<PAGE>
CAMBRIDGE SERIES TRUST
Supplement
dated April 13, 1995
to
Statement of Additional Information
dated January 27, 1995
The Statement of Additional Information of Cambridge Series
Trust (the "Trust") is hereby amended to reflect the following changes:
1. The name of Trust is changed from Cambridge Series Trust to
The Mentor Funds.
2. The names of the Portfolios of the Trust are changed as
follows:
i. Cambridge Growth Portfolio to Mentor/Cambridge Growth
Portfolio.
ii. Cambridge Capital Growth Portfolio to Mentor Capital
Growth Portfolio.
iii. Cambridge Government Income Portfolio to Mentor
Quality Income Portfolio.
iv. Cambridge Municipal Income Portfolio to Mentor
Municipal Income Portfolio.
v. Cambridge Income and Growth Portfolio to Mentor Income
and Growth Portfolio.
vi. Cambridge Global Portfolio to Mentor Perpetual Global
Portfolio.
3. The name of Cambridge Investment Advisors, Inc. is changed to
Commonwealth Advisors, Inc.
4. The name of Cambridge Distributors, Inc. is changed to Mentor
Distributors, Inc.
5. Perpetual Portfolio Management Ltd. has replaced Scudder,
Stevens & Clark as Sub-Advisor of the Global Portfolio.
6. Phoenix Investment Counsel, Inc. no longer serves as
Sub-Advisor to Mentor Capital Growth Portfolio.
7. Pacific Investment Management Company no longer serves as
Sub-Advisor to Mentor Quality Income Portfolio.
8. Kemper Financial Services no longer serves as Sub-Advisor to
Mentor/Cambridge Growth Portfolio.
9. The name of Investment Management Group, Inc. is changed to
Mentor Investment Group, Inc.
10. The Quality Income Portfolio's investment policies have been
modified. Please consult the prospectus of The Mentor Funds
dated April 13, 1995 for a discussion of the investment
policies of the Portfolio.
<PAGE>
January 27, 1995
Cambridge Series Trust
Cambridge Growth Portfolio
Cambridge Capital Growth Portfolio
Cambridge Government Income Portfolio
Cambridge Municipal Income Portfolio
Cambridge Income and Growth Portfolio
Cambridge Global Portfolio
Statement of Additional Information
This combined Statement of Additional Information should be read with the
combined Prospectus of Cambridge Series Trust (the "Trust") dated January
27, 1995. This Statement is not a prospectus itself. To receive a copy
of the Prospectus, write to the Trust or call 1-800-382-0016.
Statement dated January 27, 1995
Table of Contents
General Information About Brokerage Transactions 20
the Trust 1
How to Buy Shares 21
Investment Objectives and
Policies of the Distribution Plan (Class B Shares) 21
Portfolios 1
Conversion to Federal Funds 22
Repurchase Agreements 1
Purchases at Net Asset Value 22
When-Issued and Delayed
Delivery Transactions 1 Determining Net Asset
Value 22
Lending of Portfolio Securities 1
Determining Market Value
Bank Instruments 2 of Securities 22
Restricted Securities 2 Exchange Privilege 23
Lower-Grade Municipal
Securities 2 Redeeming Shares 23
Zero-Coupon Securities 4 Contingent Deferred Sales Charge 23
Reverse Repurchase Agreements 5 Redemptions in Kind 23
Futures and Options
Transactions 5 Tax Status 24
Futures Contracts 5 The Portfolios' Tax Status 24
Put Options on Futures
Contracts 5 Shareholders' Tax Status 25
Call Options on Futures
Contracts 6 Total Return 25
"Margin" in Futures
Transactions 6 Yield 26
Regulatory Restrictions 7 Tax-Equivalent Yield
(Municipal Income Portfolio) 26
Purchasing Put Options on
Portfolio Securities 7
Tax-Equivalency Table 26
Writing Covered Call
Options on Portfolio
Securities 7 Performance Comparisons 27
Over-the-Counter Options 7 Financial Statements 29
Collateralized Mortgage
Obligations (CMOs) 7 Appendix 30
Convertible Securities 8
Warrants 8
Dollar Rolls 8
Swaps, Caps, Floors and Collars 9
High Yield, High Risk Debt
Securities 10
Indexed Securities 10
Currency Transactions 11
Risk of Currency Transactions 12
Eurodollar Instruments 12
Portfolio Turnover 12
Investment Limitations 12
Management of the Trust 15
Officers and Trustees 15
Ownership of Portfolios 16
Trustee Liability 16
Investment Advisory
Services 16
Investment Adviser 16
Investment Adviser Fees 17
The Sub-Advisers 17
Distribution of Portfolio
Shares 19
Administrative Services 19
Shareholder Servicing Plan 19
I
General Information About the Trust
The Trust was established as a Massachusetts business trust on January 20,
1992. As of the date of this Statement, the Trust consists of two classes
of shares of beneficial interest, Class A and Class B shares, in each of
the following six separate portfolios of securities (collectively, the
1
"Portfolios" and each individually, the "Portfolio"): Cambridge Growth
Portfolio ("Growth Portfolio"); Cambridge Capital Growth Portfolio
("Capital Growth Portfolio"); Cambridge Government Income Portfolio
("Government Income Portfolio"); Cambridge Municipal Income Portfolio
("Municipal Income Portfolio"); and Cambridge Income and Growth Portfolio
("Income and Growth Portfolio"); and Cambridge Global Portfolio ("Global
Portfolio").
Investment Objectives and Policies of the Portfolios
The Prospectus discusses the objective of each Portfolio and the policies
it employs to achieve those objectives. The following discussion
supplements the description of the Portfolios' investment policies in the
Prospectus. The Portfolios' respective investment objectives cannot be
changed without approval of shareholders. Except as noted, the investment
policies described below may be changed by the Board of Trustees without
shareholder approval. Shareholders will be notified before any material
change in these policies becomes effective.
Repurchase Agreements
The Portfolios or their custodian will take possession of the securities
subject to repurchase agreements and these securities will be marked to
market daily. In the event that a defaulting seller filed for bankruptcy
or became insolvent, disposition of such securities by a Portfolio might be
delayed pending court action. The Portfolios believe that, under the
regular procedures normally in effect for custody of a Portfolio's
portfolio securities subject to repurchase agreements, a court of competent
jurisdiction would rule in favor of a Portfolio and allow retention or
disposition of such securities. The Portfolios will only enter into
repurchase agreements with banks and other recognized financial
institutions, such as broker/dealers, which are deemed by the adviser to be
creditworthy pursuant to guidelines established by the Board of Trustees.
When-Issued and Delayed Delivery Transactions
The Portfolios may engage in when-issued and delayed delivery transactions.
These transactions are arrangements in which a Portfolio purchases
securities with payment and delivery scheduled for a future time. A
Portfolio engages in when-issued and delayed delivery transactions only for
the purpose of acquiring portfolio securities consistent with its
investment objective and policies, not for investment leverage, but a
Portfolio may sell such securities prior to settlement date if such a sale
is considered to be advisable. No income accrues to the Portfolios on
securities in connection with such transactions prior to the date the
Portfolios actually take delivery of securities. In when-issued and
delayed delivery transactions, a Portfolio relies on the seller to complete
the transaction. The seller's failure to complete the transaction may
cause a Portfolio to miss a price or yield considered to be advantageous.
These transactions are made to secure what is considered to be an
advantageous price or yield for a Portfolio. Settlement dates may be a
2
month or more after entering into these transactions, and the market values
of the securities purchased may vary from the purchase prices. No fees or
other expenses, other than normal transaction costs, are incurred.
However, liquid assets of a Portfolio sufficient to make payment for the
securities to be purchased are segregated at the trade date. These
securities are marked to market daily and are maintained until the
transaction is settled. As a matter of policy, the Portfolios, other than
the Municipal Income Portfolio, do not intend to engage in when-issued and
delayed delivery transactions to an extent that would cause the segregation
of more than 20% of the total value of their respective assets.
Lending of Portfolio Securities
The collateral received when a Portfolio lends portfolio securities must be
valued daily and, should the market value of the loaned securities
increase, the borrower must furnish additional collateral to the particular
Portfolio. During the time portfolio securities are on loan, the borrower
pays a Portfolio any dividends or interest paid on such securities. Loans
are subject to termination at the option of a Portfolio or the borrower. A
Portfolio may pay reasonable administrative and custodial fees in
connection with a loan and may pay a negotiated portion of the interest
earned on the cash or equivalent collateral to the borrower or placing
broker.
A Portfolio would not have the right to vote securities on loan, but would
terminate the loan and regain the right to vote if that were considered
important with respect to the investment.
Bank Instruments
The Portfolios may invest in the instruments of banks and savings and loans
whose deposits are insured by the Bank Insurance Fund or the Savings
Association Insurance Fund, both of which are administered by the Federal
Deposit Insurance Corporation ("FDIC"), such as certificates of deposit,
demand and time deposits, savings shares, and bankers' acceptances.
However, the above-mentioned instruments are not necessarily guaranteed by
those organizations. In addition to domestic bank obligations, such as
certificates of deposit, demand and time deposits, savings shares, and
bankers' acceptances, the Portfolios may invest in:
(bullet) Eurodollar Certificates of Deposit ("ECDs") issued by foreign
branches of U.S. or foreign banks;
(bullet) Eurodollar Time Deposits ("ETDs"), which are U.S.
dollar-denominated deposits in foreign branches of U.S. or foreign
banks;
(bullet) Canadian Time Deposits, which are U.S. dollar-denominated deposits
issued by branches of major Canadian banks located in the U.S.; and
3
(bullet) Yankee Certificates of Deposit ("Yankee CDs"), which are U.S.
dollar-denominated certificates of deposit issued by U.S. branches
of foreign banks and held in the U.S.
Restricted Securities
The Portfolios may invest in restricted securities. Restricted securities
are any securities in which each Portfolio may otherwise invest pursuant to
its investment objective and policies but which are subject to restriction
on resale under federal securities law.
The ability of the Board of Trustees to determine the liquidity of certain
restricted securities is permitted under a Securities and Exchange
Commission ("SEC") Staff position set forth in the adopting release for
Rule 144A under the Securities Act of 1933 (the "Rule"). The Rule is a
non-exclusive, safe-harbor for certain secondary market transactions
involving securities subject to restrictions on resale under federal
securities laws. The Rule provides an exemption from registration for
resales of otherwise restricted securities to qualified institutional
buyers. The Rule was expected to further enhance the liquidity of the
secondary market for securities eligible for resale under the Rule. The
Trust, on behalf of the Portfolios, believes that the Staff of the SEC has
left the question of determining the liquidity of all restricted securities
(eligible for resale under Rule 144A) for determination of the Trust's
Board of Trustees. The Board of Trustees considers the following criteria
in determining the liquidity of certain restricted securities.
(bullet) the frequency of trades and quotes for the security;
(bullet) the number of dealers willing to purchase or sell the security
and the number of other potential buyers;
(bullet) dealer undertakings to make a market in the security; and
(bullet) the nature of the security and the nature of the marketplace trades.
Lower-Grade Municipal Securities
In normal circumstances, at least 80% of the Municipal Income Portfolio's
total assets will be invested in investment-grade tax-exempt municipal
securities and up to 20% of the Municipal Income Portfolio's total assets
may be invested in lower-grade tax-exempt municipal securities. The amount
of available information about the financial condition of municipal
4
securities issuers is generally less extensive than that for corporate
issuers with publicly traded securities, and the market for tax-exempt
municipal securities is considered to be generally less liquid than the
market for corporate debt obligations. Liquidity relates to the ability of
a Portfolio to sell a security in a timely manner at a price which reflects
the value of that security. As discussed below, the market for lower-grade
tax-exempt municipal securities is considered generally to be less liquid
than the market for investment-grade tax-exempt municipal securities.
Further, municipal securities in which the Municipal Income Portfolio may
invest include special obligation bonds, lease obligations, participation
certificates and variable rate instruments. The market for such securities
may be particularly less liquid. The relative illiquidity of some of the
Municipal Income Portfolio's securities may adversely affect the ability of
the Municipal Income Portfolio to dispose of such securities in a timely
manner and at a price which reflects the value of such security in the
Trust's judgment. Although the issuer of some such municipal securities
may be obligated to redeem such securities at face value, such redemption
could result in capital losses to the Municipal Income Portfolio to the
extent that such municipal securities were purchased by the Municipal
Income Portfolio at a premium to face value. The market for less liquid
securities tends to be more volatile than the market for more liquid
securities, and market values of relatively illiquid securities may be more
susceptible to change as a result of adverse publicity and investor
perceptions than are the market values of higher grade, more liquid
securities.
The Municipal Income Portfolio's net asset value will change with changes
in the value of its portfolio securities. Because the Municipal Income
Portfolio will invest primarily in fixed income municipal securities, the
Municipal Income Portfolio's net asset value can be expected to change as
general levels of interest rates fluctuate. When interest rates decline,
the value of a portfolio invested in fixed income securities can be
expected to rise. Conversely, when interest rates rise, the value of a
portfolio invested in fixed income securities can be expected to decline.
Net asset value and market value may be volatile due to the Municipal
Income Portfolio's investment in lower-grade and less liquid municipal
securities. Volatility may be greater during periods of general economic
uncertainty.
To the extent that there is no established retail market for some of the
securities in which the Municipal Income Portfolio may invest, there may be
relatively inactive trading in such securities and the ability of the Trust
to accurately value such securities may be adversely affected. During
periods of reduced market liquidity and in the absence of readily available
market quotations for securities held in the Municipal Income Portfolio,
the responsibility of the Trust to value the Municipal Income Portfolio's
securities becomes more difficult and the Trust's judgment may play a
greater role in the valuation of the Municipal Income Portfolio's
securities due to the reduced availability of reliable objective data. To
the extent that the Municipal Income Portfolio invests in illiquid
5
securities and securities which are restricted as to resale, the Municipal
Income Portfolio may incur additional risks and costs. Illiquid and
restricted securities are particularly difficult to dispose of. When
determining whether municipal leases purchased by the Municipal Income
Portfolio will be classified as a liquid or illiquid security, the Board of
Trustees has directed the Sub-Adviser to consider the following factors:
the frequency of trades and quotes for the security; the volatility of
quotations and trade prices for the security; the number of dealers willing
to purchase or sell the security and the number of potential purchases;
dealer undertaking to make a market in the security; the nature of the
security and the nature of the marketplace trades (e.g., the time needed to
dispose of the security, the method of soliciting offers, and the mechanics
of transfer); the rating of the security and the financial condition and
prospects of the issuer of the security; whether the lease can be
terminated by the lessee; the potential recovery, if any, from a sale of
the leased property upon termination of the lease; the lessee's general
credit strength (e.g., its debt, administrative, economic and financial
characteristics and prospects); the likelihood that the lessee will
discontinue appropriating funding for the leased property because the
property is no longer deemed essential to its operations (e.g., the
potential for an "event of nonappropriation"); any credit enhancement or
legal recourse provided upon an event of nonappropriation or other
termination of the lease; and such other factors as may be relevant to the
Portfolio's ability to dispose of the security.
Lower-grade tax-exempt municipal securities generally involve greater
credit risk than higher-grade municipal securities. A general economic
downturn or a significant increase in interest rates could severely disrupt
the market for lower-grade tax-exempt municipal securities and adversely
affect the market value of such securities. In addition, in such
circumstances, the ability of issuers of lower-grade tax-exempt municipal
securities to repay principal and to pay interest, to meet projected
financial goals and to obtain additional financing may be adversely
affected. Such consequences could lead to an increased incidence of
default for such securities and adversely affect the value of the lower-
grade tax-exempt municipal securities in the Municipal Income Portfolio
and, thus, the Portfolio's net asset value. The secondary market prices of
lower-grade tax-exempt municipal securities are less sensitive to changes
in interest rates than are those for higher rated tax-exempt municipal
securities, but are more sensitive to adverse economic changes or
individual issuer developments. Adverse publicity and investors'
perceptions, whether or not based on rational analysis, may also affect the
value and liquidity of lower-grade tax-exempt municipal securities.
Yields on the Municipal Income Portfolio's securities can be expected to
fluctuate over time. In addition, periods of economic uncertainty and
changes in interest rates can be expected to result in increased volatility
of the market prices of the lower-grade tax-exempt municipal securities in
the Municipal Income Portfolio's portfolio and, thus, in the net asset
value of the Portfolio. Net asset value and market value may be volatile
6
due to the Municipal Income Portfolio's investment in lower-grade and less
liquid municipal securities. Volatility may be greater during periods of
general economic uncertainty. The Municipal Income Portfolio may incur
additional expenses to the extent it is required to seek recovery upon a
default in the payment of interest or a repayment of principal on its
portfolio holdings, and the Municipal Income Portfolio may be unable to
obtain full recovery thereof. In the event that an issuer of securities
held by the Municipal Income Portfolio experiences difficulties in the
timely payment of principal or interest, and such issuer seeks to
restructure the terms of its borrowings, the Municipal Income Portfolio may
incur additional expenses and may determine to invest additional capital
with respect to such issuer or the project or projects to which the
Municipal Income Portfolio's securities relate. Recent and proposed
legislation may have an adverse impact on the market for lower-grade tax-
exempt municipal securities. Recent legislation requires federally-insured
savings and loan associations to divest their investments in lower-grade
bonds. Other legislation has, from time to time, been proposed which, if
enacted, could have an adverse impact on the market for lower-grade tax-
exempt municipal securities.
The Municipal Income Portfolio will rely on the Sub-Adviser's judgment,
analysis, and experience in evaluating the creditworthiness of an issue.
In this evaluation, the Sub-Adviser will take into consideration, among
other things, the issuer's financial resources, its sensitivity to economic
conditions and trends, its operating history, the quality of the issuer's
management and regulatory matters. The Sub-Adviser also may consider,
although it does not rely primarily on, the credit ratings of Standard &
Poor's Corporation ("S&P") and Moody's Investors Service, Inc. ("Moody's"),
in evaluating tax-exempt municipal securities. Such ratings evaluate only
the safety of principal and interest payments, not market value risk.
Additionally, because the creditworthiness of an issuer may change more
rapidly than is able to be timely reflected in changes in credit ratings,
the Sub-Adviser continuously monitors the issuers of tax-exempt municipal
securities held in the Municipal Income Portfolio. The Municipal Income
Portfolio may, if deemed appropriate by the Sub-Adviser, retain a security
whose rating has been downgraded below B-by S&P or below B3 by Moody's, or
whose rating has been withdrawn.
Because issuers of lower-grade tax-exempt municipal securities frequently
choose not to seek a rating of their municipal securities, the Sub-Adviser
will be required to determine the relative investment quality of many of
the municipal securities in the Municipal Income Portfolio. Further,
because the Municipal Income Portfolio may invest up to 20% of its total
assets in these lower-grade municipal securities, achievement by the
Municipal Income Portfolio of its investment objective may be more
dependent upon the Sub-Adviser's investment analysis than would be the case
if the Municipal Income Portfolio were investing exclusively in higher-
grade municipal securities. The relative lack of financial information
available with respect to issuers of municipal securities may adversely
affect the Sub-Adviser's ability to successfully conduct the required
7
investment analysis.
Zero-Coupon Securities
Zero-coupon securities in which the Income and Growth and Global Portfolios
may invest are debt obligations which are generally issued at a discount
and payable in full at maturity, and do not provide for current payments of
interest prior to maturity. Zero-coupon securities usually trade at a deep
discount from their face or par value and are subject to greater market
value fluctuations from changing interest rates than debt obligations of
comparable maturities which make current distributions of interest. As a
result, the net asset value of shares of a Portfolio investing in zero-
coupon securities may fluctuate over a greater range than shares of other
Portfolios and other mutual funds investing in securities making current
distributions of interest and having similar maturities.
Zero-coupon securities may include U.S. Treasury bills issued directly by
the U.S. Treasury or other short-term debt obligations, and longer-term
bonds or notes and their unmatured interest coupons which have been
separated by their holder, typically a custodian bank or investment
brokerage firm. A number of securities firms and banks have stripped the
interest coupons from the underlying principal (the "corpus") of U.S.
Treasury securities and resold them in custodial receipt programs with a
number of different names, including Treasury Income Growth Receipts
("TIGRS") and Certificates of Accrual on Treasuries ("CATS"). The
underlying U.S. Treasury bonds and notes themselves are held in book-entry
form at the Federal Reserve Bank or, in the case of bearer securities
(i.e., unregistered securities which are owned ostensibly by the bearer or
holder thereof), in trust on behalf of the owners thereof.
In addition, the Treasury has facilitated transfers of ownership of zero-
coupon securities by accounting separately for the beneficial ownership of
particular interest coupons and corpus payments on Treasury securities
through the Federal Reserve book-entry recordkeeping system. The Federal
Reserve program as established by the Treasury Department is known as
"STRIPS" or "Separate Trading of Registered Interest and Principal of
Securities." Under the STRIPS program, a Portfolio will be able to have its
beneficial ownership of U.S. Treasury zero-coupon securities recorded
directly in the book-entry recordkeeping system in lieu of having to hold
certificates or other evidence of ownership of the underlying U.S. Treasury
securities.
When debt obligations have been stripped of their unmatured interest
coupons by the holder, the stripped coupons are sold separately. The
principal or corpus is sold at a deep discount because the buyer receives
only the right to receive a future fixed payment on the security and does
not receive any rights to periodic cash interest payments. Once stripped
or separated, the corpus and coupons may be sold separately. Typically,
the coupons are sold separately or grouped with other coupons with like
maturity dates and sold in such bundled form. Purchasers of stripped
8
obligations acquire, in effect, discount obligations that are economically
identical to the zero-coupon securities issued directly by the obligor.
No more than 5% of the net assets of the Income and Growth Portfolio will
be invested in CATS, TIGRS or STRIPS.
Reverse Repurchase Agreements
The Portfolios may also enter into reverse repurchase agreements. These
transactions are similar to borrowing cash. In a reverse repurchase
agreement, the Portfolio transfers possession of a portfolio instrument to
another person, such as a financial institution, broker, or dealer, in
return for a percentage of the instrument's market value in cash, and
agrees that on a stipulated date in the future the Portfolio will
repurchase the portfolio instrument by remitting the original consideration
plus interest at an agreed upon rate. The use of reverse repurchase
agreements may enable the Portfolio to avoid selling portfolio instruments
at a time when a sale may be deemed to be disadvantageous, but the ability
to enter into reverse repurchase agreements does not ensure that the
Portfolio will be able to avoid selling portfolio instruments at a
disadvantageous time.
When effecting reverse repurchase agreements, liquid assets of the
Portfolio, in a dollar amount sufficient to make payment for the
obligations to be purchased, are segregated at the trade date. These
securities are marked to market daily and are maintained until the
transaction is settled.
Futures and Options Transactions
The Portfolios may engage in futures and options hedging transactions. The
Income and Growth Portfolio will not, however, utilize options on its
futures. In an effort to reduce fluctuations in the net asset value of
shares of a Portfolio, a Portfolio may attempt to hedge all or a portion of
its portfolio by buying and selling financial futures contracts, buying put
options on portfolio securities and listed put options on futures
contracts, and writing call options on futures contracts. A Portfolio may
also write covered call options on portfolio securities to attempt to
increase its current income. A Portfolio will maintain its positions in
securities, option rights, and segregated cash subject to puts and calls
until the options are exercised, closed, or have expired. An option
position on financial futures contracts may be closed out only on the
exchange on which the position was established.
Futures Contracts
The Portfolios may engage in transactions in futures contracts. A futures
contract is a firm commitment by two parties: the seller who agrees to
make delivery of the specific type of security called for in the contract
("going short") and the buyer who agrees to take delivery of the security
("going long") at a certain time in the future. However, a stock index
futures contract is an agreement pursuant to which two parties agree to
take or make delivery of an amount of cash equal to the difference between
9
the value of the index at the close of the last trading day of the contract
and the price at which the index contract was originally written. No
physical delivery of the underlying securities in the index is made.
The purpose of the acquisition or sale of a futures contract by a Portfolio
is to protect the Portfolio from fluctuations in the value of its
securities caused by anticipated changes in interest rates or market
conditions without necessarily buying or selling the securities. For
example, in the fixed income securities market, price generally moves
inversely to interest rates. A rise in rates generally means a drop in
price. Conversely, a drop in rates generally means a rise in price. In
order to hedge their holdings of fixed income securities against a rise in
market interest rates, Government Income Portfolio, Municipal Income
Portfolio, Income and Growth Portfolio and Global Portfolio could enter
into contracts to deliver securities at a predetermined price (i.e., "go
short") to protect themselves against the possibility that the prices of
their fixed income securities may decline during the anticipated holding
period. Any of these Portfolios would "go long" (i.e., agree to purchase
securities in the future at a predetermined price) to hedge against a
decline in market interest rates.
Put Options on Futures Contracts
The Portfolios, with the exception of the Income and Growth Portfolio, may
engage in transactions in put options on futures contracts. A Portfolio
may purchase listed put options on futures contracts. Unlike entering
directly into a futures contract, which requires the purchaser to buy a
financial instrument on a set date at a specified price, the purchase of a
put option on a futures contract entitles (but does not obligate) its
purchaser to decide on or before a future date whether to assume a short
position at the specified price. A Portfolio would purchase put options on
futures contracts to protect portfolio securities against decreases in
value resulting from market factors, such as an anticipated increase in
interest rates.
Generally, if the hedged portfolio securities decrease in value during the
term of an option, the related futures contracts will also decrease in
value and the option will increase in value. In such an event, a Portfolio
will normally close out its option by selling an identical option. If the
hedge is successful, the proceeds received by a Portfolio upon the sale of
the second option may be large enough to offset both the premium paid by
the Portfolio for the original option plus the decrease in value of the
hedged securities. Alternatively, a Portfolio may exercise its put option
to close out the position. To do so, it would simultaneously enter into a
futures contract of the type underlying the option (for a price less than
the strike price of the option) and exercise the option. The Portfolio
would then deliver the futures contract in return for payment of the strike
price. If the Portfolio neither closes out nor exercises an option, the
option will expire on the date provided in the option contract, and only
the premium paid for the contract will be lost.
10
When a Portfolio sells a put on a futures contract, it receives a cash
premium which can be used in whatever way is deemed most advantageous to
the Portfolio. In exchange for such premium, the Portfolio grants to the
purchaser of the put the right to receive from the Portfolio, at the strike
price, a short position in such futures contract, even though the strike
price upon exercise of the option is greater than the value of the futures
position received by such holder. If the value of the underlying futures
position is not such that exercise of the option would be profitable to the
option holder, the option will generally expire without being exercised.
The Portfolio has no obligation to return premiums paid to it whether or
not the option is exercised. It will generally be the policy of each
Portfolio, in order to avoid the exercise of an option sold by it, to
cancel its obligation under the option by entering into a closing purchase
transaction, if available, unless it is determined to be in such
Portfolio's interest to deliver the underlying futures position. A closing
purchase transaction consists of the purchase by the Portfolio of an option
having the same term as the option sold by the Portfolio, and has the
effect of canceling the Portfolio's position as a seller. The premium
which the Portfolio will pay in executing a closing purchase transaction
may be higher than the premium received when the option was sold, depending
in large part upon the relative price of the underlying futures position at
the time of each transaction.
Call Options on Futures Contracts
The Portfolios, with the exception of the Income and Growth Portfolio, may
engage in transactions in call options on futures contracts. In addition
to purchasing put options on futures, the Portfolios may write listed call
options on futures contracts to hedge their respective portfolios against,
for example, an increase in market interest rates. When a Portfolio writes
a call option on a futures contract, it is undertaking the obligation of
assuming a short futures position (selling a futures contract) at the fixed
strike price at any time during the life of the option if the option is
exercised. As market interest rates rise (in the case of the Government
Income Portfolio, Municipal Income Portfolio and Global Portfolio) or as
stock prices fall (in the case of the Growth Portfolio, Capital Growth
Portfolio and Global Portfolio), causing the prices of futures to go down,
a Portfolio's obligation under a call option on a future (to sell a futures
contract) costs less to fulfill, causing the value of a Portfolio's call
option position to increase. In other words, as the underlying future's
price goes down below the strike price, the buyer of the option has no
reason to exercise the call, so that a Portfolio keeps the premium received
for the option. This premium can help substantially to offset the drop in
value of a Portfolio's portfolio securities. Prior to the expiration of a
call written by a Portfolio, or exercise of it by the buyer, a Portfolio
may close out the option by buying an identical option. If the hedge is
successful, the cost of the second option will be less than the premium
received by a Portfolio for the initial option. The net premium income of
a Portfolio will then help offset the decrease in value of the hedged
securities.
11
When a Portfolio purchases a call on a financial futures contract, it
receives in exchange for the payment of a cash premium the right, but not
the obligation to enter into the underlying futures contract at a strike
price determined at the time the call was purchased, regardless of the
comparative market value of such futures position at the time the option is
exercised. The holder of a call option has the right to receive a long (or
buyer's) position in the underlying futures contract.
A Portfolio will not maintain open positions in futures contracts it has
sold or call options it has written on futures contracts if, in the
aggregate, the value of the open positions (marked to market) exceeds the
current market value of its securities portfolio (including cash or cash
equivalents) plus or minus the unrealized gain or loss on those open
positions, adjusted for the correlation of volatility between the hedged
securities and the futures contracts. If this limitation is exceeded at
any time, a Portfolio will take prompt action to close out a sufficient
number of open contracts to bring its open futures and options positions
within this limitation.
"Margin" in Futures Transactions
Unlike the purchase or sale of a security, the Portfolios do not pay or
receive money upon the purchase or sale of a futures contract. Rather, the
Portfolios are required to deposit an amount of "initial margin" in cash or
U.S. Treasury bills with the custodian (or the broker, if legally
permitted). The nature of initial margin in futures transactions is
different from that of margin in securities transactions in that futures
contracts initial margin does not involve a borrowing by a Portfolio to
finance the transactions. Initial margin is in the nature of a performance
bond or good faith deposit on the contract which is returned to a Portfolio
upon termination of the futures contract, assuming all contractual
obligations have been satisfied.
A futures contract held by a Portfolio is valued daily at the official
settlement price of the exchange on which it is traded. Each day a
Portfolio pays or receives cash, called "variation margin," equal to the
daily change in value of the futures contract. This process is known as
"marking to market." Variation margin does not represent a borrowing or
loan by a Portfolio but is instead settlement between a Portfolio and the
broker of the amount one would owe the other if the futures contract
expired. In computing its daily net asset value, a Portfolio will mark to
market its open futures positions. The Portfolios are also required to
deposit and maintain margin when they write call options on futures
contracts.
Regulatory Restrictions
To the extent required to comply with Commodity Futures Trading Commission
Regulation 4.5 and thereby avoid status as a "commodity pool operator," the
Portfolios will not enter into a futures contract, or purchase an option
12
thereon, if immediately thereafter the initial margin deposits for futures
contracts held by a Portfolio, plus premiums paid by it for open options of
futures, would exceed 5% of the total assets of the Portfolio. The
Portfolios will not engage in transactions in futures contracts or options
thereon for speculation, but only to attempt to hedge against changes in
market conditions affecting the values of assets which the Portfolios hold
or intend to purchase. When futures contracts or options thereon are
purchased in order to protect against a price increase on securities or
other assets intended to be purchased later, it is anticipated that at
least 75% of such intended purchases will be completed. When other futures
contracts or options thereon are purchased, the underlying value of such
contracts will at all times not exceed the sum of (1) accrued profit on
such contracts held by the broker; (2) cash or high-quality money market
instruments set aside in an identifiable manner; and (3) cash proceeds from
investments due in 30 days or less.
Purchasing Put Options on Portfolio Securities
With the exception of the Income and Growth Portfolio, the Portfolios may
purchase put options on portfolio securities to protect against price
movements in particular securities in their respective portfolios. A put
option gives a Portfolio, in return for a premium, the right to sell the
underlying security to the writer (seller) at a specified price during the
term of the option.
Writing Covered Call Options on Portfolio Securities
The Capital Growth, Government Income, and Municipal Income and Global
Portfolios may write covered call options to generate income. As a writer
of a call option, a Portfolio has the obligation upon exercise of the
option during the option period to deliver the underlying security upon
payment of the exercise price. A Portfolio may only sell call options
either on securities held in its portfolio or on securities which it has
the right to obtain without payment of further consideration (or has
segregated cash in the amount of any additional consideration).
Over-the-Counter Options
The Capital Growth, Government Income, and Municipal Income and Global
Portfolios may purchase and write over-the-counter options on portfolio
securities in negotiated transactions with the buyers or writers of the
options for those options on portfolio securities held by a Portfolio and
not traded on an exchange.
Over-the-counter options are two-party contracts with price and terms
negotiated between buyer and seller. In contrast, exchange-traded options
are third-party contracts with standardized strike prices and expiration
dates and are purchased from a clearing corporation. Exchange-traded
options have a continuous liquid market while over-the-counter options may
not.
13
Collateralized Mortgage Obligations (CMOs)
The Government Income and Income and Growth Portfolios may invest in CMOs.
Privately issued CMOs generally represent an ownership interest in a pool
of federal agency mortgage pass-through securities such as those issued by
the Government National Mortgage Association. The terms and
characteristics of the mortgage instruments may vary among pass-through
mortgage loan pools.
The market for such CMOs has expanded considerably since its inception.
The size of the primary issuance market and the active participation in the
secondary market by securities dealers and other investors make government-
related pools highly liquid.
Convertible Securities
The Growth, Capital Growth, Income and Growth and Global Portfolios may
invest in convertible securities. Convertible securities are fixed income
securities which may be exchanged or converted into a predetermined number
of the issuer's underlying common stock at the option of the holder during
a specified time period. Convertible securities may take the form of
convertible preferred stock, convertible bonds or debentures, units
consisting of "usable" bonds and warrants or a combination of the features
of several of these securities. The investment characteristics of each
convertible security vary widely, which allows convertible securities to be
employed for a variety of investment strategies.
A Portfolio will exchange or convert the convertible securities held in its
portfolio into shares of the underlying common stock when, in the Sub-
Adviser's opinion, the investment characteristics of the underlying common
shares will assist the Portfolio in achieving its investment objectives.
Otherwise, the Portfolio may hold or trade convertible securities. In
selecting convertible securities for the Portfolio, the Portfolio's Sub-
Adviser evaluates the investment characteristics of the convertible
security as a fixed income instrument and the investment potential of the
underlying equity security for capital appreciation. In evaluating these
matters with respect to a particular convertible security, the Portfolio's
Sub-Adviser considers numerous factors, including the economic and
political outlook, the value of the security relative to other investment
alternatives, trends in the determinants of the issuer's profits, and the
issuer's management capability and practices.
Warrants
The Growth, Capital Growth, and Income and Growth and Global Portfolios may
invest in warrants. Warrants are basically options to purchase common
stock at a specific price (usually at a premium above the market value of
the optioned common stock at issuance) valid for a specific period of time.
Warrants may have a life ranging from less than a year to twenty years or
may be perpetual. However, most warrants have expiration dates after which
14
they are worthless. In addition, if the market price of the common stock
does not exceed the warrant's exercise price during the life of the
warrant, the warrant will expire as worthless. Warrants have no voting
rights, pay no dividends, and have no rights with respect to the assets of
the corporation issuing them. The percentage increase or decrease in the
market price of the warrant may tend to be greater than the percentage
increase or decrease in the market price of the optioned common stock. A
Portfolio will not invest more than 5% of the value of its total assets in
warrants. No more than 2% of this 5% may be warrants which are not listed
on the New York or American Stock Exchanges. Warrants acquired in units or
attached to securities may be deemed to be without value for purposes of
this policy.
Dollar Rolls
The Government Income, Income and Growth and Global Portfolios may enter
into "dollar roll" transactions, which consist of the sale by the
Government Income Portfolio, Income and Growth Portfolio or Global
Portfolio to a bank or broker/dealer (the "counterparty") of GNMA
certificates or other mortgage-backed securities together with a commitment
to purchase similar, but not identical, securities at a future date, at the
same price. The counterparty receives all principal and interest payments,
including prepayments, made on the security while the counterparty is the
holder. The Government Income, Income and Growth and Global Portfolios
receive a fee from the counterparty as consideration for entering into the
commitment to purchase. Dollar rolls may be renewed over a period of
several months with a different repurchase price and a cash settlement
made at each renewal without physical delivery of securities. Moreover,
the transaction may be preceded by a firm commitment agreement pursuant
to which the Government Income Portfolio, Income and Growth Portfolio or
Global Portfolio agrees to buy a security on a future date.
The Government Income, Income and Growth and Global Portfolios will not use
such transactions for leveraging purposes and, accordingly, will
segregate cash, U.S. Government securities or other high grade debt
obligations in an amount sufficient to meet its purchase obligations
under the transactions. The Government Income, Income and Growth and
Global Portfolios will also maintain asset coverage of at least 300%
for all outstanding firm commitments, dollar rolls and other borrowings.
Dollar rolls are treated for purposes of the Investment Company Act of 1940
as borrowings of the Government Income, Income and Growth and Global
Portfolios because they involve the sale of a security coupled with an
agreement to repurchase. Like all borrowings, a dollar roll involves
costs to the Government Income, Income and Growth and Global Portfolios.
For example, while the Government Income, Income and Growth and Global
Portfolios receive a fee as consideration for agreeing to repurchase the
security, the Government Income, Income and Growth and Global Portfolios
forgo the right to receive all principal and interest payments while the
counterparty holds the security. These payments to the counterparty may
exceed the fee received by the Government Income, Income and Growth
and Global Portfolios, thereby effectively charging the Government Income,
Income and Growth and Global Portfolios interest
15
on its respective borrowing. Further, although the Government Income,
Income and Growth and Global Portfolios can estimate the amount of expected
principal prepayment over the term of the dollar roll, a variation in
the actual amount of prepayment could increase or decrease the cost of the
Government Income, Income and Growth and Global Portfolio's borrowing.
The entry into dollar rolls involves potential risks of loss which are
different from those of the securities underlying the transactions. For
example, if the counterparty becomes insolvent, the Government Income,
Income and Growth and Global Portfolios' right to purchase from the
counterparty might be restricted. Additionally, the value of such
securities may change adversely before the Government Income, Income
and Growth and Global Portfolios are able to purchase them. Similarly,
the Government Income, Income and Growth and Global Portfolios may be
required to purchase securities in connection with a dollar roll at a
higher price than may otherwise be available on the open market. Since, as
noted above, the counterparty is required to deliver a similar, but not
identical security to the Government Income, Income and Growth and Global
Portfolios, the security which the Government Income, Income and
Growth and Global Portfolios are required to buy under the dollar roll may
be worth less than an identical security. Finally, there can be no
assurance that the Government Income, Income and Growth and Global
Portfolios' use of the cash that it receives from a dollar roll
will provide a return that exceeds borrowing costs.
The Board of Trustees of the Trust on behalf of the Government Income,
Income and Growth and Global Portfolios have adopted guidelines to ensure
that those securities received are substantially identical to those sold.
To reduce the risk of default, the Government Income, Income and Growth
and Global Portfolios will engage in such transactions only with banks
and broker-dealers selected pursuant to such guidelines.
Swaps, Caps, Floors and Collars
The Global Portfolio may enter into interest rate, currency and index swaps
and the purchase or sale of related caps, floors and collars. The Global
Portfolio expects to enter into these transactions primarily to preserve a
return or spread on a particular investment or portion of its portfolio, to
protect against currency fluctuations, as a duration management technique
or to protect against any increase in the price of securities the Global
Portfolio anticipates purchasing at a later date. The Global Portfolio
intends to use these transactions as hedges and not as speculative
investments and will not sell interest rate caps or floors where it does
not own securities or other instruments providing the income stream the
Global Portfolio may be obligated to pay. Interest rate swaps involve the
exchange by the Global Portfolio with another party of their respective
commitments to pay or receive interest, e.g., an exchange of floating rate
payments for fixed rate payments with respect to a notional amount of
principal. A currency swap is an agreement to exchange cash flows on a
notional amount of two or more currencies based on the relative value
differential among them and an index swap is an agreement to swap cash
flows on a notional amount based on changes in the values of the reference
16
indices. The purchase of a cap entitles the purchaser to receive payments
on a notional principal amount from the party selling such cap to the
extent that a specified index exceeds a predetermined interest rate or
amount. The purchase of a floor entitles the purchaser to receive payments
on a notional principal amount from the party selling such floor to the
extent that a specified index falls below a predetermined interest rate or
amount. A collar is a combination of a cap and a floor that preserves a
certain return within a predetermined range of interest rates or values.
The Global Portfolio will usually enter into swaps on a net basis, i.e.,
the two payment streams are netted out in a cash settlement on the payment
date or dates specified in the instrument, with the Global Portfolio
receiving or paying, as the case may be, only the net amount of the two
payments. Inasmuch as these swaps, caps, floors and collars are entered
into for good faith hedging purposes, the Global Portfolio and its Sub-
Adviser believe such obligations do not constitute senior securities under
the Investment Company Act of 1940 and, accordingly, will not treat them as
being subject to its borrowing restrictions. The Global Portfolio will not
enter into any swap, cap, floor or collar transaction unless, at the time
of entering into such transaction, the unsecured long-term debt of the
Counterparty, combined with any credit enhancements, is rated at least A by
S&P or Moody's or has an equivalent rating from a NRSRO or is determined to
be of equivalent credit quality by the Global Portfolio's Sub-Adviser. If
there is a default by the Counterparty, the Global Portfolio may have
contractual remedies pursuant to the agreements related to the transaction.
The swap market has grown substantially in recent years with a large number
of banks and investment banking firms acting both as principals and as
agents utilizing standardized swap documentation. As a result, the swap
market has become relatively liquid. Caps, floors and collars are more
recent innovations for which standardized documentation has not yet been
fully developed and, accordingly, they are less liquid than swaps.
High Yield, High Risk Debt Securities
The Global Portfolio may invest up to 5% of its net assets in securities
rated Baa/BBB or lower and in unrated securities of equivalent quality in
the Sub-Adviser's judgment. The Global Portfolio may invest in debt
securities which are rated as low as C by Moody's or D by S&P. Such
securities may be in default with respect to payment of principal or
interest.
Below investment grade securities (rated below Baa by Moody's and below BBB
by S&P) or unrated securities of equivalent quality in the Sub-Adviser's
judgment, carry a high degree of risk (including the possibility of default
or bankruptcy of the issuers of such securities), generally involve greater
volatility of price and risk of principal and income, and may be less
liquid, than securities in the higher rating categories and are considered
speculative. The lower the ratings of such debt securities, the greater
their risks render them like equity securities. See the Appendix to this
Statement of Additional Information for a more complete description of the
17
ratings assigned by ratings organizations and their respective
characteristics.
An economic downturn could disrupt the high yield market and impair the
ability of issuers to repay principal and interest. Also, an increase in
interest rates would likely have a greater adverse impact on the value of
such obligations than on higher quality debt securities. During an
economic downturn or period of rising interest rates, highly leveraged
issues may experience financial stress which could adversely affect their
ability to service their principal and interest payment obligations.
Prices and yields of high yield securities will fluctuate over time and,
during periods of economic uncertainty, volatility of high yield securities
may adversely affect the Global Portfolio's net asset value. In addition,
investments in high yield zero coupon or pay-in-kind bonds, rather than
income-bearing high yield securities, may be more speculative and may be
subject to greater fluctuations in value due to changes in interest rates.
The trading market for high yield securities may be thin to the extent that
there is no established retail secondary market. A thin trading market may
limit the ability of the Global Portfolio to accurately value high yield
securities in its portfolio and to dispose of those securities. Adverse
publicity and investor perceptions may decrease the values and liquidity of
high yield securities. These securities may also involve special
registration responsibilities, liabilities and costs, and liquidity and
valuation difficulties.
Credit quality in the high-yield securities market can change suddenly and
unexpectedly, and even recently issued credit ratings may not fully reflect
the actual risks posed by a particular high-yield security. For these
reasons, it is the policy of the Sub-Adviser not to rely exclusively on
ratings issued by established credit rating agencies, but to supplement
such ratings with its own independent and on-going review of credit
quality. The achievement of the Global Portfolio's investment objective by
investment in such securities may be more dependent on the Sub-Adviser's
credit analysis than is the case for higher quality bonds. Should the
rating of a portfolio security be downgraded, the Sub-Adviser will
determine whether it is in the best interest of the Global Portfolio to
retain or dispose of such security.
Prices for below investment-grade securities may be affected by legislative
and regulatory developments. For example, new federal rules require
savings and loan institutions to gradually reduce their holdings of this
type of security. Also, recent legislation restricts the issuer's tax
deduction for interest payments on these securities. Such legislation may
significantly depress the prices of outstanding securities of this type.
Indexed Securities
The Global Portfolio may invest in indexed securities, the value of which
is linked to currencies, interest rates, commodities, indices or other
18
financial indicators ("reference instruments"). Most indexed securities
have maturities of three years or less.
Indexed securities differ from other types of debt securities in which the
Global Portfolio may invest in several respects. First, the interest rate
or, unlike other debt securities, the principal amount payable at maturity
of an indexed security may vary based on changes in one or more specified
reference instruments, such as an interest rate compared with a fixed
interest rate or the currency exchange rates between two currencies
(neither of which need be the currency in which the instrument is
denominated). The reference instrument need not be related to the terms of
the indexed security. For example, the principal amount of a U.S. dollar
denominated indexed security may vary based on the exchange rate of two
foreign currencies. An indexed security may be positively or negatively
indexed; that is, its value may increase or decrease if the value of the
reference instrument increases. Further, the change in the principal
amount payable or the interest rate of an indexed security may be a
multiple of the percentage change (positive or negative) in the value of
the underlying reference instrument(s).
Investment in indexed securities involves certain risks. In addition to
the credit risk of the security's issuer and the normal risks of price
changes in response to changes in interest rates, the principal amount of
indexed securities may decrease as a result of changes in the value of
reference instruments. Further, in the case of certain indexed securities
in which the interest rate is linked to a reference instrument, the
interest rate may be reduced to zero, and any further declines in the value
of the security may then reduce the principal amount payable on maturity.
Finally, indexed securities may be more volatile than the reference
instruments underlying indexed securities.
Currency Transactions
The Global Portfolio may engage in currency transactions with
counterparties in order to hedge the value of portfolio holdings
denominated in particular currencies against fluctuations in relative
value. Currency transactions include forward currency contracts, exchange
listed currency futures, exchange listed and OTC options on currencies, and
currency swaps. A forward currency contract involves a privately
negotiated obligation to purchase or sell (with delivery generally
required) 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. A currency swap is an agreement
to exchange cash flows based on the notional difference among two or more
currencies and operates similarly to an interest rate swap, which is
described below. A Global Portfolio may enter into currency transactions
with counterparties which have received (or the guarantors of the
obligations which have received) a credit rating of A-1 or P-1 by S&P or
Moody's, respectively, or that have an equivalent rating from a NRSRO or
(except for OTC currency options) are determined to be of equivalent credit
19
quality by the Sub-Adviser.
The Global Portfolio dealings in forward currency contracts and other
currency transactions such as futures, options, options on futures and
swaps will be limited to hedging involving either specific transactions or
portfolio positions. Transaction hedging is entering into a currency
transaction with respect to specific assets or liabilities of the Global
Portfolio, which will generally arise in connection with the purchase or
sale of its portfolio securities or the receipt of income therefrom.
Position hedging is entering into a currency transaction with respect to
portfolio security positions denominated or generally quoted in that
currency.
The Global Portfolio will not enter into a transaction to hedge currency
exposure to an extent greater, after netting all transactions intended
wholly or partially to offset other transactions, than the aggregate market
value (at the time of entering into the transaction) of the securities held
in its portfolio that are denominated or generally quoted in or currently
convertible into such currency, other than with respect to proxy hedging as
described below.
The Global Portfolio may also cross-hedge currencies by entering into
transactions to purchase or sell one or more currencies that are expected
to decline in value relative to other currencies to which the Global
Portfolio has or in which a Global Portfolio expects to have portfolio
exposure.
To reduce the effect of currency fluctuations on the value of existing or
anticipated holdings of portfolio securities, the Global Portfolio may also
engage in proxy hedging. Proxy hedging is often used when the currency to
which the Portfolio is exposed is difficult to hedge or to hedge against
the dollar. Proxy hedging entails entering into a forward contract to sell
a currency whose changes in value are generally considered to be linked to
a currency or currencies in which some or all of the Global Portfolio's
securities are or are expected to be denominated, and to buy U.S. dollars.
The amount of the contract would not exceed the value of the Global
Portfolio's securities denominated in linked currencies. For example, if
the Sub-Adviser considers that the Austrian schilling is linked to the
German deutschemark (the "D-mark"), the Global Portfolio holds securities
denominated in schillings and the Sub-Adviser believes that the value of
schillings will decline against the U.S. dollar, the Sub-Adviser may enter
into a contract to sell D-marks and buy dollars. Currency hedging involves
some of the same risks and considerations as other transactions with
similar instruments. Currency transactions can result in losses to the
Global Portfolio if the currency being hedged fluctuates in value to a
degree or in a direction that is not anticipated. Further, there is the
risk that the perceived linkage between various currencies may not be
present or may not be present during the particular time that the Global
Portfolio is engaging in proxy hedging. Except when the Global Portfolio
enters into a forward contract for the purchase or sale of a security
20
denominated in a particular currency, which requires no segregation, a
currency contract which obligates the Global Portfolio to buy or sell
currency will generally require the Global Portfolio to hold an amount of
that currency or liquid securities denominated in that currency equal to
the Global Portfolio's obligations or to segregate liquid high grade assets
equal to the amount of the Global Portfolio's obligation.
Risk of Currency Transactions
Currency transactions are subject to risks different from those of other
portfolio transactions. Because currency control is of great importance to
the issuing governments and influences economic planning and policy,
purchases and sales of currency and related instruments can be negatively
affected by government exchange controls, blockages, and manipulations or
exchange restrictions imposed by governments. These can result in losses
to the Global Portfolio if it is unable to deliver or receive currency or
funds in settlement of obligations and could also cause hedges it has
entered into to be rendered useless, resulting in full currency exposure as
well as incurring transaction costs. Buyers and sellers of currency
futures are subject to the same risks that apply to the use of futures
generally. Further, settlement of a currency futures contract for the
purchase of most currencies must occur at a bank based in the issuing
nation. Trading options on currency futures is relatively new, and the
ability to establish and close out positions on such options is subject to
the maintenance of a liquid market which may not always be available.
Currency exchange rates may fluctuate based on factors extrinsic to that
country's economy.
Eurodollar Instruments
The Global Portfolio may make investments in Eurodollar instruments.
Eurodollar instruments are U.S. dollar-denominated futures contracts or
options thereon which are linked to the London Interbank Offered Rate
("LIBOR"), although foreign currency-denominated instruments are available
from time to time. Eurodollar futures contracts enable purchasers to
obtain a fixed rate for the lending of funds and sellers to obtain a fixed
rate for borrowings. The Global Portfolio might use Eurodollar futures
contracts and options thereon to hedge against changes in LIBOR, to which
many interest rate swaps and fixed income instruments are linked.
Portfolio Turnover
The annual turnover rate of the Portfolios may vary from year to year, and
may also be affected by cash requirements for redemptions and repurchases
of Portfolio shares and by the necessity of maintaining the Portfolios as
regulated investment companies under the Internal Revenue Code, as amended,
in order to receive certain favorable tax treatment.
The Portfolios will not attempt to set or meet a portfolio turnover rate
since any turnover would be incidental to transactions undertaken in an
21
attempt to achieve each Portfolio's investment objective. During the
fiscal years ended September 30, 1994 and 1993, the respective portfolio
turnover rates for the indicated Portfolios were as follows: Growth
Portfolio, 132% and 137%; Capital Growth Portfolio, 149% and 192%;
Government Income Portfolio, 455% and 102%; and Municipal Income Portfolio,
87% and 88%. During the fiscal year ended September 30, 1994 and the period
of May 24, 1993 (date of initial public investment), to September 30, 1993,
the portfolio turnover rate for the Income and Growth Portfolio was 78%
and 13%. During the period of March 29, 1994 (date of initial public
investment), to September 30, 1994, the portfolio turnover rate for the
Global Portfolio was 2%.
Investment Limitations
Issuing Senior Securities and Borrowing Money
The Portfolios will not issue senior securities except that a Portfolio
(other than the Municipal Income Portfolio) may borrow money directly or
through reverse repurchase agreements in amounts up to one-third of the
value of its net assets, including the amount borrowed; and except to the
extent that a Portfolio may enter into futures contracts. The Municipal
Income Portfolio may borrow money from banks for temporary purposes in
amounts up to 5% of its total assets. The Portfolios will not borrow money
or engage in reverse repurchase agreements for investment leverage, but
rather as a temporary, extraordinary, or emergency measure or to facilitate
management of the Portfolio by enabling it to meet redemption requests when
the liquidation of portfolio securities is deemed to be inconvenient or
disadvantageous. The Portfolios will not purchase any securities while any
borrowings in excess of 5% of its total assets are outstanding. During the
period any reverse repurchase agreements are outstanding, the Government
Income Portfolio will restrict the purchase of portfolio securities to
money market instruments maturing on or before the expiration date of the
reverse repurchase agreements, but only to the extent necessary to assure
completion of the reverse repurchase agreements. Notwithstanding this
restriction, the Portfolios may enter into when-issued and delayed delivery
transactions.
Selling Short and Buying on Margin
22
The Portfolios will not sell any securities short or purchase any
securities on margin, but may obtain such short-term credits as are
necessary for clearance of purchases and sales of securities. The deposit
or payment by a Portfolio of initial or variation margin in connection with
futures contracts or related options transactions is not considered the
purchase of a security on margin.
Pledging Assets
The Portfolios will not mortgage, pledge, or hypothecate any assets, except
to secure permitted borrowings. In these cases the Portfolios may pledge
assets having a value of 10% of assets taken at cost. For purposes of this
restriction, (a) the deposit of assets in escrow in connection with the
writing of covered put or call options and the purchase of securities on a
when-issued basis; and (b) collateral arrangements with respect to (i) the
purchase and sale of stock options (and options on stock indexes) and (ii)
initial or variation margin for futures contracts, will not be deemed to be
pledges of a Portfolio's assets. Margin deposits for the purchase and sale
of futures contracts and related options are not deemed to be a pledge.
Lending Cash or Securities
The Portfolios will not lend any of their respective assets except
portfolio securities up to one-third of the value of total assets. (The
Municipal Income Portfolio will not lend portfolio securities.) This shall
not prevent a Portfolio from purchasing or holding U.S. government
obligations, money market instruments, variable amount demand master notes,
bonds, debentures, notes, certificates of indebtedness, or other debt
securities, entering into repurchase agreements, or engaging in other
transactions where permitted by a Portfolio's investment objective,
policies and limitations or Declaration of Trust. The Municipal Income
Portfolio will not make loans except to the extent the obligations the
Portfolio may invest in are considered to be loans.
Investing in Restricted Securities
The Portfolios (other than the Government Income Portfolio) will not invest
more than 10% of the value of their net assets in restricted securities;
the Government Income Portfolio will not invest more than 15% of the value
of its net assets in restricted securities.
23
Investing in Commodities
None of the Portfolios will invest in commodities, except to the extent
that the Portfolios may engage in transactions involving futures contracts
or options on futures contracts, and except to the extent the securities
the Municipal Income Portfolio invests in are considered interests in
commodities or commodities contracts or to the extent the Portfolio
exercises its rights under agreements relating to such municipal
securities.
Investing in Real Estate
None of the Portfolios will purchase or sell real estate, including limited
partnership interests, except to the extent the securities the Income and
Growth Portfolio and Municipal Income Portfolio may invest in are
considered to be interests in real estate or to the extent the Municipal
Income Portfolio exercises its rights under agreements relating to such
municipal securities (in which case the Portfolio may liquidate real estate
acquired as a result of a default on a mortgage), although the Portfolios
may invest in securities of issuers whose business involves the purchase or
sale of real estate or in securities which are secured by real estate or
interests in real estate.
Diversification of Investments
With respect to 75% of the value of its respective total assets, a
Portfolio will not purchase securities issued by any one issuer (other than
cash or securities issued or guaranteed by the government of the United
States or its agencies or instrumentalities and repurchase agreements
collateralized by such securities), if as a result more than 5% of the
value of its total assets would be invested in the securities of that
issuer. A Portfolio will not acquire more than 10% of the outstanding
voting securities of any one issuer.
Concentration of Investments
A Portfolio will not invest 25% or more of the value of its respective
total assets in any one industry (other than securities issued by the U.S.
government, its agencies or instrumentalities). As described in the
Prospectus, the Municipal Income Portfolio may from time to time invest
more than 25% of its assets in a particular segment of the municipal bond
market; however, that Portfolio will not invest more than 25% of its assets
in industrial development bonds in a single industry except as described in
the Prospectus.
24
Underwriting
A Portfolio will not underwrite any issue of securities, except as a
Portfolio may be deemed to be an underwriter under the Securities Act of
1933 in connection with the sale of securities in accordance with its
investment objective, policies, and limitations.
The above limitations cannot be changed with respect to a Portfolio without
approval of holders of a majority of that Portfolio's shares. The
following limitations may be changed by the Board of Trustees without
shareholder approval. Shareholders will be notified before any material
change in these limitations becomes effective.
Investing in Illiquid Securities
The Portfolios will not invest more than 15% of the value of their
respective net assets in illiquid securities, including repurchase
agreements providing for settlement more than seven days after notice;
over-the-counter options; certain restricted securities not determined by
the Trustees to be liquid; and non-negotiable fixed income time deposits
with maturities over seven days.
Investing in Securities of Other Investment Companies
The Portfolios will limit their respective investments in other investment
companies to no more than 3% of the total outstanding voting stock of any
investment company, invest no more than 5% of total assets in any one
investment company, or invest more than 10% of total assets in investment
companies in general. The Portfolios will purchase securities of closed-
end investment companies only in open market transactions involving only
customary broker's commissions. However, these limitations are not
applicable if the securities are acquired in a merger, consolidation,
reorganization, or acquisition of assets. It should be noted that
investment companies incur certain expenses such as management fees, and
therefore any investment by a Portfolio in shares of another investment
company would be subject to duplicative expenses.
Investing in New Issuers
Except for the Municipal Income Portfolio, no Portfolio will invest more
than 5% of the value of its respective total assets in securities of
issuers which have records of less than three years of continuous
operations, including the operation of any predecessor. The Municipal
Income Portfolio will not invest more than 5% of its total assets in
industrial development bonds where the payment of principal and interest is
25
the responsibility of companies with less than three years of operating
history.
Investing in Issuers Whose Securities are Owned by Officers and Trustees of
the Trust
A Portfolio will not purchase or retain the securities of any issuer if the
officers and Trustees of the Trust, the Investment Adviser, or Sub-Adviser
own individually more than 1/2 of 1% of the issuer's securities or together
own more than 5% of the issuer's securities.
Investing in Minerals
A Portfolio will not purchase interests in oil, gas, or other mineral
exploration or development programs or leases, except it may purchase the
securities of issuers which invest in or sponsor such programs and except
pursuant to the exercise by the Municipal Income Portfolio of its rights
under agreements relating to municipal securities.
Arbitrage Transactions
A Portfolio will not enter into transactions for the purpose of engaging in
arbitrage.
Purchasing Securities to Exercise Control
A Portfolio will not purchase securities of a company for the purpose of
exercising control or management, except to the extent that exercise by the
Municipal Income Portfolio of its rights under agreements related to
municipal securities would be deemed to constitute such control or
management.
None of the Portfolios borrowed money (including through use of reverse
repurchase agreements) or loaned portfolio securities in excess of 5% of
the value of its net assets during the last fiscal year, and no Portfolio
has any present intent to do so in the coming fiscal year.
26
Except with respect to the Portfolios' policy of borrowing money, if a
percentage limitation is adhered to at the time of investment, a later
increase or decrease in percentage resulting from any change in value or
net assets will not result in a violation of such restriction.
To comply with registration requirements in certain states, the Portfolios
(1) will limit the aggregate value of the assets underlying covered call
options or put options written by a Portfolio to not more than 25% of its
net assets, (2) will limit the premiums paid for options purchased by a
Portfolio to 5% of its net assets, (3) will limit the margin deposits on
futures contracts entered into by a Portfolio to 5% of its net assets, and
(4) will limit investment in warrants to 5% of its net assets. No more
than 2% will be warrants which are not listed on the New York or American
Stock Exchanges. Also to comply with certain state restrictions, the
Growth Portfolio, Capital Growth Portfolio, and Income and Growth Portfolio
will limit their investment in restricted securities to 5% of total assets.
(If state requirements change, these restrictions may be revised without
shareholder notification.)
Management of the Trust
Officers and Trustees
Officers and Trustees are listed with their addresses, principal
occupations, and present positions, including any affiliation with
Cambridge Administrative Services, Cambridge Distributors, Inc., Cambridge
Investment Advisors, Inc., and WFS Financial, Inc.
<TABLE>
Positions with Principal Occupations
Name and Address the Trust During Past Five Years
<S> <C> <C>
Daniel J. Ludeman*** Chairman Chairman, Investment Management Group, Inc.; Managing Director, WFS
901 E. Byrd Street and Trustee Financial Corp.; formerly, Managing Director, Wheat First Butcher Singer,
Richmond, Virginia 23219 Inc.
Peter J. Quinn, Jr.*** President President, Cambridge Investment Advisors, Inc., and
901 E. Byrd Street and Trustee Cambridge Distributors, Inc.; Managing Director, Investment
Richmond, Virginia 23219 Management Group, Inc.; formerly, Senior Vice
President/Director of Mutual Funds, Wheat First Butcher Singer, Inc.
Paul F. Costello Senior Vice Managing Director, Investment Management Group.,
901 E. Byrd Street President, Inc.; Senior Vice President, Cambridge Investment
Richmond, Virginia 23219 Treasurer, Advisors, Inc., and Cambridge Distributors, Inc.;
and Secretary President, Mentor Series Trust and Cash
Resource Trust; President, Mentor Income Fund, Inc.;
President, IMG Series Trust; formerly, Director, President
and Chief Executive Officer, First Variable
Life Insurance Company; President and Chief Financial Officer,
Variable Investors Series Trust; President and
Treasurer, Atlantic Capital & Research, Inc.; Vice President and
Treasurer, Variable Stock Fund, Inc., Monarch Investment Series
Trust, and GEICO Tax Advantage Series Trust; Vice President,
Monarch Life Insurance Company, GEICO Investment Services
Company, Inc., Monarch Investment Services Company, Inc.,
and Springfield Life Insurance Company.
Arnold H. Dreyfuss Trustee Formerly, Chairman and Chief Executive
5100 Cary Street Road Officer, Hamilton Beach/Proctor-Silex, Inc.;
Richmond, Virginia 23225 Director, Mentor Growth Fund.
Thomas F. Keller Trustee Dean, The Fuqua School of Business, Duke
Duke University University, Durham, NC.
Durham, North Carolina 27706
Louis W. Moelchert, Jr. Trustee Vice President for Business & Finance,
University of Richmond University of Richmond, Richmond, VA.
Richmond, Virginia 23173
Stanley F. Pauley Trustee Chairman, E. R. Carpenter Company, Inc.
P.O. Box 27205
Richmond, Virginia 23261
Troy A. Peery, Jr.** Trustee President, Heilig-Meyers Company;
2235 Staples Mill Road Member, Board of Directors, ACME Markets.
Richmond, Virginia 23230
</TABLE>
27
*
This Trustee is deemed to be an "interested person" of the Trust as defined
in the Investment Company Act of 1940.
**
Members of the Executive Committee. The Executive Committee of the Board
of Trustees handles the responsibilities of the Board of Trustees between
meetings of the Board.
28
Ownership of Portfolios
Officers and Trustees own less than 1% of the outstanding Class A shares
and Class B shares of each Portfolio.
Trustee Liability
The Trust's Declaration of Trust provides that the Trustees will not be
liable for errors of judgment or mistakes of fact or law. However, they
are not protected against any liability to which they would otherwise be
subject by reason of willful misfeasance, bad faith, gross negligence, or
reckless disregard of the duties involved in the conduct of their office.
Investment Advisory Services
Investment Adviser
The Trust's Investment Adviser is Cambridge Investment Advisors, Inc. It
is the Investment Adviser's responsibility to select, subject to review and
approval by the Trust's Board of Trustees and shareholders, the sub-
advisers for the Portfolios (collectively, the "Sub-Advisers" and each
individually the "Sub-Adviser") who have distinguished themselves in their
respective areas of expertise in asset management and to review their
continued performance. Cambridge Investment Advisors, Inc., is a wholly-
owned subsidiary of Investment Management Group, Inc., which in turn is a
wholly-owned subsidiary of WFS Financial, Inc.
The Investment Adviser and the Sub-Advisers shall not be liable for any
losses that may be sustained in the purchase, holding or sale of any
security, or for anything done or omitted by it, except acts or omissions
involving willful misfeasance, bad faith, gross negligence, or reckless
disregard of the duties imposed upon it by its contract with the Trust.
Investment Adviser Fees
For performing its responsibilities, the Investment Adviser receives an
annual investment advisory fee from each Portfolio as described in the
Prospectus. The Investment Adviser, in turn, made payments to the Sub-
Advisers for their services as stated in the section entitled "The Sub-
Advisers."
During the fiscal years ended September 30, 1994 and 1993,
29
the Investment Adviser earned and waived advisory fees as follows:
<TABLE>
1994 1993
Investment Investment Investment Investment
Advisory Advisory Advisory Advisory
Portfolio Fee Earned Fee Waived Fee Earned Fee Waived
<S> <C> <C> <C> <C>
Growth Portfolio . . . . . . . . $ 410,955 $ -- $ 316,743 $ 18,450
Capital Growth Portfolio . . . . 590,693 -- 570,705 35,435
Government Income Portfolio . . . 839,139 -- 888,963 230,311
Municipal Income Portfolio . . . 468,787 81,713 378,268 374,138
Income and Growth Portfolio . . . 374,462 -- 45,081* --*
Global Portfolio**. . . . . . . . 69,515 69,515 -- --
* For the period May 24, 1993 (date of initial public investment), to
September 30, 1993.
** For the period March 29, 1994 (date of initial public investment), to
September 30, 1994.
</TABLE>
State Expense Limitations
The Investment Adviser has undertaken to comply with the expense limitation
established by certain states for investment companies whose shares are
registered for sale in those states. If a Portfolio's normal operating
expenses (including the investment advisory fee, but not including
brokerage commissions, interest, taxes, and extraordinary expenses) exceed
2 1/2% per year of the first $30 million of average net assets, 2% per year
of the next $70 million of average net assets, and 1 1/2% per year of the
remaining average net assets, the Investment Adviser will reimburse the
particular Portfolio for its expenses over the limitation.
If a Portfolio's monthly projected operating expenses exceed this expense
limitation, the investment advisory fee paid will be reduced by the amount
of the excess, subject to an annual adjustment. If the expense limitation
is exceeded, the amount to be reimbursed by the Investment Adviser will be
limited, in any single fiscal year, by the amount of the investment
advisory fee.
This arrangement is not part of the Investment Advisory Agreement and may
30
be amended or rescinded in the future.
The Sub-Advisers
Pursuant to a Sub-Advisory Agreement entered into between the Investment
Adviser and each Sub-Adviser, each Portfolio is advised by a Sub-Adviser
who has complete discretion to purchase and sell portfolio securities for
the Portfolio to which it serves as the Sub-Adviser within the particular
Portfolio's investment objective, restrictions, and policies.
Kemper Financial Services, Inc. ("KFS"), serves as the Sub-Adviser to the
Growth Portfolio under the terms of a Sub-Advisory Agreement between the
Investment Adviser and KFS. KFS is a wholly-owned subsidiary of Kemper
Financial Companies, Inc. ("KFC"). KFC is a business corporation
incorporated under the laws of the State of Delaware. It was founded in
1986 and is a financial services holding company and a subsidiary of Kemper
Corporation. Kemper Corporation was incorporated under the laws of the
State of Delaware in 1968 and is a diversified insurance and financial
services holding company. During the fiscal years ended September 30, 1994
and 1993, KFS earned $205,478 and $158,980, respectively, as its
sub-advisory fee for services it provided on behalf of the Growth Portfolio.
Phoenix Investment Counsel, Inc. ("PIC"), serves as the Sub-Adviser to the
Capital Growth Portfolio under the terms of a Sub-Advisory Agreement
between the Investment Adviser and PIC. PIC is a wholly-owned subsidiary
of Phoenix Equity Planning Corporation, which was incorporated under the
laws of the State of Connecticut in 1968, and is registered as a broker-
dealer in fifty states. Phoenix Equity Planning Corporation is an indirect
subsidiary of Phoenix Home Life Mutual Insurance Company. Phoenix Home
Life Mutual Insurance Company has been engaged in the business of writing
ordinary and group life and health insurance and annuities since 1861.
During the fiscal years ended September 30, 1994 and 1993, PIC earned
$295,347 and $286,476, respectively, as its sub-advisory fee for services
it provided on behalf of the Capital Growth Portfolio.
Pacific Investment Management Company ("PIMCO") serves as the Sub- Adviser
to the Government Income Portfolio under the terms of a Sub- Advisory
Agreement between the Investment Adviser and PIMCO. PIMCO and certain of
its affiliates have entered into an Agreement and Plan of Consolidation
with Thompson Advisory Group L.P. ("TAG") which provides for the
consolidation of the investment advisory and related businesses of PIMCO
and TAG. The consolidation resulted in the transfer of the current
investment advisory business of PIMCO to a new entity, Pacific Investment
Management Company ("New PIMCO"). The terms and conditions of the new
sub-advisory agreement between the Cambridge Government Income Portfolio
and New PIMCO are identical in all material respects to those of the
previous sub-advisory contract with PIMCO, and were approved
by the shareholders of the Cambridge Government Income Portfolio of
Cambridge Series Trust at a meeting held on October 28, 1994.
31
PIMCO, established in 1971, provides investment advisory services to
investment companies, pension plans, foundations, endowments and other
institutions located both in the U.S. and abroad. As of November 30, 1993,
PIMCO had over $52.6 billion of assets under management, of which
approximately $26.0 billion were invested in U.S. Government securities.
PIMCO, a wholly owned subsidiary of Pacific Mutual Life Insurance Company,
is located at 840 Newport Center Drive, Suite 360, Newport Beach,
California 92660. Prior to PIMCO's serving as the Sub-Adviser to the
Government Income Portfolio, the Sub-Adviser to this Portfolio was
Federated Advisers. During the fiscal year ended September 30, 1994, PIMCO
earned $419,570 as its sub-advisory fee for services it provided on behalf
of the Government Income Portfolio. During the fiscal year ended September
30, 1993, Federated Advisers, the Portfolio's former sub-adviser, earned
$442,982 as its sub-advisory fee for services it provided on behalf of the
Government Income Portfolio, of which $42,481 was voluntarily waived.
Van Kampen/American Capital Management Inc. ("VK/AC Management") serves as
the Sub-Adviser to the Municipal Income Portfolio under the terms of a
Sub-Advisory Agreement between the Investment Adviser and VK/AC
Management. VK/AC Management is a wholly-owned subsidiary of Van Kampen/
American Capital, Inc., which, in turn, is a wholly-owned subsidiary of VK/
AC Holding, Inc. VK/AC Holding, Inc., is indirectly controlled by
Clayton & Dubilier Associates IV Limited Partnership, the general
partners of which are Joseph L. Rice, III, B. Charles Ames, Alberto
Cribiore, Donald J. Gogel, and Hubbard C. Howe, each of whom is a principal
of Clayton, Dubilier & Rice, Inc., a New York-based private investment
firm. During the fiscal year ended September 30, 1994, VK/AC Management
earned $234,393 for services it provided on behalf of the Municipal
Income Portfolio. During the period from February 17, 1993, to September
30, 1993, VK/AC Management earned $132,315 as its sub-advisory fee for
services it provided on behalf of the Municipal Income Portfolio, of which
$130,250 was voluntarily waived. During the period from October 1, 1992, to
February 16, 1993, Van Kampen/American Capital Investment Advisory Corp.,
the Portfolio's former sub-adviser, earned $56,819 as its sub-advisory fee
for services it provided on behalf of the Municipal Income Portfolio, all
of which was voluntarily waived.
Wellington Management Company ("WMC") serves as the Sub-Adviser to the
Income and Growth Portfolio under the terms of a Sub-Advisory Agreement
between the Investment Adviser and WMC. WMC is a professional investment
counseling firm which provides investment services to investment companies,
employee benefit plans, endowments, foundations, and other institutions and
individuals. During the fiscal year ended September 30, 1994, and for the
period from May 24, 1993 (date of initial public investment), to September
30, 1993, WMC earned $187,231 and $22,521, respectively, as its
sub-advisory fees for services it provided on behalf of the Income and
Growth Portfolio.
Scudder, Stevens & Clark, Inc. ("Scudder") serves as the Sub-Adviser to the
Global Portfolio under the terms of a Sub-Advisory Agreement between the
Investment Adviser and Scudder. Scudder is an investment counseling firm
which was established as a partnership in 1919. In 1953, Scudder
introduced Scudder International Fund, the first mutual fund registered
with the Commission in the U.S. investing internationally in securities of
32
issuers in several foreign countries. The Investment Adviser pays the
Sub-Adviser an annual fee expressed as a percentage of Global Portfolio
assets: .55% on the first $75 million in Global Portfolio assets and .50%
on assets over $75 million. During the period from March 29, 1994 (date of
initial public investment), to September 30, 1994, Scudder earned $34,757
as its sub-advisory fee for services it provided on behalf of the Global
Portfolio.
Distribution of Portfolio Shares
Cambridge Distributors, Inc., is the principal distributor of Portfolio
shares, as explained in the prospectus. During the fiscal year ended
September 30, 1994, the distributors, both affiliated parties of the
Trust, received the following commissions and other compensation:
<TABLE>
Net Underwriting Compensation on
Discounts and Redemption and Brokerage *Other
Name of Principal Underwriter Commissions Repurchases Commissions Compensation
<S> <C> <C> <C> <C>
Cambridge Distributors, Inc. . . $ 77,089 $142,445 $ -- $2,650,747
Federated Securities Corp. . . . $ -- $ -- $ -- $ --
* "Other Compensation" represents $1,652,605 for services performed under
the Trust's Distribution Plan and $998,142 for services performed
under the Trust's Shareholder Servicing Plan.
</TABLE>
Administrative Services
Investment Management Group, Inc. ("IMG"), which is the parent of the
Investment Adviser, provides administrative personnel and services to
the Portfolios for the fees set forth in the Prospectus. Prior to June
1, 1994, Cambridge Administrative Services ("CAS"), a subsidiary of
Federated Advisers, had provided such services. During the fiscal
years ended September 30, 1994 and 1993, the Portfolios incurred
costs for administrative services as follows:
<TABLE>
1994 1993
Administrative Administrative Administrative Administrative Administrative Administrative
Portfolio Fee Earned Fee Waived Fee Earned Fee Waived Fee Earned Fee Earned
CAS CAS IMG IMG CAS CAS
<S> <C> <C> <C> <C> <C> <C>
Growth Portfolio . . . . . . $ 45,092 $ 6,569 $19,103 $ -- $ 55,468 $ 20,121
Capital Growth Portfolio . . 65,005 -- 27,273 -- 104,427 36,269
Government Income Portfolio . 126,300 23,563 48,497 -- 184,593 41,518
Municipal Income Portfolio . 66,804 -- 30,849 -- 97,110 34,261
Income and Growth Portfolio . 37,484 15,033 24,831 -- 7,514* 3,005*
Global Portfolio**. . . . . . 1,326 530 6,344 -- -- --
* For the period May 24, 1993 (date of initial public investment),
to September 30, 1993.
** For the period March 29, 1994 (date of initial public investment),
to September 30, 1994.
</TABLE>
33
Shareholder Servicing Plan
The Trust has adopted a Shareholder Servicing Plan (the "Service Plan")
with respect to both classes of shares of each Portfolio. Pursuant to the
Service Plan, financial institutions will enter into shareholder service
agreements with the Portfolios to provide administrative support services
to their customers who from time to time may be owners of record or
beneficial owners of shares of one or more Portfolios. In return for
providing these support services, a financial institution may receive
payments from one or more Portfolios at a rate not exceeding .25% of the
average daily net assets of the Class A or Class B shares of the particular
Portfolio or Portfolios beneficially owned by the financial institution's
customers for whom it is holder of record or with whom it has a servicing
relationship. The Service Plan is designed to stimulate financial
institutions to render administrative support services to the Portfolios
and their shareholders. These administrative support services include, but
are not limited to, the following functions: providing office space,
equipment, telephone facilities, and various personnel including clerical,
supervisory, and computer as necessary or beneficial to establish and
maintain shareholder accounts and records; processing purchase and
redemption transactions and automatic investments of client account cash
balances; answering routine client inquiries regarding the Portfolios;
assisting clients in changing dividend options, account designations and
addresses; and providing such other services as the Portfolios reasonably
request.
Among the benefits the Board of Trustees expects to achieve in adopting the
Service Plan are the following: (1) an efficient and effective
administrative system; (2) a more efficient use of shareholder assets by
having them rapidly invested in the Portfolios, through an automatic
transfer of funds from a demand deposit account to an investment account,
with a minimum of delay and administrative detail; and (3) an efficient and
reliable shareholder records system and prompt responses to shareholder
requests and inquiries concerning their accounts.
In addition to receiving payments under the Service Plan, financial
institutions may be compensated by the Investment Adviser, a Sub-Adviser,
and/or the administrator, or affiliates thereof, for providing
administrative support services to holders of Class A or Class B shares of
the Portfolios. These payments will be made directly by the Investment
Adviser, a Sub-Adviser, and/or the administrator and will not be made from
the assets of any of the Portfolios.
During the fiscal years ended September 30, 1994 and 1993, the Portfolios
incurred shareholder service fees under the Service Plan (all of which
was received by the Distributor) as follows:
34
Portfolio 1994 1993
Growth Portfolio . . . . . . . . . . . . . . . . $128,423 $ 98,981
Capital Growth Portfolio . . . . . . . . . . . . 184,588 178,345
Government Income Portfolio. . . . . . . . . . . 349,642 369,151
Municipal Income Portfolio . . . . . . . . . . . 195,328 157,611
Income and Growth Portfolio . . . . . . . . . . 124,821 15,027*
Global Portfolio** . . . . . . . . . . . . . . . 15,340 --
* For the period May 24, 1993 (date of initial public investment),
to September 30, 1993.
** For the period March 29, 1994 (date of initial public investment),
to September 30, 1994.
Brokerage Transactions
When selecting brokers and dealers to handle the purchase and sale of
portfolio instruments, a Sub-Adviser looks for prompt execution of the
order at the best overall terms available. In working with dealers, a Sub-
Adviser will generally use those who are recognized dealers in specific
portfolio instruments, except when a better price and execution of the
order can be obtained elsewhere. A Sub-Adviser makes decisions on
portfolio transactions and selects brokers and dealers subject to
guidelines established by the Board of Trustees.
A Sub-Adviser may select brokers and dealers who offer brokerage and
research services. These services may be furnished directly to the
Portfolios or to a Sub-Adviser and may include:
(bullet) advice as to the advisability of investing in securities;
(bullet) security analysis and reports;
(bullet) economic studies;
(bullet) receipt of quotations for portfolio evaluations; and
(bullet) similar services.
A Sub-Adviser and its affiliates exercise reasonable judgment in selecting
brokers who offer brokerage and research services to execute securities
transactions. They determine in good faith that commissions charged by
such persons are reasonable in relationship to the value of the brokerage
and research services provided.
Research services provided by brokers may be used by a Sub-Adviser in
advising a Portfolio and other accounts. To the extent that receipt of
these services may supplant services for which a Sub-Adviser or its
35
affiliates might otherwise have been paid, it would tend to reduce their
expenses, but it is not expected that such reduction will be material.
During the fiscal years ended September 30, 1994 and 1993, the Portfolios
paid brokerage commissions on brokerage transactions as follows:
Portfolio 1994 1993
Growth Portfolio . . . . . . . . . . . . . . . . $159,585 $173,167
Capital Growth Portfolio . . . . . . . . . . . . 195,086 334,227
Income and Growth Portfolio . . . . . . . . . . 116,782 25,668*
Global Portfolio** . . . . . . . . . . . . . . . 45,449 --
* For the period May 24, 1993 (date of initial public investment),
to September 30, 1993.
** For the period March 29, 1994 (date of initial public investment),
to September 30, 1994.
Wheat First Butcher & Singer Capital Markets ("Wheat First"), an affiliated
party of the Investment Adviser, received for the fiscal year ended
September 30, 1994 and 1993, brokerage commissions of $101,279 and $120,726,
respectively, for services performed on behalf of certain of the
Portfolios, as follows:
1994 1993
Growth Portfolio . . . . . . . . . . . . . . . . $ 588 $ 3,297
Capital Growth Portfolio . . . . . . . . . . . . 78,085 113,126
Income and Growth Portfolio. . . . . . . . . . . 22,606 4,303*
Global Portfolio** . . . . . . . . . . . . . . . -- --
* For the period May 24, 1993 (date of initial public investment),
to September 30, 1993.
** For the period March 29, 1994 (date of initial public investment),
to September 30, 1994.
During the fiscal year ended September 30, 1994, with respect to the Growth
Portfolio, the brokerage commissions received by Wheat First represented
0.37% of the aggregate brokerage commissions paid by the Portfolio and
represented 0.18% of the Portfolio's transactions effected through brokers.
Also during the same period, the brokerage commissions received by Wheat
First on behalf of the Capital Growth Portfolio represented 40.03% of the
aggregate brokerage commissions paid by the Portfolio and represented
35.20% of the Portfolio's transactions effected through brokers. With
respect to the Income and Growth Portfolio, during the fiscal year ended
September 30, 1994, the brokerage commissions received by Wheat First
represented 19.36% of the aggregate brokerage commissions paid by the
Portfolio and represented 11.81% of the Portfolio's transactions effected
through brokers.
The Portfolios' brokerage Transactions with affiliated broker-dealers will
comply with Rule 17e-1 under the 1940 Act.
36
How to Buy Shares
Except under certain circumstances described in the Prospectus, Class A
shares of the Portfolios are sold at their net asset value plus an
applicable sales charge on days the New York Stock Exchange is open for
business. Class B shares of the Portfolios are sold at their net asset
value with no sales charge on days the New York Stock Exchange is open for
business. The procedure for purchasing Class A and Class B shares of the
Portfolios is explained in the Prospectus under the section entitled "How
to Buy Shares."
Dealers will be compensated on purchases of Class A shares in accordance to
the following schedule:
Amount of Purchase Dealer Commission
Less than $2 million . 1.00%
$2 million but less than $3 million .80%
$3 million but less than $50 million .50%
$50 million but less than $100 million .25%
$100 million or more . .15%
The above commission will be paid by the Distributor and not the Trust or
its shareholders.
Distribution Plan (Class B Shares)
With respect to the Class B shares of the Portfolios, the Trust has adopted
a Plan pursuant to Rule 12b-1, which was promulgated by the SEC under the
Investment Company Act of 1940 (the "Plan"). The Plan provides for payment
of fees to the Distributor to finance any activity which is principally
intended to result in the sale of Class B shares of the Portfolios. Such
activities may include the advertising and marketing of Class B shares;
preparing, printing and distributing prospectuses and sales literature to
prospective shareholders, brokers or administrators; and implementing and
operating the Plan. Pursuant to the Plan, the Distributor may pay fees to
brokers for distribution services as to Class B shares.
The Board of Trustees expects that the adoption of the Plan will result in
the sale of a sufficient number of Class B shares of the Portfolios so as
to allow each Portfolio to achieve economic viability. It is also
anticipated that an increase in the size of each Portfolio will facilitate
more efficient portfolio management and assist each Portfolio in seeking to
achieve its investment objective.
Pursuant to the Plan, during the fiscal years ended September 30, 1994 and
1993, financial institutions (such as a broker/dealer or bank) received
fees for services provided on behalf of Class B shares of the Portfolios
as follows, all of which was received by the Distributor:
37
Portfolio 1994 1993
Growth Portfolio . . . . . . . . . . . . . . . . $253,834 $178,568
Capital Growth Portfolio . . . . . . . . . . . . 360,712 326,101
Government Income Portfolio . . . . . . . . . . 511,023 512,241
Municipal Income Portfolio . . . . . . . . . . . 253,801 193,150
Income and Growth Portfolio. . . . . . . . . . . 252,486 26,967*
Global Portfolio** . . . . . . . . . . . . . . . 20,749 --
* For the period May 24, 1993 (date of initial public investment), to
September 30, 1993.
** For the period March 29, 1994 (date of initial public investment), to
September 30, 1994.
Conversion to Federal Funds
The Shareholder Services Group, Inc., acts as the shareholder's agent in
depositing checks and converting them to federal funds.
Purchases at Net Asset Value
Class A shares of the Portfolios may be purchased at net asset value,
without a sales charge, by the following: advisory accounts through
registered investment advisers; bank trust departments purchasing on behalf
of their clients; Trustees, emeritus trustees, employees and retired
employees of the Trust; or directors, emeritus directors, employees and
retired employees of the Distributor, or affiliates thereof, or any
financial institution who has a sales agreement with the Distributor with
regard to the Trust. Spouses and children under age 21 of the foregoing
persons may also buy Class A shares of the Portfolios at net asset value
with no sales charge.
Determining Net Asset Value
Net asset value generally changes each day. The days on which net asset
value is calculated by each Portfolio are described in the Prospectus. Net
asset value will not be calculated on days on which the New York Stock
Exchange is closed.
Determining Market Value of Securities
Market values of each Portfolio's portfolio securities are determined as
follows:
(bullet) according to the last sale price on a national securities exchange,
if available;
38
(bullet) in the absence of recorded sales for equity securities, according to
the mean between the last closing bid and asked prices, and for bonds
and other fixed income securities as determined by an independent
pricing service; or
(bullet) for short-term obligations, according to the prices as furnished
by an independent pricing service or for short-term obligations with
maturities of less than 60 days, at amortized cost, or at fair value
as determined in good faith by the Board of Trustees.
Prices provided by independent pricing services may be determined without
relying exclusively on quoted prices and may consider yield, quality,
coupon rate, maturity, type of issue, trading characteristics, and other
market data.
Over-the-counter put options will be valued at the mean between the bid and
the asked prices. Covered call options will be valued at the last sale
price on the national exchange on which such option is traded. Unlisted
call options will be valued at the latest bid price as provided by brokers.
Following the calculation of security values in terms of currency in which
the market quotation used is expressed ("local currency"), the valuing
agent shall calculate these values in terms of U.S. dollars on the basis of
the conversion of the local currencies (if other than U.S.) into U.S.
dollars at the rates of exchange prevailing at the value time as determined
by the valuing agent.
Trading in securities on European and Far Eastern securities exchanges and
over-the-counter markets is normally completed well before the close of
business on each business day in New York (i.e., a day on which the
Exchange is open). In addition, European or Far Eastern securities trading
generally or in a particular country or countries may not take place on all
business days in New York. Furthermore, trading takes place in Japanese
markets on certain Saturdays and in various foreign markets on days which
are not business days in New York and on which the Global Portfolio's net
asset value is not calculated. The Global Portfolio calculates net asset
value per share, and therefore effects sales, redemptions and repurchases
of its shares, as of the close of the Exchange once on each day on which
the Exchange is open. Such calculation does not take place
contemporaneously with the determination of the prices of the majority of
the portfolio securities used in such calculation. If events materially
affecting the value of such securities occur between the time when their
price is determined and the time when the Global Portfolio's net asset
value is calculated, such securities will be valued at fair value as
determined in good faith by the Board of Trustees.
Exchange Privilege
The SEC has issued an order exempting the Trust from certain provisions of
39
the Investment Company Act of 1940. As a result, shareholders of the
Portfolios are allowed to exchange all or some of their Class A or Class B
shares with no sales charge or contingent deferred sales charge ("CDSC"),
as described in the Prospectus. For a complete description of the exchange
privilege, see the section in the Prospectus entitled "Exchange Privilege."
Redeeming Shares
The Portfolios redeem shares at the next computed net asset value, less the
applicable CDSC, after the particular Portfolio receives the redemption
request. Redemption procedures are explained in the Prospectus under the
section entitled "Redeeming Shares." Although The Shareholder Services
Group, Inc., does not charge for telephone redemptions, it reserves the
right to charge a fee for the cost of wire-transferred redemptions.
Contingent Deferred Sales Charge
During certain periods, Class A shares of the Portfolios were eligible to
be purchased at net asset value (without a sales charge) with the proceeds
from the redemption, sale, or maturity of other investments and may,
therefore, be subject to a CDSC as explained in the prospectus. The
eligible period for the Global Portfolio was from February 22, 1994,
through and including June 30, 1994. The eligible period for the Income
and Growth Portfolio was prior to July 31, 1993. For the Growth
Portfolio, Capital Growth Portfolio, Government Income Portfolio, and
Municipal Income Portfolio, these eligible periods were (1) prior to
June 30, 1992, and (2) from December 1, 1992, through and including January
31, 1993.
Redemptions in Kind
Although the Trust intends to redeem Class A and Class B shares in cash, it
reserves the right under certain circumstances to pay the redemption price
in whole or in part by a distribution of securities from the respective
Portfolio's investment portfolio. To the extent available, such securities
will be readily marketable.
Redemption in kind will be made in conformity with applicable SEC rules,
taking such securities at the same value employed in determining net asset
value and selecting the securities in a manner that the Trustees determine
to be fair and equitable.
The Trust has elected to be governed by Rule 18f-1 of the Investment
Company Act of 1940, under which, with respect to each Portfolio, the Trust
is obligated to redeem Class A or Class B shares for any one shareholder in
cash only up to the lesser of $250,000 or 1% of the respective class's net
asset value during any 90-day period.
40
Tax Status
The Portfolios' Tax Status
The Portfolios expect to pay no federal income tax because they expect to
meet the requirements of Subchapter M of the Internal Revenue Code, as
amended, applicable to regulated investment companies and to receive the
special tax treatment afforded to such companies. To qualify for this
treatment, each Portfolio must, among other requirements:
(bullet) derive at least 90% of its gross income from dividends, interest and
gains from the sale of securities;
(bullet) derive less than 30% of its gross income from the sale of securities
held less than three months;
(bullet) invest in securities within certain statutory limits; and
(bullet) distribute to its shareholders at least 90% of its net income earned
during the year.
Each Portfolio will be treated as a single, separate entity for federal
income tax purposes so that income and losses (including capital gains and
losses) realized by a Portfolio will not be combined for tax purposes with
income and losses realized by any of the other Portfolios.
The Global Portfolio intends to qualify for and may make the election
permitted under Section 853 of the Internal Revenue Code so that
shareholders may (subject to limitations) be able to claim a credit or
deduction on their federal income tax returns for, and may be required to
treat as part of the amounts distributed to them, their pro rata portion of
qualified taxes paid by the Portfolio to foreign countries (which taxes
relate primarily to investment income). The Global Portfolio may make an
election under Section 853 of the Internal Revenue Code, provided that more
than 50% of the value of the total assets of the Global Portfolio at the
close of the taxable year consists of securities in foreign corporations.
The foreign tax credit available to shareholders is subject to certain
limitations imposed by the Internal Revenue Code.
If the Global Portfolio invests in stock of certain foreign investment
companies, the Global Portfolio may be subject to U.S. federal income
taxation on a portion of any "excess distribution" with respect to, or gain
from the disposition of, such stock. The tax would be determined by
allocating such distribution or gain ratably to each day of the Global
Portfolio's holding period for the stock. The distribution or gain so
41
allocated to any taxable year of the Global Portfolio, other than the
taxable year of the excess distribution or disposition, would be taxed to
the Global Portfolio at the highest ordinary income rate in effect for such
year, and the tax would be further increased by an interest charge to
reflect the value of the tax deferral deemed to have resulted from the
ownership of the foreign company's stock. Any amount of distribution or
gain allocated to the taxable year of the distribution or disposition would
be included in the Global Portfolio's investment company taxable income
and, accordingly, would not be taxable to the Global Portfolio to the
extent distributed by the Global Portfolio as a dividend to its
shareholders.
Proposed regulations have been issued which may allow the Global Portfolio
to make an election to mark to market its shares of these foreign
investment companies in lieu of being subject to U.S. federal income
taxation. At the end of each taxable year to which the election applies,
the Global Portfolio would report as ordinary income the amount by which
the fair market value of the foreign company's stock exceed the Global
Portfolio's adjusted basis in these shares. No mark to market losses would
be recognized. The effect of the election would be to treat excess
distributions and gain on dispositions as ordinary income which is not
subject to a fund level tax when distributed to shareholders as a dividend.
Alternatively, the Global Portfolio may elect to include as income and gain
their share of the ordinary earnings and net capital gain of certain
foreign investment companies in lieu of being taxed in the manner described
above.
Many futures contracts (including foreign currency futures contracts)
entered into by the Global Portfolio, certain forward foreign currency
contracts, and all listed nonequity options written or purchased by the
Global Portfolio (including options on debt securities, options on futures
contracts, options on securities indices and options on broad-based stock
indices) will be governed by Section 1256 of the Internal Revenue Code.
Absent a tax election to the contrary, gain or loss attributable to the
lapse, exercise or closing out of any such position generally will be
treated as 60% long-term and 40% short-term capital gain or loss, and on
the last trading day of the Global Portfolio's fiscal year, all outstanding
Section 1256 positions will be marked to market (i.e., treated as if such
positions were closed out at their closing price on such day), with any
resulting gain or loss recognized. Under certain circumstances, entry into
a futures contract to sell a security may constitute a short sale for
federal income tax purposes, causing an adjustment in the holding period of
the underlying security or a substantially identical security in the Global
Portfolio. Under Section 988 of the Internal Revenue Code, discussed
below, foreign currency gains or loss from foreign currency related forward
contracts, certain futures and similar financial instruments entered into
or acquired by a Global Portfolio will be treated as ordinary income or
loss.
Under the Internal Revenue Code, gains or losses attributable to
42
fluctuations in exchange rates which occur between the time the Global
Portfolio accrues receivables or liabilities denominated in a foreign
currency and the time the Global Portfolio actually collects such
receivables, or pays such liabilities, generally are treated as ordinary
income or ordinary loss. Similarly, on disposition of debt securities
denominated in a foreign currency and on disposition of certain futures and
forward contracts, gains or losses attributable to fluctuations in the
value of foreign currency between the date of acquisition of the security
or contract and the date of disposition are also treated as ordinary gain
or loss. These gains or losses, referred to under the Internal Revenue
Code as "Section 988" gains or losses, may increase or decrease the amount
of the Global Portfolio's investment company taxable income to be
distributed to its shareholders as ordinary income.
A portion of the difference between the issue price of zero coupon
securities and their face value ("original issue discount") is considered
to be income to a Portfolio each year, even though the Portfolio will not
receive cash interest payments from these securities. This original issue
discount imputed income will comprise a part of the investment company
taxable income of the Portfolios which must be distributed to shareholders
in order to maintain the qualification of the Portfolios as regulated
investment companies and to avoid federal income tax at the level of the
Portfolios.
Shareholders' Tax Status
Except as described below for the Municipal Income Portfolio, unless
otherwise exempt, shareholders are subject to federal income tax on
dividends and capital gains received as cash or additional shares. With
respect to the Government Income and Municipal Income Portfolios, no
portion of any income dividend paid by a Portfolio is expected to be
eligible for the dividends received deduction available to corporations.
With respect to the Growth, Capital Growth, Income and Growth and Global
Portfolios, the dividends received deduction for corporations will apply to
ordinary income distributions to the extent the distribution represents
amounts that would qualify for the dividends received deduction to a
particular Portfolio if that Portfolio were a regular corporation and to
the extent designated by a Portfolio as so qualifying. These dividends and
any short-term capital gains are taxable as ordinary income.
Capital Gains
Shareholders will pay federal tax on long-term capital gains distributed to
them regardless of how long they have held the shares of the particular
Portfolio.
43
Shareholders of the Municipal Income Portfolio are not required to pay the
federal regular income tax on any dividends received from the Portfolio
that represent net interest on tax-exempt municipal bonds. However, under
the Tax Reform Act of 1986, dividends representing net interest earned on
some municipal bonds may be included in calculating the federal individual
alternative minimum tax or the federal alternative minimum tax for
corporations.
For a more complete discussion of shareholders' tax status, including a
discussion of the individual alternative minimum tax and the corporate
alternative minimum tax, see the section of the prospectus entitled "Tax
Information."
Total Return
The average annual total return for both classes of shares of the following
Portfolios for the fiscal year ended September 30, 1994, were as follows:
Since Inception
Portfolio Class A Class B Class A Class B
Growth Portfolio . . . . . -16.87% -12.48% -0.84%* 0.99%*
Capital Growth Portfolio . -6.79% -2.00% 0.68%* 2.44%*
Government Income Portfolio -7.97% -3.97% 0.14%* 1.66%*
Municipal Income Portfolio -9.35% -5.34% 4.42%* 6.00%*
Income and Growth Portfolio 0.68% 5.66% 4.30%** 8.15%**
Global***. . . . . . . . . -5.17% -1.21% -5.17% -1.21%
* For the period from April 29, 1992 (date of initial public investment),
to September 30, 1994.
** For the period from May 24, 1993 (date of initial public investment),
to September 30, 1994.
*** For the period from March 29, 1994 (date of initial public investment),
to September 30, 1994.
The average annual total return for a Portfolio is the average compounded
rate of return for a given period that would equate a $1,000 initial
investment to the ending redeemable value of that investment. The ending
redeemable value is computed by multiplying the number of shares owned at
the end of the period by the maximum offering price per share at the end of
the period. The number of shares owned at the end of the period is based
on the number of shares purchased at the beginning of the period with
$1,000, less any applicable sales load, adjusted over the period by any
additional shares, assuming the monthly, quarterly, or semi-annual (as
applicable) reinvestment of all dividends and distributions. Any
applicable CDSC is deducted from the ending value of the investment based
on the lesser of the original purchase price or the net asset value of
shares redeemed.
44
Cumulative total return reflects a Portfolio's total performance over a
specific period of time. This total return assumes and is reduced by the
payment of the maximum sales load and CDSC.
Yield
The thirty-day yield for both classes of shares of the Portfolios for the
period ending September 30, 1994, were as follows:
Portfolio Class A Class B
Government Income Portfolio. 6.08% 5.73%
Municipal Income Portfolio . 4.56% 4.11%
Income and Growth Portfolio. 1.87% 1.57%
The yield for both classes of each Portfolio is determined by dividing the
net investment income per share (as defined by the SEC) earned by the
particular Portfolio over a thirty-day period by the maximum offering price
per share of the particular Portfolio on the last day of the period. This
value is then annualized using semi-annual compounding. This means that
the amount of income generated during the thirty-day period is assumed to
be generated each month over a twelve-month period and is reinvested every
six months. The yield does not necessarily reflect income actually earned
by the particular Portfolio because of certain adjustments required by the
SEC and, therefore, may not correlate to the dividends or other
distributions paid to shareholders.
To the extent that financial institutions and broker/dealers charge fees in
connection with services provided in conjunction with an investment in a
Portfolio, the performance will be reduced for those shareholders paying
those fees.
Tax-Equivalent Yield (Municipal Income Portfolio)
The tax-equivalent yield for Class A shares of the Municipal Income
Portfolio for the thirty-day period ended September 30, 1994, was 7.55%.
The tax-equivalent yield for the Class B shares was 6.81% for the same
period.
The tax-equivalent yield for both classes of the Municipal Income Portfolio
is calculated similarly to the yield, but is adjusted to reflect the
45
taxable yield that the Portfolio would have had to earn to equal its actual
yield, assuming a 39.6% tax rate (the maximum effective federal rate for
individuals) and assuming that income is 100% tax-exempt.
Tax-Equivalency Table
The Portfolio may also use a tax-equivalency table in advertising and sales
literature. The interest earned by the municipal bonds in the Portfolio's
investment portfolio generally remains free from federal regular income
tax* but may be subject to state and local taxes. Capital gains, if any,
are subject to federal, state and local tax. As the table below indicates,
a "tax-fee" investment is an attractive choice for investors, particularly
in times of narrow spreads between tax-free and taxable yields.
<TABLE>
Taxable Yield Equivalent for 1994
Federal Income Tax Bracket:
15.00% 20.00% 31.00% 36.00% 39.60%
<S> <C> <C> <C> <C> <C>
Joint Return: $1-36,900 $36,901-89,150 $89,151-140,000 $140,001-250,000 Over $250,000
Single Return: $1-22,100 $22,101-53,500 $53,501-115,000 $115,001-250,000 Over $250,000
</TABLE>
Tax-Exempt
Yield Taxable Yield Equivalent
2.50% 2.94% 3.47% 3.62% 3.91% 4.14%
3.00 3.53 4.17 4.35 4.69 4.97
3.50 4.12 4.86 5.07 5.47 5.79
4.00 4.71 5.56 5.80 6.25 6.62
4.50 5.29 6.25 6.52 7.03 7.45
5.00 5.88 6.94 7.25 7.81 8.28
5.50 6.47 7.64 7.97 8.59 9.11
6.00 7.06 8.33 8.70 9.38 9.93
6.50 7.65 9.03 9.42 10.16 10.76
7.00 8.24 9.72 10.14 10.94 11.59
7.50 8.82 10.42 10.87 11.72 12.42
8.00 9.41 11.11 11.59 12.50 13.25
8.50 10.00 11.81 12.32 13.28 14.07
Note: The maximum marginal tax rate for each bracket was used in
calculating the taxable yield equivalent.
The table above is for illustrative purposes only. It is not an indicator
of past or future performance of the Portfolio.
*
Some portion of the Portfolio's income maybe subject to the federal
46
alternative minimum tax and state and local taxes.
Performance Comparisons
The performance of Class A and Class B shares of each Portfolio depends
upon such variables as:
(bullet) portfolio quality;
(bullet) average portfolio maturity;
(bullet) type of instruments in which the particular Portfolio is invested;
(bullet) changes in the expenses of the Trust or Class A or Class B shares
of a particular Portfolio; and
(bullet) various other factors.
The performance of each Portfolio's Class A and Class B shares fluctuates
on a daily basis largely because net earnings and net asset value per share
fluctuate daily. Both net earnings and net asset value per share are
factors in the computation of yield and total return for each class of the
Portfolios.
From time to time each Portfolio may advertise its performance of both
classes of shares of the Portfolios compared to similar funds or portfolios
using certain indices, reporting services, and financial publications.
These may include the following:
(bullet) Lipper Analytical Services, Inc., ranks funds in various fund
categories by making comparative calculations using total
return. Total return assumes the reinvestment of all capital
gains distributions and income dividends and takes into account
any change in net asset value over a specified period of time.
From time to time, a Portfolio will quote its Lipper
ranking in advertising and sales literature.
(bullet) Dow Jones Industrial Average ("DJIA") is an unmanaged index
representing share prices of major industrial corporations,
public utilities, and transportation companies. Produced by
the Dow Jones & Company, it is cited as a principal indicator of
market conditions.
47
(bullet) Standard & Poor's Daily Stock Price Index of 500 Common Stocks, a
composite index of common stocks in industry, transportation,
and financial and public utility companies, can be used to compare
to the total returns of funds whose portfolios are invested
primarily in common stocks. In addition, the Standard & Poor's
index assumes reinvestments of all dividends paid by stocks
listed on its index. Taxes due on any of these distributions are
not included, nor are brokerage or other fees calculated,
in the Standard & Poor's figures.
(bullet) Consumer Price Index is generally considered to be a measure of
inflation.
(bullet) CDA Mutual Fund Growth Index is a weighted performance average
of other mutual funds with growth of capital objectives.
(bullet) Lipper Growth Fund Index is an average of the net asset-valuated
total returns for the top 30 growth funds tracked by Lipper Analytical
Services, Inc., an independent mutual fund rating service.
(bullet) Shearson Lehman Government/Corporate (Total) Index is comprised
of approximately 5,000 issues, which include non-convertible bonds
publicly issued by the U.S. government or its agencies; corporate bonds
guaranteed by the U.S. government and quasi-federal corporations; and
publicly issued, fixed-rate, non-convertible domestic bonds of
companies in industry, public utilities and finance. The average
maturity of these bonds approximates nine years. Tracked by Shearson
Lehman Brothers Inc., the index calculates total returns for one
month, three month, twelve month and ten year periods and year-to-date.
(bullet) Shearson Lehman Government Index is an unmanaged index comprised of
all publicly issued, non-convertible domestic debt of the U.S.
government, or any agency thereof, or any quasi-federal corporation
and of corporate debt guaranteed by the U.S. government. Only
notes and bonds with a minimum outstanding principal of $1 million
and a minimum maturity of one year are included.
(bullet) Morningstar, Inc., an independent rating service, is the publisher of
the bi-weekly Mutual Fund Values. Mutual Fund Values rates more
than 1,000 NASDAQ-listed mutual funds of all types, according to
their risk-adjusted returns. The maximum rating is five stars,
and ratings are effective for two weeks.
(bullet) Russell Growth 1000 (Russell 1000 Index) is a broadly diversified
index consisting of approximately 1,000 common stocks of companies
with market
48
values between $20 million and $300 million that can be used to compare the
total returns of funds whose portfolios are invested primarily in growth
common stocks.
(bullet) Shearson Lehman Aggregate Bond Index is a total return index measuring
both the capital price changes and income provided by the underlying
universe of securities, weighted by market value outstanding. The
Aggregate Bond Index is comprised of the Shearson Lehman Government
Bond Index, Corporate Bond Index, Mortgage-Backed Securities Index,
and Yankee Bond Index. These indices include: U.S. Treasury
obligations, including bonds and notes; U.S. agency obligations,
including those of the Federal Farm Credit Bank, Federal Land Bank,
and the Bank for Cooperatives; foreign obligations; and
U.S. investment-grade corporate debt and mortgage-backed obligations.
All corporate debt included in the Aggregate Bond Index has a
minimum S&P rating of BBB, a minimum Moody's rating of Baa, or a
minimum Fitch rating of BBB.
(bullet) Salomon Brothers Mortgage-Backed Securities Index-15 Years includes
the average of all 15-year mortgage securities, which include Federal
Home Loan Mortgage Corporation (Freddie Mac), Federal National
Mortgage Association (Fannie Mae), and Government National Mortgage
Association (Ginnie Mae).
(bullet) Shearson Lehman Municipal Bond Index is a total return
performance benchmark for the long-term, investment-grade
tax-exempt bond market. Returns and attributes for the
Index are calculated semi-monthly using approximately 21,000
municipal bonds, which are priced by Muller Data Corporation.
From time to time, the Global Portfolio may advertise its performance of
both classes of shares of the Portfolio compared to similar funds or
portfolios using certain indices, reporting services, and financial
publications. These may include the following: Morgan Stanley Capital
International World Index, The Morgan Stanley Capital International EAFE
(Europe, Australia, Far East) index, J. P. Morgan Global Traded Bond Index,
Salomon Brothers World Government Bond Index, and the Standard & Poor's 500
Composite Stock Price Index (S&P 500). The Global Portfolio also may
compare its performance to the performance of unmanaged stock and bond
indices, including the total returns of foreign government bond markets in
various countries. All index returns are translated into U.S. dollars.
The total return calculation for these unmanaged indices may assume the
reinvestment of dividends and any distributions, if applicable, may include
withholding taxes, and generally do not reflect deductions for
administrative and management costs.
Investors may use such indices or reporting services in addition to the
Trust's Prospectus to obtain a more complete view of a particular
Portfolio's performance before investing. Of course, when comparing a
49
Portfolio's performance to any index, conditions such as composition of the
index and prevailing market conditions should be considered in assessing
the significance of such comparisons. When comparing funds using reporting
services, or total return and yield, investors should take into
consideration any relevant differences in funds, such as permitted
portfolio compositions and methods used to value portfolio securities and
compute net asset value.
Advertisements and other sales literature for the Trust may quote total
returns which are calculated on non-standardized base periods. These total
returns also represent the historic change in the value of an investment in
the Trust based on monthly reinvestment of dividends over a specified
period of time.
From time to time the Portfolios may advertise their performance, using
charts, graphs, and descriptions, compared to federally insured bank
products, including certificates of deposit and time deposits, and to money
market funds using the Lipper Analytical Service money market instruments
average.
Advertisements may quote performance information which does not reflect the
effect of the sales load.
Financial Statements
The financial statements for the fiscal year ended September 30, 1994, are
incorporated herein by reference to the combined Annual Report of the Trust
dated September 30, 1994 (File Nos. 33-45315 and 811-6550). You may
request a copy of the combined Annual Report free of charge by writing the
Trust or by calling 1-800-382-0016.
50
Appendix
Moody's Investors Service, Inc., Long-Term Municipal Debt 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.
Ba-Bonds which are Ba are judged to have speculative elements; their future
cannot be considered as well assured. Often the protection of interest and
principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B-Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance
of other terms of the contract over any long period of time may be small.
Note:
Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols
Aa1, A1, Baa1, Ba1 and B1.
51
Standard and Poor's Corporation Long-Term Municipal Debt Ratings
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 higher rated issues only in small degree.
A-Debt rated A has a strong capacity to pay interest and repay principal
although it is 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 in higher rated
categories.
BB, B, CCC, CC-Debt rated BB, B, CCC and CC is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and
repay principal in accordance with the terms of the obligation. BB
indicates the lowest degree of speculation and CC the highest degree of
speculation. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties of major risk
exposure to adverse conditions.
Plus (+) or Minus (-): The ratings from "A" to "B" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Moody's Investors Service, Inc., Short-Term Loan Ratings
MIG1/VMIG1-This designation denotes best quality. There is present strong
protection by established cash flows, superior liquidity support or
demonstrated broadbased access to the market for refinancing.
MIG2/VMIG2-This designation denotes high quality. Margins of protection
are ample although not so large as in the preceding group.
Standard and Poor's Corporation Municipal Note Ratings
SP-1-Very strong or strong capacity to pay principal and interest. Those
issues determined to possess overwhelming safety characteristics will be
given a plus (+) designation.
SP-2-Satisfactory capacity to pay principal and interest.
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Fitch Investors Service, Inc., Short-Term Debt Ratings
F-1+-Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely payment.
F-1-Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues rated
F-1+.
F-2-Good Credit Quality. Issues carrying this rating have a satisfactory
degree of assurance for timely payment.
Moody's Investors Service, Inc., Commercial Paper Ratings
P-1-Issuers rated PRIME-1 (or related supporting institutions) have a
superior capacity for repayment of short-term promissory obligations.
PRIME-1 repayment capacity will normally be evidenced by the following
characteristics: conservative capitalization structures with moderate
reliance on debt and ample asset protection; broad margins in earning
coverage of fixed financial charges and high internal cash generation; and
well-established access to a range of financial markets and assured sources
of alternate liquidity.
P-2-Issuers rated PRIME-2 (or related supporting institutions) have a
strong capacity for repayment of short-term promissory obligations. This
will normally be evidenced by many of the characteristics cited above but
to a lesser degree. Earnings trends and coverage ratios, while sound, will
be more subject to variation. Capitalization characteristics, while still
appropriate, may be more affected by external conditions. Ample alternate
liquidity is maintained.
Standard and Poor's Corporation Commercial Paper Ratings
A-1-This designation indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Those issues determined to
possess overwhelming safety characteristics are denoted with a plus (+)
sign designation.
A-2-Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as high as for issues
designated A-1.
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