear signature guarantees when required by the Fund or
the Transfer Agent. If redemption is requested by a corporation, partnership,
trust or fiduciary, the Transfer Agent may require that written evidence of
authority acceptable to the Transfer Agent be submitted before such request is
accepted.
Whether certificates are held by the shareholder or shares are held in
a shareholder's account, if the proceeds are to be paid to any person other
than the record owner, or if the proceeds are to be paid to a corporation
(other than the Distributor or a selected broker-dealer for the account of the
shareholder),
37
<PAGE>
partnership, trust or fiduciary, or sent to the shareholder at an address other
than the registered address, signatures must be guaranteed by an eligible
guarantor acceptable to the Transfer Agent (shareholders should contact the
Transfer Agent for a determination as to whether a particular institution is
such an eligible guarantor). A stock power may be obtained from any dealer or
commercial bank. The Fund may change the signature guarantee requirements from
time to time upon notice to shareholders, which may be by means of a new
prospectus.
Contingent Deferred Sales Charge. As stated in the Prospectus, a
contingent deferred sales charge ("CDSC") will be imposed on any redemption by
an investor if after such redemption the current value of the investor's shares
of the Fund is less than the dollar amount of all payments by the shareholder
for the purchase of Fund shares during the preceding six years. However, no
CDSC will be imposed to the extent that the net asset value of the shares
redeemed does not exceed: (a) the current net asset value of shares purchased
more than six years prior to the redemption, plus (b) the current net asset
value of shares purchased through reinvestment of dividends or distributions of
the Fund or another Dean Witter Fund (see "Shareholder Services--Targeted
Dividends"), plus (c) the current net asset value of shares acquired in
exchange for (i) shares of Dean Witter front-end sales charge funds, or (ii)
shares of other Dean Witter Funds for which shares of front-end sales charge
funds have been exchanged (see "Shareholder Services--Exchange Privilege"),
plus (d) increases in the net asset value of the investor's shares above the
total amount of payments for the purchase of Fund shares made during the
preceding six years. The CDSC will be paid to the Distributor.
In determining the applicability of the CDSC to each redemption, the
amount which represents an increase in the net asset value of the investor's
shares above the amount of the total payments for the purchase of shares within
the last six years will be redeemed first. In the event the redemption amount
exceeds such increase in value, the next portion of the amount redeemed will be
the amount which represents the net asset value of the investor's shares
purchased more than six years prior to the redemption and/or shares purchased
through reinvestment of dividends or distributions and/or shares acquired in
exchange for shares of Dean Witter front-end sales charge funds, or for shares
of other Dean Witter funds for which shares of front-end sales charge funds
have been exchanged. A portion of the amount redeemed which exceeds an amount
which represents both such increase in value and the value of shares purchased
more than six years prior to the redemption and/or shares purchased through
reinvestment of dividends or distributions and/or shares acquired in the above-
described exchanges will be subject to a CDSC.
The amount of the CDSC, if any, will vary depending on the number of
years from the time of payment for the purchase of Fund shares until the time
of redemption of such shares. For purposes of determining the number of years
from the time of any payment for the purchase of shares, all payments made
during a month will be aggregated and deemed to have been made on the last day
of the month. The following table sets forth the rates of the CDSC:
CONTINGENT DEFERRED
YEAR SINCE SALES CHARGE
PURCHASE AS A PERCENTAGE OF
PAYMENT MADE AMOUNT REDEEMED
------------ -------------------
First........................................ 5.0%
Second....................................... 4.0%
Third........................................ 3.0%
Fourth....................................... 2.0%
Fifth........................................ 2.0%
Sixth........................................ 1.0%
Seventh and thereafter....................... None
In determining the rate of the CDSC it will be assumed that a
redemption is made of shares held by the investor for the longest period of
time within the applicable six-year period. This will result in any such CDSC
being imposed at the lowest possible rate. Accordingly, shareholders may
redeem, without incurring any CDSC, amounts equal to any net increase in the
value of their shares above the amount of their purchase payments made within
the past six years and amounts equal to the current value of shares purchased
more than six years prior to the redemption and shares purchased through
reinvestment of
38
<PAGE>
dividends or distributions or acquired in exchange for shares of Dean Witter
front-end sales charge funds, or for shares of other Dean Witter Funds for
which shares of front-end sales charge funds have been exchanged. The CDSC will
be imposed, in accordance with the table shown above, on any redemptions within
six years of purchase which are in excess of these amounts and which
redemptions are not (a) requested within one year of death or initial
determination of disability of a shareholder, or (b) made pursuant to certain
taxable distributions from retirement plans or retirement accounts, as
described in the Prospectus.
Payment for Shares Redeemed or Repurchased. As discussed in the Prospectus,
payment for shares presented for repurchase or redemption will be made by check
within seven days after receipt by the Transfer Agent of the certificate and/or
written request in good order. The term good order means that the share
certificate, if any, and request for redemption are properly signed,
accompanied by any documentation required by the Transfer Agent, and bear
signature guarantees when required by the Fund or the Transfer Agent. Such
payment may be postponed or the right of redemption suspended at times (a) when
the New York Stock Exchange is closed for other than customary weekends and
holidays, (b) when trading on that Exchange is restricted, (c) when an
emergency exists as a result of which disposal by the Fund of securities owned
by it is not reasonably practicable or it is not reasonably practicable for the
Fund fairly to determine the value of its net assets, or (d) during any other
period when the Securities and Exchange Commission by order so permits;
provided that applicable rules and regulations of the Securities and Exchange
Commission shall govern as to whether the conditions prescribed in (b) or (c)
exist. If the shares to be redeemed have recently been purchased by check
(including a certified or bank cashier's check), payment of redemption proceeds
may be delayed for the minimum time needed to verify that the check used for
investment has been honored (not more than fifteen days from the time of
receipt of the check by the Transfer Agent). Shareholders maintaining margin
accounts with DWR or another selected broker-dealer are referred to their
account executive regarding restrictions on redemption of shares of the Fund
pledged in the margin account.
Transfers of Shares. In the event a shareholder requests a transfer of
shares to a new registration, such shares will be transferred without sales
charge at the time of transfer. With regard to the status of shares which are
either subject to the contingent deferred sales charge or free of such charge
(and with regard to the length of time shares subject to the charge have been
held), any transfer involving less than all of the shares in an account will be
made on a pro-rata basis (that is, by transferring shares in the same
proportion that the transferred shares bear to the total shares in the account
immediately prior to the transfer). The transferred shares will continue to be
subject to any applicable contingent deferred sales charge as if they had not
been so transferred.
Reinstatement Privilege. As described in the Prospectus, a shareholder
who has had his or her shares redeemed or repurchased and has not previously
exercised this reinstatement privilege may, within thirty days after the date
of the redemption or repurchase, reinstate any portion or all of the proceeds
of such redemption or repurchase in shares of the Fund at net asset value
(without sales charge) next determined after a reinstatement request, together
with the proceeds, is received by the Transfer Agent.
Exercise of the reinstatement privilege will not affect the federal income
tax treatment of any gain or loss realized upon the redemption or repurchase,
except that if the redemption or repurchase resulted in a loss and
reinstatement is made in shares of the Fund, some or all of the loss, depending
on the amount reinstated, will not be allowed as a deduction for federal income
tax purposes but will be applied to adjust the cost basis of the shares
acquired upon reinstatement.
DIVIDENDS, DISTRIBUTIONS AND TAXES
===============================================================================
As discussed in the Prospectus, the Fund will determine either to
distribute or to retain all or part of any net long-term capital gains in any
year for reinvestment. If any such gains are retained, the Fund will pay
federal income tax thereon, and will notify shareholders that, following an
election by the Fund, the shareholders will be required to include such
undistributed gains in determining their taxable income and may claim their
share of the tax paid by the Fund as a credit against their individual federal
income tax.
39
<PAGE>
Gains or losses on sales of securities by the Fund will generally be long-
term capital gains or losses if the securities have been held by the Fund for
more than twelve months. Gains or losses on the sale of securities held for
twelve months or less will be generally short-term gains or losses.
The Fund has qualified and intends to remain qualified as a regulated
investment company under Subchapter M of the Internal Revenue Code (the
"Code"). If so qualified, the Fund will not be subject to federal income tax on
its net investment income and capital gains, if any, realized during any fiscal
year in which it distributes such income and capital gains to its shareholders.
In addition, the Fund intends to distribute to its shareholders each calendar
year a sufficient amount of ordinary income and capital gains to avoid the
imposition of a 4% excise tax. Shareholders will normally have to pay federal
income taxes, and any state and/or local income taxes, on the dividends and
distributions they receive from the Fund. Such dividends and distributions, to
the extent that they are derived from net investment income or short-term
capital gains, are taxable to the shareholder as ordinary income regardless of
whether the shareholder receives such payments in additional shares or in cash.
Any dividends declared in the last quarter of any year which are paid in the
following year prior to February 1 will be deemed received by the shareholder
in the prior year.
Any dividend or capital gains distribution received by a shareholder from
any investment company will have the effect of reducing the net asset value of
the shareholder's stock in that company by the exact amount of the dividend or
capital gains distribution. Furthermore, capital gains distributions and
dividends are subject to federal income taxes. If the net asset value of the
shares should be reduced below a shareholder's cost as a result of the payment
of dividends or the distribution of realized net long-term capital gains, such
payment or distribution would be in part a return of the shareholder's
investment to the extent of such reduction below the shareholder's cost, but
nonetheless would be fully taxable. Therefore, an investor should consider the
tax implications of purchasing Fund shares immediately prior to a dividend or
distribution record date.
Any loss realized by shareholders upon a redemption of shares within six
months of the date of their purchase will be treated as a long-term capital
loss to the extent of any distributions of net long-term capital gains during
the six-month period.
Dividends, interest and capital gains received by the Fund may give
rise to withholding and other taxes imposed by foreign countries. Tax
conventions between certain countries and the United States may reduce or
eliminate such taxes. Investors may be entitled to claim United States foreign
tax credits or deductions with respect to such taxes, subject to certain
provisions and limitations contained in the Code. If more than 50% of the
Fund's total assets at the close of its fiscal year consist of securities of
foreign corporations, the Fund would be eligible and would determine whether or
not to file an election with the Internal Revenue Service pursuant to which
shareholders of the Fund will be required to include their respective pro rata
portions of such withholding taxes in their United States income tax returns as
gross income, treat such respective pro rata portions as taxes paid by them,
and deduct such respective pro rata portions in computing their taxable income
or, alternatively, use them as foreign tax credits against their United States
income taxes. If the Fund makes such election, it will report annually to its
shareholders the amount per share of such withholding.
Special Rules for Certain Foreign Currency Transactions. In general,
gains from foreign currencies and from foreign currency options, foreign
currency futures and forward foreign exchange contracts relating to investments
in stock, securities or foreign currencies are currently considered to be
qualifying income for purposes of determining whether the Fund qualifies as a
regulated investment company. It is currently unclear, however, who will be
treated as the issuer of certain foreign currency instruments or how foreign
currency options, futures, or forward foreign currency contracts will be valued
for purposes of the regulated investment company diversification requirements
applicable to the Fund. The Fund may request a private letter ruling from the
Internal Revenue Service on some or all of these issues.
Under Code Section 988, special rules are provided for certain
transactions in a foreign currency other than the taxpayer's functional
currency (i.e., unless certain special rules apply, currencies other than the
U.S. dollar). In general, foreign currency gains or losses from forward
contracts, from futures contracts, and from options will be treated as
ordinary income or loss under Code Section 988. Also,
40
<PAGE>
certain foreign exchange gains or losses derived with respect to foreign fixed-
income securities are also subject to Section 988 treatment. In general,
therefore, Code Section 988 gains or losses will increase or decrease the
amount of the Fund's investment company taxable income available to be
distributed to shareholders as ordinary income, rather than increasing or
decreasing the amount of the Fund's net capital gain. Additionally, if Code
Section 988 losses exceed other investment company taxable income during a
taxable year, the Fund would not be able to make any ordinary dividend
distributions.
After the end of the calendar year, shareholders will be sent full
information on their dividends and capital gains distributions for tax
purposes, including information as to the portion taxable as ordinary income,
the portion taxable as long-term capital gains and the portion eligible for the
dividends received deduction. To avoid being subject to a 31% federal backup
withholding tax on taxable dividends, capital gains distributions and the
proceeds of redemptions and repurchases, shareholders' taxpayer identification
numbers must be furnished and certified as to their accuracy.
Shareholders are urged to consult their attorneys or tax advisers
regarding specific questions as to federal, state or local taxes.
PERFORMANCE INFORMATION
===============================================================================
As discussed in the Prospectus, from time to time the Fund may quote
its "yield" and/or its "total return" in advertisements and sales literature.
Yield is calculated for any 30-day period as follows: the amount of interest
and/or dividend income for each security in the Fund's portfolio is determined
in accordance with regulatory requirements; the total for the entire portfolio
constitutes the Fund's gross income for the period. Expenses accrued during the
period are subtracted to arrive at "net investment income". The resulting
amount is divided by the product of the maximum offering price per share on
the last day of the period multiplied by the average number of Fund shares
outstanding during the period that were entitled to dividends. This amount is
added to 1 and raised to the sixth power. 1 is then subtracted from the result
and the difference is multiplied by 2 to arrive at the annualized yield. For
the 30-day period ended October 31, 1993, the Fund's yield, calculated pursuant
to this formula, was 6.38%.
The Fund's "average annual total return" represents an annualization of the
Fund's total return over a particular period and is computed by finding the
annual percentage rate which will result in the ending redeemable value of a
hypothetical $1,000 investment made at the beginning of a one, five or ten year
period, or for the period from the date of commencement of the Fund's
operations, if shorter than any of the foregoing. The ending redeemable value
is reduced by any contingent deferred sales charge at the end of the one, five,
or ten year or other period. For the purpose of this calculation, it is
assumed that all dividends and distributions are reinvested. The formula for
computing the average annual total return involves a percentage obtained by
dividing the ending redeemable value by the amount of the initial investment,
taking a root of the quotient (where the root is equivalent to the number of
years in the period) and subtracting 1 from the result. The average annual
total return of the Fund for the fiscal year ended October 31, 1993 and for the
period April 9, 1992 (commencement of operations) through October 31, 1993 was
5.0% and 6.36%, respectively.
In addition to the foregoing, the Fund may advertise its total return over
different periods of time by means of aggregate, average, year-by-year or other
types or total return figures. Such calculations may or may not reflect the
deduction of the contingent deferred sales charge which, if reflected, would
reduce the performance quoted. For example, the average annual total return of
the Fund may be calculated in the manner described above, but without deduction
for any applicable contingent deferred sales charge. Based on this calculation,
the average annual total return of the Fund for the fiscal year ended October
31, 1993 and for the period April 9, 1992 through October 31, 1993 was 10.0%
and 8.82%, respectively.
In addition, the Fund may compute its aggregate total return for specified
periods by determining the aggregate percentage rate which will result in the
ending value of a hypothetical $1,000 investment made at the beginning of the
period. For the purpose of this calculation, it is assumed that all dividends
and distributions are reinvested. The formula for computing aggregate total
return involves a percentage obtained by dividing the ending value (without
reduction for any sales charge) by the initial $1,000 investment and
subtracting 1 from the result. Based upon the foregoing calculations, the
Fund's total return for
41
<PAGE>
the fiscal year ended October 31, 1993 and for the period April 9, 1992 through
October 31, 1993 was 10.00% and 14.10%, respectively.
The Fund may also advertise the growth of hypothetical investments of
$10,000, $50,000, and $100,000 in shares of the Fund by adding 1 to the Fund's
aggregate total return to date (expressed as a decimal and without taking into
account the effect of any applicable CDSC) and multiplying by 10,000, $50,000,
and $100,000, as the case may be. Investments of $10,000, $50,000 or $100,000
in the Fund at inception would have grown to $11,410, $57,050, and $114,100,
respectively at October 31, 1993.
The Fund from time to time may also advertise its performance relative to
certain performance rankings and indexes compiled by independent organizations.
DESCRIPTION OF SHARES OF THE FUND
===============================================================================
The shareholders of the Fund are entitled to a full vote for each full
share held. The Trustees have been elected by the shareholders of the Fund at a
Special Meeting of Shareholders held on January 12, 1993. The Trustees
themselves have the power to alter the number and the terms of office of the
Trustees, and they may at any time lengthen their own terms or make their terms
of unlimited duration and appoint their own successors, provided that always at
least a majority of the Trustees has been elected by the shareholders of the
Fund. Under certain circumstances the Trustees may be removed by action of the
Trustees. The shareholders also have the right under certain circumstances to
remove the Trustees in accordance with the provisions of Section 16(c) of the
Investment Company Act of 1940. The voting rights of shareholders are not
cumulative, so that holders of more than 50 percent of the shares voting can,
if they choose, elect all Trustees being selected, while the holders of the
remaining shares would be unable to elect any Trustees.
The Declaration of Trust permits the Trustees to authorize the creation of
additional series of shares (the proceeds of which would be invested in
separate, independently managed portfolios) and additional classes of shares
within any series (which would be used to distinguish among the rights of
different categories of shareholders, as might be required by future
regulations or other unforeseen circumstances). However, the Trustees have not
authorized any such additional series or classes of shares.
The Declaration of Trust further provides that no Trustee, officer,
employee or agent of the Fund is liable to the Fund or to a shareholder, nor is
any Trustee, officer, employee or agent liable to any third persons in
connection with the affairs of the Fund, except as such liability may arise
from his or its own bad faith, willful misfeasance, gross negligence, or
reckless disregard of his duties. It also provides that all third persons shall
look solely to the Fund's property for satisfaction of claims arising in
connection with the affairs of the Fund. With the exceptions stated, the
Declaration of Trust provides that a Trustee, officer, employee or agent is
entitled to be indemnified against all liability in connection with the affairs
of the Fund.
The Fund is authorized to issue an unlimited number of shares of
beneficial interest. The Fund shall be of unlimited duration subject to the
provisions in the Declaration of Trust concerning termination by action of the
shareholders.
CUSTODIAN AND TRANSFER AGENT
===============================================================================
The Bank of New York, 110 Washington Street, New York, New York 10286
is the Custodian of the Fund's assets as described in groupings 2 and 3 in the
Prospectus. The Chase Manhattan Bank, One Chase Plaza, New York, New York
10005 is the Custodian of the Fund's assets as described in grouping 1 in the
Prospectus. As Custodian, The Chase Manhattan Bank has contracted with various
foreign banks and depositaries to hold portfolio securities of non-U.S. issuers
on behalf of the Fund. Any Fund cash balances with either Custodian in excess
of $100,000 are unprotected by Federal deposit insurance. Such amounts may, at
times, be substantial.
42
<PAGE>
Dean Witter Trust Company, Harborside Financial Center, Plaza Two,
Jersey City, New Jersey 07311 is the Transfer Agent of the Trust's shares and
Dividend Disbursing Agent for payment of dividends and distributions on Trust
shares and Agent for shareholders under various investment plans described
herein. Dean Witter Trust Company is an affiliate of Dean Witter InterCapital
Inc., the Fund's Investment Manager, and Dean Witter Distributors Inc., the
Fund's Distributor. As Transfer Agent and Dividend Disbursing Agent, Dean
Witter Trust Company's responsibilities include maintaining shareholder
accounts; disbursing cash dividends and reinvesting dividends; processing
account registration changes; handling purchase and redemption transactions;
mailing prospectuses and reports; mailing and tabulating proxies; processing
share certificate transactions; and maintaining shareholder records and lists.
For these services Dean Witter Trust Company receives a per shareholder account
fee from the Fund.
INDEPENDENT ACCOUNTANTS
===============================================================================
Price Waterhouse serves as the independent accountants of the Fund. The
independent accountants are responsible for auditing the annual financial
statements of the Fund.
REPORTS TO SHAREHOLDERS
===============================================================================
The Fund will send to shareholders, at least semi-annually, reports
showing the Fund's portfolio and other information. An annual report,
containing financial statements audited by independent accountants, will be
sent to shareholders each year.
The Fund's fiscal year ends on October 31. The financial statements of the
Fund must be audited at least once a year by independent accountants whose
selection is made annually by the Fund's Board of Trustees.
LEGAL COUNSEL
===============================================================================
Sheldon Curtis, Esq., who is an officer and the General Counsel of the
Investment Manager, is an officer and the General Counsel of the Fund.
EXPERTS
===============================================================================
The Financial Statements of the Fund for the fiscal year ended October
31, 1993 included in this Statement of Additional Information and incorporated
by reference in the Prospectus have been so included and incorporated in
reliance on the report of Price Waterhouse, independent accountants, given on
the authority of said firm as experts in auditing and accounting.
REGISTRATION STATEMENT
===============================================================================
This Statement of Additional Information and the Prospectus do not
contain all of the Information set forth in the Registration Statement the Fund
has filed with the Securities and Exchange Commission. The complete
Registration Statement may be obtained from the Securities and Exchange
Commission upon payment of the fee prescribed by the rules and regulations of
the Commission.
43
<PAGE>
<TABLE>
DEAN WITTER DIVERSIFIED INCOME TRUST
PORTFOLIO OF INVESTMENTS October 31, 1993
===================================================================================================================================
<CAPTION>
Principal
Amount (in Coupon Maturity
thousands) Rate Date Value
- --------- ---- ---- -----
<C> <S> <C> <C> <C>
CURRENCY DENOMINATED+++
BONDS (94.9%)
AUSTRALIA (2.4%)
GOVERNMENT OBLIGATION (2.4%)
Au$ 5,600 New South Wales Treasury Bond................................. 8.50 % 3/ 1/96 $ 3,979,071
-----------
CANADA (2.7%)
GOVERNMENT OBLIGATION (2.7%)
Ca$ 5,468 Government of Canada Treasury Bond............................ 10.25 3/ 1/96 4,587,978
-----------
DENMARK (3.1%)
GOVERNMENT OBLIGATIONS (3.1%)
DKr 29,000 Government of Denmark Treasury Note........................... 9.75 2/10/95 4,435,269
4,522 Government of Denmark Treasury Note........................... 9.25 8/10/95 700,639
-----------
TOTAL DENMARK................................................. 5,135,908
-----------
FINLAND (0.9%)
GOVERNMENT OBLIGATION (0.9%)
FMk 8,000 Government of Finland Treasury Note........................... 11.00 6/15/95 1,488,734
-----------
FRANCE (2.8%)
GOVERNMENT OBLIGATION (2.8%)
FFr 25,174 Government of France Treasury Bond............................ 9.80 1/30/96 4,689,111
-----------
GERMANY (2.7%)
GOVERNMENT OBLIGATIONS (2.7%)
DEM 2,900 Bundes Schatzweisungen........................................ 8.875 7/20/95 1,823,396
2,200 Government of Germany Bundes Obligation....................... 8.625 2/20/96 2,679,854
-----------
TOTAL GERMANY................................................. 4,503,250
-----------
ITALY (4.2%)
GOVERNMENT OBLIGATIONS (4.2%)
ITL 4,100,000 Government of Italy Treasury Bond............................. 12.00 1/ 1/96 2,665,959
6,700,000 Government of Italy Treasury Bond............................. 11.50 3/ 1/96 4,352,443
-----------
TOTAL ITALY................................................... 7,018,402
-----------
NEW ZEALAND (3.9%)
GOVERNMENT OBLIGATION (3.9%)
NZ$ 11,400 Government of New Zealand Treasury Bond....................... 8.00 11/15/95 6,615,660
-----------
SPAIN (4.3%)
GOVERNMENT OBLIGATION (4.3%)
ESP 866,000 Government of Spain Treasury Note............................. 13.45 4/15/96 7,173,125
-----------
UNITED KINGDOM (4.0%)
GOVERNMENT OBLIGATIONS (4.0%)
POUND 1,700 United Kingdom Treasury Gilt.................................. 12.75 11/15/95 2,880,289
2,209 United Kingdom Treasury Gilt.................................. 13.25 5/15/96 3,864,986
-----------
TOTAL UNITED KINGDOM.......................................... 6,745,275
-----------
UNITED STATES (63.9%)
AEROSPACE (2.7%)
US$ 3,000 GPA Del, Inc.................................................. 8.75 12/15/98 2,306,250
2,000 PA Holdings Corp.............................................. 13.75 7/15/99 2,142,500
-----------
4,448,750
-----------
</TABLE>
44
<PAGE>
<TABLE>
DEAN WITTER DIVERSIFIED INCOME TRUST
PORTFOLIO OF INVESTMENTS October 31, 1993 (continued)
===================================================================================================================================
<CAPTION>
Principal
Amount (in Coupon Maturity
thousands) Rate Date Value
- --------- ---- ---- -----
<C> <S> <C> <C> <C>
BUILDING & CONSTRUCTION (2.6%)
US$ 2,010 American Standard, Inc........................................ 14.25 % 6/30/03 $ 2,165,775
2,000 Snydergeneral Corp............................................ 14.25 11/15/00 2,125,000
-----------
4,290,775
-----------
CABLE & TELECOMMUNICATIONS (1.9%)
2,000 Cablevision Systems Corp...................................... 14.00* 11/15/03 2,120,000
1,000 Marcus Cable.................................................. 11.875 10/ 1/05 1,055,000
-----------
3,175,000
-----------
CHEMICALS (2.7%)
1,000 General Chemical Corp......................................... 14.00 11/ 1/98 1,125,000
3,112 Georgia Gulf Corp............................................. 15.00 4/15/00 3,442,650
-----------
4,567,650
-----------
CONSUMER PRODUCTS (1.0%)
1,631 Playtex Family Products Corp.................................. 14.75 ++ 12/15/97 1,704,395
-----------
CONTAINERS (1.3%)
2,000 Crown Packaging--144A(b)...................................... 12.25 ++ 11/ 1/03 880,000
3,000 Ivex Holdings Corp. Series B.................................. 13.25 ++ 3/15/05 1,365,000
-----------
2,245,000
-----------
ENTERTAINMENT, GAMING & LODGING (2.2%)
1,705 Aztar Mortgage Funding, Inc................................... 13.50 9/15/96 1,811,563
1,000 Trump Plaza Holding Assoc..................................... 12.50 + 6/15/03 940,000
1,019 Trump Taj Mahal Funding, Inc.................................. 11.35 + 11/15/99 999,858
-----------
3,751,421
-----------
FOREST & PAPER PRODUCTS (3.4%)
400 Container Corp................................................ 15.50 ++ 12/ 1/04 768,000
3,000 Fort Howard Corp.............................................. 14.125++ 11/ 1/04 2,730,000
3,000 Gaylord Container Corp........................................ 12.75 ++ 5/15/05 2,145,000
-----------
5,643,000
-----------
HEALTHCARE (0.2%)
250 Epic Healthcare Group, Inc.................................... 15.00 2/ 1/01 273,750
-----------
HEALTHCARE--PRODUCTS (1.4%)
2,000 Alco Health Service Corp...................................... 14.50 9/15/99 2,260,000
-----------
MANUFACTURING (4.3%)
1,500 Carlisle Plastic Corp......................................... 13.75 4/ 1/97 1,599,375
1,000 Flagstar Corp................................................. 11.25 11/ 1/04 1,016,250
3,000 Jordan Industries, Inc........................................ 11.75 ++ 8/ 1/05 1,672,500
1,500 MS Essex Holdings, Inc........................................ 16.00 ++ 5/15/04 1,290,000
1,000 Talley Industries, Inc........................................ 12.25 ++ 10/15/05 557,500
1,000 Uniroyal Technology Corp...................................... 11.75 6/ 1/03 995,000
10 Uniroyal Technology Corp. (Warrants) (a)...................... 6/ 1/03 20,000
-----------
7,150,625
-----------
OIL & GAS (0.3%)
500 Presidio Oil Co.--144A(b)..................................... 13.85 * 7/15/02 520,000
-----------
RESTAURANTS (1.2%)
1,000 Carrols Corp.................................................. 11.50 8/15/03 1,015,000
1,000 Foodmaker, Inc................................................ 14.25 5/15/98 1,067,500
-----------
2,082,500
-----------
</TABLE>
45
<PAGE>
<TABLE>
DEAN WITTER DIVERSIFIED INCOME TRUST
PORTFOLIO OF INVESTMENTS October 31, 1993 (continued)
===================================================================================================================================
<CAPTION>
Principal
Amount (in Coupon Maturity
thousands) Rate Date Value
- --------- ---- ---- -----
<C> <S> <C> <C> <C>
RETAIL (2.9%)
US$ 1,000 Cole National Group, Corp..................................... 11.25 % 10/ 1/01 $ 991,250
2,000 Cort Furniture Rental Corp. (Series Unit)..................... 12.00 9/ 1/00 2,019,980
2,000 County Seat Stores Co......................................... 12.00 10/ 1/01 1,950,000
-----------
4,961,230
-----------
RETAIL--FOOD CHAINS (3.2%)
600 Big Bear Stores Co............................................ 13.75 6/15/99 650,250
1,500 Cullum Cos., Inc.............................................. 16.00++ 12/ 1/03 1,485,000
2,000 Food 4 Less Holdings, Inc..................................... 15.25++ 12/15/04 1,260,000
15,000 Grand Union Capital Corp. (Series A).......................... 0 1/15/07 1,912,500
-----------
5,307,750
-----------
TEXTILES (1.2%)
2,000 Collins & Aikman Corp......................................... 11.875 6/ 1/01 1,935,000
-----------
GOVERNMENT AGENCIES (25.2%)
653 Federal National Mortgage Association......................... 7.50 2/ 1/22 678,591
99 Federal National Mortgage Association......................... 7.50 3/ 1/22 102,500
3,293 Federal National Mortgage Association......................... 8.00 6/ 1/22 3,440,676
267 Federal National Mortgage Association......................... 7.50 7/ 1/22 277,379
2,792 Federal National Mortgage Association......................... 7.50 8/ 1/22 2,898,973
992 Federal National Mortgage Association......................... 7.50 9/ 1/22 1,030,367
911 Federal National Mortgage Association......................... 7.00 10/ 1/22 933,030
31 Federal National Mortgage Association......................... 7.00 11/ 1/22 31,592
81 Federal National Mortgage Association......................... 7.50 11/ 1/22 84,307
31 Federal National Mortgage Association......................... 7.00 12/ 1/22 31,847
4,471 Federal National Mortgage Association......................... 7.50 12/ 1/22 4,642,568
5,775 Federal National Mortgage Association......................... 7.50 1/ 1/23 5,996,728
1,768 Federal National Mortgage Association......................... 7.50 2/ 1/23 1,835,571
973 Federal National Mortgage Association......................... 7.00 3/ 1/23 997,363
963 Federal National Mortgage Association......................... 7.00 5/ 1/23 986,540
3,920 Federal National Mortgage Association......................... 7.00 7/ 1/23 4,016,515
2,940 Federal National Mortgage Association......................... 6.50 10/ 1/23 2,959,294
2,940 Federal National Mortgage Association......................... 7.00 10/ 1/23 3,012,589
2,000 Federal National Mortgage Association......................... 6.50 ** 1,998,750
2,000 Federal National Mortgage Association......................... 6.50 ** 2,005,625
4,000 Federal National Mortgage Association......................... 7.00 ** 4,098,750
-----------
42,059,555
-----------
GOVERNMENT OBLIGATIONS (6.2%)
2,000 United States Treasury Note................................... 3.875 8/31/95 1,997,188
2,000 United States Treasury Note................................... 3.875 10/31/95 1,995,000
1,000 United States Treasury Note................................... 4.75 9/30/98 996,406
2,000 United States Treasury Note................................... 4.75 10/31/98 1,990,625
4,000 United States Treasury Strip.................................. 0 5/15/97 3,405,404
-----------
10,384,623
-----------
TOTAL UNITED STATES........................................... 106,761,024
-----------
TOTAL BONDS (IDENTIFIED COST $159,058,523).................... 158,697,538
-----------
SHORT-TERM INVESTMENTS (10.2%)
PORTUGAL (2.0%)
BANKING--INTERNATIONAL (2.0%)
PTE567,166 Chemical Bank Time Deposit (Identified Cost $3,257,701)....... 11.00 11/11/93 3,282,209
-----------
</TABLE>
46
<PAGE>
<TABLE>
DEAN WITTER DIVERSIFIED INCOME TRUST
PORTFOLIO OF INVESTMENTS October 31, 1993 (continued)
===================================================================================================================================
<CAPTION>
Principal
Amount (in Coupon Maturity
thousands) Rate Date Value
- --------- ---- ---- -----
<C> <S> <C> <C> <C>
UNITED STATES (7.5%)
FINANCIAL SERVICES (4.5%)
US$ 7,500 Exxon Credit Corporation Commercial Paper (c)................. 2.951% 11/ 1/93 $ 7,500,000
------------
GOVERNMENT OBLIGATIONS (3.0%)
3,000 United States Treasury Note................................... 9.00 11/15/93 3,006,094
2,000 United States Treasury Note................................... 13.125 5/15/94 2,103,750
------------
5,109,844
------------
TOTAL UNITED STATES (Identified Cost $12,705,546)............. 12,609,844
------------
REPURCHASE AGREEMENT (0.7%)
1,091 The Bank of New York 2.9375% due 11/01/93 (dated 10/29/93; pro-
ceeds $1,091,413; collateralized by $1,095,203 U.S. Treasury
Note 4.25% due 7/31/94 valued at $1,113,342)
(Identified Cost $1,091,146)................................. 1,091,146
------------
TOTAL SHORT-TERM INVESTMENTS
(IDENTIFIED COST $17,054,393)................................ 16,983,199
------------
TOTAL INVESTMENTS (IDENTIFIED COST $176,112,916)(D)........... 105.1% 175,680,737
LIABILITIES IN EXCESS OF CASH AND OTHER ASSETS................ (5.1) (8,544,039)
------ ------------
NET ASSETS.................................................... 100.0% $167,136,698
====== ============
<FN>
- ------------
* Adjustable rate. Rate shown is the rate in effect at October 31, 1993.
** Securities purchased on a forward commitment basis with an approximate principal amount and no definite maturity date; the
actual principal amount and maturity date will be determined upon settlement.
+ Payment in kind security.
++ Currently zero coupon under terms of the initial offering.
+++ Percentages of holdings are presented in the portfolio by currency denomination. Percentages by country of issuers are as
follows: Australia 2.4%, Canada 2.7%, Denmark 3.1%, Finland 0.9%, France 2.8%, Germany 2.7%, Italy 4.2%, New Zealand 3.9%,
Portugal 2.0%, Spain 4.3%, United Kindom 4.0%, United States 72.1%.
(a) Non-income producing.
(b) Resale is restricted to qualified institutional investors.
(c) Security was purchased on a discount basis. The interest rate shown has been adjusted to reflect a bond equivalent yield.
(d) The aggregate cost for federal income tax purposes is $176,140,572; the aggregate gross unrealized appreciation is $2,044,672
and the aggregate gross unrealized depreciation is $2,504,507, resulting in net unrealized depreciation of $459,835.
FORWARD CONTRACTS FOR THE SALE OF FOREIGN CURRENCY AT OCTOBER 31, 1993:
<CAPTION> Unrealized
Contracts In Exchange Delivery Appreciation/
to Deliver for Date (Depreciation)
---------- ----------- ---------- --------------
<S> <C> <C> <C> <C> <C>
AtS 29,610,000 US$ 2,502,239 04/25/94 $ 35,967
Ca$ 6,000,000 US$ 4,457,321 04/01/94 (55,507)
DKr 10,000,000 US$ 1,514,234 11/29/93 41,347
DEM 2,300,000 US$ 1,322,219 01/26/94 (37,399)
DEM 15,000,000 US$ 8,773,469 02/28/94 (71,946)
DEM 200,000 US$ 117,578 03/02/94 (297)
DEM 8,200,000 US$ 5,008,551 04/19/94 185,128
ESP 750,000,000 NGldr 10,039,892 02/02/94 (192,625)
FFr 1,700,000 US$ 281,900 01/18/94 (5,203)
FMk 8,600,000 US$ 1,478,527 01/12/94 (3,791)
NGldr 8,824,000 US$ 4,821,858 12/17/93 159,792
NGldr 5,808,000 US$ 3,026,261 02/24/94 (30,536)
SFr 1,524,000 US$ 1,030,356 02/28/94 6,453
---------
Net Unrealized Appreciation.................................... $ 31,383
=========
</TABLE>
See Notes to Financial Statements
47
<PAGE>
DEAN WITTER DIVERSIFIED INCOME TRUST
FINANCIAL STATEMENTS
===============================================================================
STATEMENT OF ASSETS AND LIABILITIES
October 31, 1993
===============================================================================
ASSETS:
Investments in securities, at value
(Identified cost $176,112,916) (Note 1)...................... $175,680,737
Cash (foreign currency)....................................... 40,617
Net appreciation on forward foreign currency contracts....... 31,383
Receivable for:
Shares of beneficial interest sold........................... 6,179,795
Interest..................................................... 3,891,519
Investments sold............................................. 2,014,069
Compensated foreign currency contracts....................... 1,123,106
Deferred organizational expenses (Note 1)..................... 103,795
Prepaid expenses.............................................. 1,463
-----------
TOTAL ASSETS................................................ 189,066,484
-----------
LIABILITIES:
Payable to custodian bank..................................... 6,148
Payable for:
Investments purchased........................................ 20,752,942
Compensated foreign currency contracts....................... 655,417
Shares of beneficial interest repurchased.................... 71,427
Dividend payable.............................................. 152,582
Plan of distribution fee payable (Note 3)..................... 112,897
Investment management fee payable (Note 2).................... 52,751
Accrued expenses and other payables (Note 4).................. 125,622
-----------
TOTAL LIABILITIES........................................... 21,929,786
-----------
NET ASSETS:
Paid in capital............................................... 166,579,981
Accumulated realized gain--net................................ 342,817
Unrealized depreciation--net.................................. (452,146)
Accumulated undistributed investment
income--net.................................................. 666,046
-----------
NET ASSETS ................................................. $167,136,698
============
NET ASSET VALUE PER SHARE, 16,379,593
shares outstanding (unlimited authorized
shares of $0.1 par value).................................... $10.20
======
<PAGE>
===============================================================================
STATEMENT OF OPERATIONS
For the year ended October 31, 1993
===============================================================================
INVESTMENT INCOME:
INTEREST (net of $45,610 in foreign
withholding tax)............................................. $9,897,918
---------
EXPENSES
Plan of distribution fee (Note 3)............................ 882,934
Investment management fee (Note 2)........................... 375,426
Custodian fees............................................... 81,663
Professional fees............................................ 79,734
Registration fees............................................ 66,786
Transfer agent fees & expenses
(Note 4).................................................... 60,161
Shareholder reports & notices................................ 48,473
Organizational expenses (Note 1)............................. 25,144
Trustees' fees & expenses.................................... 22,229
Other........................................................ 2,414
---------
TOTAL EXPENSES................................................ 1,644,964
---------
INVESTMENT INCOME--NET....................................... 8,252,954
---------
REALIZED AND UNREALIZED GAIN
(LOSS)--NET (Note 1):
Realized gain (loss) on:
Investments--net............................................ (188,449)
Foreign exchange transactions--net.......................... 1,063,461
---------
875,012
---------
Change in unrealized appreciation or
depreciation on:
Investments--net............................................ 466,641
Translation of foreign exchange forward contracts,
other assets and liabilities denominated in
foreign currencies--net.................................... (484,775)
---------
(18,134)
---------
NET GAIN.................................................... 856,878
---------
NET INCREASE IN NET ASSETS
RESULTING FROM OPERATIONS................................. $9,109,832
==========
<PAGE>
<TABLE>
STATEMENT OF CHANGES IN NET ASSETS
===================================================================================================================================
<CAPTION>
For the period
For the April 9, 1992 through
year ended October 1, 1992
October 31, 1993 (Note 1)
---------------- ----------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS:
Operations:
Investment income--net.................................... $ 8,252,954 $ 1,201,851
Realized gain (loss)--net................................. 875,012 (192,911)
Change in unrealized appreciation or depreciation--net.... (18,134) (434,012)
------------ ----------
Net increase in net assets resulting from operations....... 9,109,832 574,928
------------ ----------
Dividends and distributions to shareholders from:
Investment income--net.................................... (7,590,502) (1,198,257)
Realized gain on investments--net......................... (339,284) -0-
------------ ----------
(7,929,786) (1,198,257)
------------ ----------
Transactions in shares of beneficial interest--net
increase (Note 5)......................................... 110,659,806 55,820,175
------------ ----------
Total increase............................................. 111,839,852 55,196,846
NET ASSETS:
Beginning of period........................................ 55,296,846 100,000
------------ ----------
END OF PERIOD (including undistributed net investment
income of $666,046 and $3,594, respectively).............. $167,136,698 $55,296,846
============ ===========
</TABLE>
See Notes to Financial Statements
48
<PAGE>
DEAN WITTER DIVERSIFIED INCOME TRUST
NOTES TO FINANCIAL STATEMENTS
===============================================================================
1. ORGANIZATION AND ACCOUNTING POLICIES--Dean Witter Diversified Income Trust
(the "Fund") is registered under the Investment Company Act of 1940, as amended
(the "Act"), as a diversified, open-end management investment company. It was
organized on December 20, 1991 as a Massachusetts business trust and on
February 5, 1992 issued 10,000 shares of beneficial interest for $100,000 to
Dean Witter Reynolds Inc. to effect the Fund's initial capitalization. The
Fund commenced operations on April 9, 1992.
The following is a summary of the significant accounting policies:
A. Valuation of Investments--(1) an equity portfolio security listed or
traded on the New York or American Stock Exchange or other domestic or foreign
stock exchange is valued at its latest sale price on that exchange prior to the
time when assets are valued (4:00 p.m. New York time); if there were no sales
that day, the security is valued at the latest available bid price. In cases
where securities are traded on more than one exchange, the securities are
valued on the exchange designated as the primary market by the Trustees; (2)
all other portfolio securities for which over-the-counter market quotations are
readily available are valued at the latest available bid price prior to the
time of valuation; (3) when market quotations are not readily available,
portfolio securities are valued at their fair value as determined in good faith
under procedures established by and under the general supervision of the
Trustees (valuation of debt securities for which market quotations are not
readily available may be based upon current market prices of securities which
are comparable in coupon, rating and maturity or an appropriate matrix
utilizing similar factors); (4) certain of the Fund's portfolio securities may
be valued by an outside pricing service approved by the Fund's Trustees. The
pricing service utilizes a matrix system incorporating security quality,
maturity and coupon as the evaluation model parameters, and/or research and
evaluations by its staff, including review of broker-dealer market price
quotations, in determining what it believes is the fair valuation of the
portfolio securities valued by such pricing service; and (5) short-term debt
securities with remaining maturities of 60 days or less at the time of purchase
are valued at amortized cost; other short-term debt securities are valued on a
mark-to-market basis until such time as they reach a remaining maturity of 60
days, whereupon they will be valued at amortized cost using their value on the
61st day. All other securities and other assets are valued at their fair value
as determined in good faith under procedures established by and under the
supervision of the Trustees.
B. Accounting for Investments--Security transactions are accounted for
on the trade date (date the order to buy or sell is executed). In computing net
investment income, the Fund does not amortize premiums or accrue discounts on
fixed income securities in the portfolio, except those original issue discounts
for which amortization is required for federal income tax purposes.
Additionally, with respect to market discount on bonds, a portion of any
capital gain realized upon disposition may be recharacterized as investment
income. Realized gains and losses on security transactions are determined on
the identified cost method. Interest income is accrued daily except where
collection is not expected.
C. Foreign Currency Translation--The books and records of the Fund are
maintained in U.S. dollars as follows: (1) the foreign currency market value of
investment securities, other assets and liabilities and forward contracts
stated in foreign currencies are translated at the exchange rates at the end of
the period; and (2) purchases, sales, income and expenses are translated at the
rate of exchange prevailing on the respective dates of such transactions. The
resultant exchange gains and losses are included in the Statement of
Operations. Pursuant to U.S. Federal income tax regulations, certain net
foreign exchange gains/losses included in realized and unrealized gain/loss in
the Statement of Operations for the year ended October 31, 1993 are included in
or are a reduction of ordinary income for federal income tax purposes.
49
<PAGE>
DEAN WITTER DIVERSIFIED INCOME TRUST
NOTES TO FINANCIAL STATEMENTS (continued)
===============================================================================
D. Forward Foreign Currency Exchange Contracts--The Fund may enter into
forward foreign currency contracts as a hedge against fluctuations in future
foreign exchange rates. All forward contracts are valued daily at the
appropriate exchange rates and any resulting unrealized currency gains or
losses are reflected in the Fund's accounts. The Fund records realized gains or
losses on delivery of the currency or at the time the forward contract is
extinguished (compensated) by entry into a closing transaction prior to
delivery.
E. Federal Income Tax Status--It is the Fund's policy to comply with
the requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute all of its taxable income to its
shareholders. Accordingly, no federal income tax provision is required.
F. Dividends and Distributions to Shareholders--The Fund records
dividends and distributions to its shareholders on the ex-dividend date.
G. Organizational Expenses--The Fund's Investment Manager paid the
organizational expenses of the Fund in the amount of approximately $151,000.
Organizational expenses were reimbursed by the Fund for the full amount
exclusive of any amounts assumed by the Investment Manager. The Fund has
deferred and is amortizing the organizational expenses on the straight-line
method over a period not to exceed five years from the commencement of
operations.
H. Repurchase Agreements--The Fund's custodian takes possession on
behalf of the Fund of the collateral pledged for investments in repurchase
agreements. It is the policy of the Fund to value the underlying collateral
daily on a mark-to-market basis to determine that the value, including accrued
interest, is at least equal to the repurchase price plus accrued interest. In
the event of default of the obligation to repurchase, the Fund has the right to
liquidate the collateral and apply the proceeds in satisfaction of the
obligation.
2. INVESTMENT MANAGEMENT AGREEMENT--Pursuant to an Investment Management
Agreement (the "Agreement") with Dean Witter InterCapital Inc. (the "Investment
Manager"), formerly the Intercapital Division of Dean Witter Reynolds Inc., the
Fund pays its Investment Manager a management fee, accrued daily and payable
monthly, by applying the annual rate of .40% to the net assets of the Fund
determined as of the close of each business day.
Under the terms of the Agreement, in addition to managing the Fund's
investments, the Investment Manager maintains certain of the Fund's books and
records and furnishes office space and facilities, equipment, clerical,
bookkeeping and certain legal services, and pays the salaries of all personnel,
including officers of the Fund, who are employees of the Investment Manager.
The Investment Manager also bears the cost of telephone services, heat, light,
power and other utilities provided to the Fund.
The Investment Manager undertook to assume all expenses (except for the
Plan of Distribution fee and brokerage fees) and waive the compensation
provided for in the Agreement until January 1, 1993. The management fee waived
and the other expenses assumed by the Investment Manager approximated $42,000
and $43,000, respectively, for the period November 1, 1992 through December 31,
1992.
3. PLAN OF DISTRIBUTION--Shares of beneficial interest of the Fund are
distributed by Dean Witter Distributors Inc. (the "Distributor"), an affiliate
of the Investment Manager. The Fund has adopted a Plan of Distribution (the
"Plan") pursuant to Rule 12b-1 under the Act pursuant to which the Fund pays
the Distributor compensation accrued daily and payable monthly at the annual
rate of 0.85% of the lesser of: (a) the average daily aggregate gross sales of
the Fund's shares since the inception of the Fund (not including reinvestments
of dividends or capital gains distributions), less the average daily aggregate
net asset value of the Fund's shares redeemed since the Fund's inception upon
which a contingent deferred sales charge has been imposed or upon which such
charge has been waived; or (b) the Fund's average daily net assets. Amounts
paid under the Plan are paid to the Distributor to compensate it for the
services
50
<PAGE>
DEAN WITTER DIVERSIFIED INCOME TRUST
NOTES TO FINANCIAL STATEMENTS (continued)
===============================================================================
provided and the expenses borne by it and others in the distribution of the
Fund's shares, including the payment of commissions for sales of the Fund's
shares and incentive compensation to and expenses of account executives of Dean
Witter Reynolds Inc. and others, who engage in or support distribution of the
Fund's shares or who service shareholder accounts, including overhead and
telephone expenses; printing and distribution of prospectuses and reports used
in connection with the offering of the Fund's shares; and preparation, printing
and distribution of sales literature and advertising materials. In addition,
the Distributor may be compensated under the Plan for its opportunity costs in
advancing such amounts which compensation would be in the form of a carrying
charge on any unreimbursed expenses.
Provided that the Plan continues in effect, any cumulative expenses
incurred by the Distributor, but not yet recovered, may be recovered through
future distribution fees from the Fund and contingent deferred sales charges
from the Fund's shareholders.
The Distributor has informed the Fund that for the year ended October
31, 1993, it received approximately $152,000 in contingent deferred sales
charges from certain redemptions of the Fund's shares. The Fund's shareholders
pay such charges which are not an expense of the Fund.
4. SECURITY TRANSACTIONS AND TRANSACTIONS WITH AFFILIATES--The cost of
purchases and the proceeds from sales of portfolio securities for the year
ended October 31, 1993, excluding short-term investments, were as follows:
Purchases Sales
--------- -----
Corporate Bonds............................... $88,339,508 $54,822,266
Foreign Government Obligations................ 77,527,925 31,925,352
U.S. Government Agencies and Obligations...... 65,514,370 31,869,866
Dean Witter Trust Company, an affiliate of the Investment Manager and
Distributor, is the Fund's transfer agent. During the year ended October 31,
1993, the Fund incurred transfer agent fees and expenses of approximately
$60,000, of which approximately $10,000 was payable at October 31, 1993.
5. SHARES OF BENEFICIAL INTEREST--Transactions in shares of beneficial interest
were as follows:
<TABLE>
<CAPTION>
For the year ended For the year ended
October 31, 1993 October 31, 1992
------------------------------ -----------------------------
Shares Amount Shares Amount
----------- -------------- ---------- -------------
<S> <C> <C> <C> <C>
Sold.................. 13,123,934 $133,844,244 5,679,625 $57,481,672
Reinvestment of
dividends and
distributions........ 395,578 4,018,772 67,150 677,186
--------- ------------ --------- -----------
13,519,512 137,863,016 5,746,775 58,158,858
Repurchased........... (2,665,659) (27,203,210) (231,035) (2,338,683)
---------- ------------ --------- -----------
Net increase.......... 10,853,853 $110,659,806 5,515,740 $55,820,175
========== ============ ========= ===========
</TABLE>
6. FEDERAL INCOME TAX STATUS--During the year ended October 31, 1993 the Fund
utilized all of its net capital loss carryovers of approximately $80,000.
7. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK--At October 31, 1993, the
Fund had outstanding forward foreign currency exchange contracts ("forward
contracts") as a hedge against changes in future foreign exchange rates.
Forward contracts involve elements of market risk in excess of the amount
reflected in the Statement of Assets and Liabilities. The Fund bears the risk
of an unfavorable change in the foreign exchange rate underlying the forward
contract.
51
<PAGE>
<TABLE>
DEAN WITTER DIVERSIFIED INCOME TRUST
FINANCIAL HIGHLIGHTS
===================================================================================================================================
Selected data and ratios for a share of beneficial interest outstanding throughout each period:
<CAPTION>
For the period
For the year April 9, 1992*
ended through
October 31, 1993 October 31, 1992
---------------- ----------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period............. $ 10.01 $ 10.00
-------- -------
Investment income--net.......................... 0.77 0.37
Realized and unrealized gain--net............... 0.20 -0-
-------- -------
Total from investment operations................. 0.97 0.37
-------- -------
Less dividends and distributions:
Dividends from net investment income............ (0.73) (0.36)
Distributions to shareholders from net realized
gains on investments........................... (0.05) -0-
-------- -------
Total dividends and distributions................ (0.78) (0.36)
-------- -------
Net asset value, end of period................... $ 10.20 $ 10.01
======== =======
TOTAL INVESTMENT RETURN+.......................... 10.00% 3.73%(1)
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)......... $167,137 $55,297
Ratio of expenses to average net assets.......... 1.58%(4) 0.85%(2)(3)
Ratio of net investment income to average
net assets...................................... 7.92%(4) 7.86%(2)(3)
Portfolio turnover rate.......................... 117% 37%
<FN>
- ------------
* Date of commencement of operations.
+ Does not reflect the deduction of sales load.
(1) Not annualized.
(2) Annualized.
(3) If the fund had borne all expenses that were assumed or waived by the Investment Manager, the above annualized expense ratio
would have been 2.08% and the above annualized investment income--net ratio would have been 6.63%.
(4) If the fund had borne all expenses that were assumed or waived by the Investment Manager (Note 2), the above annualized expense
ratio would have been 1.66% and the above annualized investment income--net ratio would have been 7.84%.
</TABLE>
See Notes to Financial Statements
52
<PAGE>
DEAN WITTER DIVERSIFIED INCOME TRUST
REPORT OF INDEPENDENT ACCOUNTANTS
===============================================================================
To the Shareholders and Trustees of Dean Witter Diversified Income Trust
In our opinion, the accompanying statement of assets and liabilities, including
the portfolio of investments, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of Dean Witter Diversified Income
Trust (the "Fund") at October 31, 1993, the results of its operations for the
year then ended, the changes in its net assets and the financial highlights for
the year then ended and for the period April 9, 1992 (commencement of
operations) through October 31, 1992, in conformity with generally accepted
accounting principles. These financial statements and financial highlights
(hereafter referred to as "financial statements") are the responsibility of the
Fund's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
financial statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of securities owned at October 31, 1993 by correspondence with the
custodian and brokers, provide a reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE
New York, New York
December 14, 1993
53
<PAGE>
