MENTOR FUNDS
STATEMENT OF ADDITIONAL INFORMATION
November 29, 1996, as revised June 4, 1997
Mentor Funds (the "Trust") is an open-end series investment company.
This Statement of Additional Information is not a prospectus and should be read
in conjunction with the prospectus of the Trust dated November 29, 1996 and the
prospectus of Mentor Balanced Portfolio dated November 29, 1996. A copy of
either prospectus can be obtained upon request by writing to Mentor
Distributors, LLC, the Trust's distributor, at 901 East Byrd Street, Richmond,
Virginia 23219, or by calling Mentor Distributors at 1-800-382-0016.
This Statement is in three parts. Part I contains information with
respect to Mentor Capital Growth Portfolio, Mentor Quality Income Portfolio,
Mentor Municipal Income Portfolio, Mentor Income and Growth Portfolio, and
Mentor Perpetual Global Portfolio. Part II contains information with respect to
Mentor Growth Portfolio, Mentor Strategy Portfolio, Mentor ShortDuration Income
Portfolio, and Mentor Balanced Portfolio, which are the successors to Mentor
Growth Fund, Mentor Strategy Fund, Mentor Short-Duration Income Fund, and Mentor
Balanced Fund, respectively, each of which was previously a series of shares of
Mentor Series Trust. Part III provides general information with respect to the
Trust and all of the Portfolios.
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TABLE OF CONTENTS
INTRODUCTION................................................1
PART I......................................................1
INVESTMENT RESTRICTIONS.....................................1
PART II.....................................................5
INVESTMENT RESTRICTIONS.....................................5
PART III....................................................9
CERTAIN INVESTMENT TECHNIQUES ..............................9
MANAGEMENT OF THE TRUST....................................31
INVESTMENT ADVISORY SERVICES...............................34
ADMINISTRATIVE SERVICES....................................38
SHAREHOLDER SERVICING PLAN.................................39
BROKERAGE TRANSACTIONS.....................................40
HOW TO BUY SHARES..........................................43
DISTRIBUTION...............................................44
DETERMINING NET ASSET VALUE................................45
REDEMPTIONS IN KIND........................................47
TAXES......................................................47
INDEPENDENT ACCOUNTANTS....................................52
CUSTODIAN..................................................52
PERFORMANCE INFORMATION ...................................52
MEMBERS OF INVESTMENT MANAGEMENT TEAMS.....................57
PERFORMANCE COMPARISONS....................................60
SHAREHOLDER LIABILITY......................................66
FINANCIAL STATEMENTS.......................................66
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INTRODUCTION
Mentor Funds is a Massachusetts business trust organized on January 20,
1992 as Cambridge Series Trust. As of the date of this Statement, the Trust
consisted of the following nine portfolios (collectively, the "Portfolios" and
each individually, the "Portfolio"): Mentor Growth Portfolio (the "Growth
Portfolio"); Mentor Quality Income Portfolio (the "Quality Income Portfolio");
Mentor Balanced Portfolio (the "Balanced Portfolio"); Mentor Capital Growth
Portfolio (the "Capital Growth Portfolio"); Mentor Perpetual Global Portfolio
(the "Global Portfolio"); Mentor Income and Growth Portfolio (the "Income and
Growth Portfolio"); Mentor Municipal Income Portfolio (the "Municipal Income
Portfolio"); Mentor Short-Duration Income Portfolio (the "Short-Duration Income
Portfolio"); and Mentor Strategy Portfolio (the "Strategy Portfolio"). With the
exception of the Balanced Portfolio, which has only one class of shares, each
Portfolio has two classes of shares of beneficial interest, Class A shares and
Class B shares.
With respect to the investment restrictions described below, all
percentage limitations on investments will apply at the time of investment and
shall not be considered violated unless an excess or deficiency occurs or exists
immediately after and as a result of such investment. Except for the investment
restrictions listed below as fundamental or to the extent designated as such in
the Prospectus in respect of a Portfolio, the other investment policies
described in this Statement or in the Prospectus are not fundamental and may be
changed by approval of the Trustees. As a matter of policy, the Trustees would
not materially change a Portfolio's investment objective without shareholder
approval.
The Investment Company Act of 1940, as amended (the "1940 Act"),
provides that a "vote of a majority of the outstanding voting securities" of a
Portfolio means the affirmative vote of the lesser of (1) more than 50% of the
outstanding shares of the Portfolio, or (2) 67% or more of the shares present at
a meeting if more than 50% of the outstanding shares are represented at the
meeting in person or by proxy.
PART I
The following information relates to each of the Capital Growth,
Quality Income, Municipal Income, Income and Growth, and the Global Portfolios,
except where otherwise noted.
INVESTMENT RESTRICTIONS
The following investment restrictions are fundamental and may not be
changed without a vote of a majority of the outstanding voting securities of a
Portfolio:
1. 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
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agreements in amounts of 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
of 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 Quality 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.
2. 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.
3. 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.
4. 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.
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5. The Portfolios (other than the Quality Income Portfolio) will not
invest more than 10% of the value of their net assets in restricted
securities; the Quality Income Portfolio will not invest more than 15%
of the value of its net assets in restricted securities.
6. 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.
7. 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.
8. 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.
9. 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 Trust's 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 Trust's Prospectus.
10. 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.
In addition, the it is contrary to the current policy of each
Portfolio, which may be changed without shareholder approval, to invest in (a)
securities which at the time of such investment are not readily marketable, (b)
securities restricted as to resale (excluding securities determined by the
Trustees (or the person designated by the Trustees to make such determinations)
to be readily marketable), and (c) repurchase agreements maturing in more than
seven days, if, as a result, more than 15% of the Portfolio's net assets (taken
at current value) would then be invested in the aggregate in securities
described in (a), (b), and (c) above.
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PART II
The following information relates to each of the Balanced, Growth,
Short-Duration Income, and Strategy Portfolios, except where otherwise noted.
INVESTMENT RESTRICTIONS
As fundamental investment restrictions, which may not be changed with
respect to a Portfolio without a vote of a majority of the outstanding shares of
that Portfolio, a Portfolio may not:
1. Issue any securities which are senior to the Portfolio's shares as
described herein and in the relevant prospectus, except that each of
the Portfolios other than the Growth Portfolio and the Strategy
Portfolio may borrow money to the extent contemplated by Restriction 4
below.
2. Purchase securities on margin (but a Portfolio may obtain such
short-term credits as may be necessary for the clearance of
transactions). (Margin payments in connection with transactions in
futures contracts, options, and other financial instruments are not
considered to constitute the purchase of securities on margin for this
purpose.)
3. Make short sales of securities or maintain a short position, unless at
all times when a short position is open, it owns an equal amount of
such securities or securities convertible into or exchangeable, without
payment of any further consideration, for securities of the same issue
as, and equal in amount to, the securities sold short ("short sale
against-the-box"), and unless not more than 25% of the Portfolio's net
assets (taken at current value) is held as collateral for such sales at
any one time.
4. (Growth Portfolio and Strategy Portfolio) Borrow money or pledge its
assets except that a Portfolio may borrow from banks for temporary or
emergency purposes (including the meeting of redemption requests which
might otherwise require the untimely disposition of securities) in
amounts not exceeding 10% (taken at the lower of cost or market value)
of its total assets (not including the amount borrowed) and pledge its
assets to secure such borrowings; provided that a Portfolio will not
purchase additional portfolio securities when such borrowings exceed 5%
of its total assets. (Collateral or margin arrangements with respect
to options, futures contracts, or other financial instruments are not
considered to be pledges.)
(All other Portfolios included in Part II) Borrow more than 33 1/3% of
the value of its total assets less all liabilities and indebtedness
(other than such borrowings) not represented by senior securities.
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5. Act as underwriter of securities of other issuers except to the extent
that, in connection with the disposition of portfolio securities, it
may be deemed to be an underwriter under certain federal securities
laws.
6. Purchase any security if as a result the Portfolio would then have more
than 5% of its total assets (taken at current value) invested in
securities of companies (including predecessors) less than three years
old or (in the case of Growth Portfolio) in equity securities for which
market quotations are not readily available.
7. (as to the Growth Portfolio only) Purchase any security if as a result
the Portfolio would then hold more than 10% of any class of securities
of an issuer (taking all common stock issues of an issuer as a single
class, all preferred stock issues as a single class, and all debt
issues as a single class) or more than 10% of the outstanding voting
securities of an issuer.
8. Purchase any security (other than obligations of the U.S. Government,
its agencies or instrumentalities) if as a result: (i) more than 5% of
the Portfolio's total assets (taken at current value) would then be
invested in securities of a single issuer, or (ii) more than 25% of the
Portfolio's total assets (taken at current value) would be invested in
a single industry; provided that the restriction set out in (i) above
shall apply, in the case of each Portfolio other than the Growth
Portfolio, only as to 75% of such Portfolio's total assets.
9. Invest in securities of any issuer if, to the knowledge of the Trust,
any officer or Trustee of the Trust or of Mentor Investment Advisors,
LLC as the case may be, owns more than 1/2 of 1% of the outstanding
securities of such issuer, and such officers and Trustees who own more
than 1/2 of 1% own in the aggregate more than 5% of the outstanding
securities of such issuer.
10. Purchase or sell real estate or interests in real estate, including
real estate mortgage loans, although it may purchase and sell
securities which are secured by real estate and securities of companies
that invest or deal in real estate (or, in the case of any Portfolio
other than the Growth Portfolio, real estate or limited partnership
interests). (For purposes of this restriction, investments by a
Portfolio in mortgage-backed securities and other securities
representing interests in mortgage pools shall not constitute the
purchase or sale of real estate or interests in real estate or real
estate mortgage loans.)
11. Make investments for the purpose of exercising control or management.
12. (as to the Growth Portfolio only) Participate on a joint or a joint and
several basis in any trading account in securities.
13. (as to the Growth Portfolio only) Purchase any security restricted as
to disposition under federal securities laws if as a result more than
5% of the Portfolio's total assets (taken at current value) would be
invested in restricted securities.
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14. (as to the Growth Portfolio only) Invest in securities of other
registered investment companies, except by purchases in the open market
involving only customary brokerage commissions and as a result of which
not more than 5% of its total assets (taken at current value) would be
invested in such securities, or except as part of a merger,
consolidation or other acquisition.
15. Invest in interests in oil, gas or other mineral exploration or
development programs or leases, although it may invest in the common
stocks of companies that invest in or sponsor such programs.
16. (as to the Growth Portfolio only) Make loans, except through (i)
repurchase agreements (repurchase agreements with a maturity of longer
than 7 days together with other illiquid assets being limited to 10% of
the Portfolio's assets,) and (ii) loans of portfolio securities
(limited to 33% of the Portfolio's total assets).
17. (as to the Growth Portfolio only) Purchase foreign securities or
currencies except foreign securities which are American Depository
Receipts listed on exchanges or otherwise traded in the United States
and certificates of deposit, bankers' acceptances and other obligations
of foreign banks and foreign branches of U.S. banks if, giving effect
to such purchase, such obligations would constitute less than 10% of
the Trust's total assets (at current value).
18. (as to the Growth Portfolio only) Purchase warrants if as a result the
Portfolio would then have more than 5% of its total assets (taken at
current value) invested in warrants.
19. (as to each Portfolio other than the Growth Portfolio) Acquire more
than 10% of the voting securities of any issuer.
20. (as to each Portfolio other than the Growth Portfolio) Make loans,
except by purchase of debt obligations in which the Portfolio may
invest consistent with its investment policies, by entering into
repurchase agreements with respect to not more than 25% of its total
assets (taken at current value), or through the lending of its
portfolio securities with respect to not more than 25% of its total
assets.
In addition, it is contrary to the current policy of each of the
Portfolios, other than the Growth Portfolio (except as specified below), which
policy may be changed without shareholder approval, to:
1. Purchase or sell commodities or commodity contracts,
except that a Portfolio may purchase or sell
financial futures contracts, options on financial
futures contracts, and futures contracts, forward
contracts, and options with respect to foreign
currencies, and may enter into swap transactions.
(This restriction applies to the Growth Portfolio.)
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2. Invest in (a) securities which at the time of such investment
are not readily marketable, (b) securities restricted as to
resale, and (c) repurchase agreements maturing in more than
seven days, if, as a result, more than 15% of the Portfolio's
net assets (taken at current value) would then be invested in
the aggregate in securities described in (a), (b), and (c)
above. (All Portfolios other than the Growth Portfolio)
Shares of beneficial interest in the Mentor Balanced Portfolio have
been registered only in the Commonwealth of Virginia. These shares may not be
offered or sold in any other state without being registered or exempt from
registration.
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PART III
The following information relates to all of the Portfolios of the
Trust, except where otherwise noted.
All information with respect to fees, expenses and performance (except
where otherwise indicated) is based on a Portfolio's fiscal year end. All of the
Portfolios have a September 30 fiscal year end. Prior to September 30, 1995,
each of the Balanced, Growth, Short-Duration Income, and Strategy Portfolios had
a December 31 fiscal year end. Information concerning the expenses of those
Portfolios for fiscal 1995 is provided for the fiscal period January 1, 1995
through September 30, 1995. Certain information with respect to certain
Portfolios is given for partial fiscal years. See "Financial Highlights" in the
Trust's prospectus for information concerning the commencement of operations of
each of the Portfolios.
CERTAIN INVESTMENT TECHNIQUES
Set forth below is information concerning certain investment techniques
in which one or more of the Portfolios may engage, and certain of the risks they
may entail. Certain of the investment techniques may not be available to a
Portfolio. See the Prospectus relating to a particular Portfolio for a
description of the investment techniques generally applicable to that Portfolio.
For purposes of this section, a Portfolio's investment adviser or subadviser (if
any) is referred to as an "Adviser".
Options
A Portfolio may purchase and sell put and call options on its portfolio
securities to enhance investment performance or to protect against changes in
market prices.
Covered call options. A Portfolio may write covered call options on its
securities to realize a greater current return through the receipt of premiums
than it would realize on its securities alone. Such option transactions may also
be used as a limited form of hedging against a decline in the price of
securities owned by the Portfolio.
A call option gives the holder the right to purchase, and obligates the
writer to sell, a security at the exercise price at any time before the
expiration date. A call option is "covered" if the writer, at all times while
obligated as a writer, either owns the underlying securities (or comparable
securities satisfying the cover requirements of the securities exchanges), or
has the right to acquire such securities through immediate conversion of
securities.
In return for the premium received when it writes a covered call
option, a Portfolio gives up some or all of the opportunity to profit from an
increase in the market price of the securities covering the call option during
the life of the option. The Portfolio retains the risk of loss should the price
of such securities decline. If the option expires unexercised, the Portfolio
realizes a gain
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equal to the premium, which may be offset by a decline in price of the
underlying security. If the option is exercised, the Portfolio realizes a gain
or loss equal to the difference between the Portfolio's cost for the underlying
security and the proceeds of sale (exercise price minus commissions) plus the
amount of the premium.
A Portfolio may terminate a call option that it has written before it
expires by entering into a closing purchase transaction. A Portfolio may enter
into closing purchase transactions in order to free itself to sell the
underlying security or to write another call on the security, realize a profit
on a previously written call option, or protect a security from being called in
an unexpected market rise. Any profits from a closing purchase transaction may
be offset by a decline in the value of the underlying security. Conversely,
because increases in the market price of a call option will generally reflect
increases in the market price of the underlying security, any loss resulting
from a closing purchase transaction is likely to be offset in whole or in part
by unrealized appreciation of the underlying security owned by the Portfolio.
Covered put options. A Portfolio may write covered put options in order
to enhance its current return. Such options transactions may also be used as a
limited form of hedging against an increase in the price of securities that the
Portfolio plans to purchase. A put option gives the holder the right to sell,
and obligates the writer to buy, a security at the exercise price at any time
before the expiration date. A put option is "covered" if the writer segregates
cash and high-grade short-term debt obligations or other permissible collateral
equal to the price to be paid if the option is exercised.
In addition to the receipt of premiums and the potential gains from
terminating such options in closing purchase transactions, a Portfolio also
receives interest on the cash and debt securities maintained to cover the
exercise price of the option. By writing a put option, the Portfolio assumes the
risk that it may be required to purchase the underlying security for an exercise
price higher than its then current market value, resulting in a potential
capital loss unless the security later appreciates in value.
A Portfolio may terminate a put option that it has written before it
expires by a closing purchase transaction. Any loss from this transaction may be
partially or entirely offset by the premium received on the terminated option.
Purchasing put and call options. A Portfolio may also purchase put
options to protect portfolio holdings against a decline in market value. This
protection lasts for the life of the put option because the Portfolio, as a
holder of the option, may sell the underlying security at the exercise price
regardless of any decline in its market price. In order for a put option to be
profitable, the market price of the underlying security must decline
sufficiently below the exercise price to cover the premium and transaction costs
that the Portfolio must pay. These costs will reduce any profit the Portfolio
might have realized had it sold the underlying security instead of buying the
put option.
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A Portfolio may purchase call options to hedge against an increase in
the price of securities that the Portfolio wants ultimately to buy. Such hedge
protection is provided during the life of the call option since the Portfolio,
as holder of the call option, is able to buy the underlying security at the
exercise price regardless of any increase in the underlying security's market
price. In order for a call option to be profitable, the market price of the
underlying security must rise sufficiently above the exercise price to cover the
premium and transaction costs. These costs will reduce any profit the Portfolio
might have realized had it bought the underlying security at the time it
purchased the call option.
Options on foreign securities. A Portfolio may purchase and sell
options on foreign securities if in the opinion of its Adviser the investment
characteristics of such options, including the risks of investing in such
options, are consistent with the Portfolio's investment objectives. It is
expected that risks related to such options will not differ materially from
risks related to options on U.S. securities. However, position limits and other
rules of foreign exchanges may differ from those in the U.S. In addition,
options markets in some countries, many of which are relatively new, may be less
liquid than comparable markets in the U.S.
Risks involved in the sale of options. Options transactions involve
certain risks, including the risks that a Portfolio's Adviser will not forecast
interest rate or market movements correctly, that a Portfolio may be unable at
times to close out such positions, or that hedging transactions may not
accomplish their purpose because of imperfect market correlations. The
successful use of these strategies depends on the ability of a Portfolio's
Adviser to forecast market and interest rate movements correctly.
An exchange-listed option may be closed out only on an exchange which
provides a secondary market for an option of the same series. There is no
assurance that a liquid secondary market on an exchange will exist for any
particular option or at any particular time. If no secondary market were to
exist, it would be impossible to enter into a closing transaction to close out
an option position. As a result, a Portfolio may be forced to continue to hold,
or to purchase at a fixed price, a security on which it has sold an option at a
time when its Adviser believes it is inadvisable to do so.
Higher than anticipated trading activity or order flow or other
unforeseen events might cause The Options Clearing Corporation or an exchange to
institute special trading procedures or restrictions that might restrict the
Portfolio's use of options. The exchanges have established limitations on the
maximum number of calls and puts of each class that may be held or written by an
investor or group of investors acting in concert. It is possible that the
Portfolio and other clients of the Portfolio's Adviser may be considered such a
group. These position limits may restrict the Portfolio's ability to purchase or
sell options on particular securities.
Options which are not traded on national securities exchanges may be
closed out only with the other party to the option transaction. For that reason,
it may be more difficult to close out
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unlisted options than listed options. Furthermore, unlisted options are not
subject to the protection afforded purchasers of listed options by The Options
Clearing Corporation.
Government regulations, particularly the requirements for qualification
as a "regulated investment company" under the Internal Revenue Code, may also
restrict the Portfolio's use of options.
Futures Contracts
In order to hedge against the effects of adverse market changes a
Portfolio that may invest in debt securities may buy and sell futures contracts
on debt securities of the type in which the Portfolio may invest and on indexes
of debt securities. In addition, a Portfolio that may invest in equity
securities may purchase and sell stock index futures to hedge against changes in
stock market prices. A Portfolio may also, to the extent permitted by applicable
law, buy and sell futures contracts and options on futures contracts to increase
its current return. All such futures and related options will, as may be
required by applicable law, be traded on exchanges that are licensed and
regulated by the Commodity Futures Trading Commission (the "CFTC").
Futures on Debt Securities and Related Options. A futures contract on a
debt security is a binding contractual commitment which, if held to maturity,
will result in an obligation to make or accept delivery, during a particular
month, of securities having a standardized face value and rate of return. By
purchasing futures on debt securities -- assuming a "long" position -- a
Portfolio will legally obligate itself to accept the future delivery of the
underlying security and pay the agreed price. By selling futures on debt
securities -- assuming a "short" position -- it will legally obligate itself to
make the future delivery of the security against payment of the agreed price.
Open futures positions on debt securities will be valued at the most recent
settlement price, unless that price does not, in the judgment of persons acting
at the direction of the Trustees as to the valuation of a Portfolio's assets,
reflect the fair value of the contract, in which case the positions will be
valued by the Trustees or such persons.
Positions taken in the futures markets are not normally held to
maturity, but are instead liquidated through offsetting transactions that may
result in a profit or a loss. While futures positions taken by a Portfolio will
usually be liquidated in this manner, a Portfolio may instead make or take
delivery of the underlying securities whenever it appears economically
advantageous to do so. A clearing corporation associated with the exchange on
which futures are traded assumes responsibility for such closing transactions
and guarantees that a Portfolio's sale and purchase obligations under closed-out
positions will be performed at the termination of the contract.
Hedging by use of futures on debt securities seeks to establish with
more certainty than would otherwise be possible the effective rate of return on
securities. A Portfolio may, for example, take a "short" position in the futures
market by selling contracts for the future delivery of debt securities held by
the Portfolio (or securities having characteristics similar to those held
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by the Portfolio) in order to hedge against an anticipated rise in interest
rates that would adversely affect the value of the Portfolio's securities. When
hedging of this character is successful, any depreciation in the value of
securities may substantially be offset by appreciation in the value of the
futures position.
On other occasions, the Portfolio may take a "long" position by
purchasing futures on debt securities. This would be done, for example, when the
Portfolio expects to purchase particular securities when it has the necessary
cash, but expects the rate of return available in the securities markets at that
time to be less favorable than rates currently available in the futures markets.
If the anticipated rise in the price of the securities should occur (with its
concomitant reduction in yield), the increased cost to the Portfolio of
purchasing the securities may be offset, at least to some extent, by the rise in
the value of the futures position taken in anticipation of the subsequent
purchase.
Successful use by a Portfolio of futures contracts on debt securities
is subject to its Adviser's ability to predict correctly movements in the
direction of interest rates and other factors affecting markets for debt
securities. For example, if a Portfolio has hedged against the possibility of an
increase in interest rates which would adversely affect the market prices of
debt securities held by it and the prices of such securities increase instead
the Portfolio will lose part or all of the benefit of the increased value of its
securities which it has hedged because it will have offsetting losses in its
futures positions. In addition, in such situations, if the Portfolio has
insufficient cash, it may have to sell securities to meet daily margin
maintenance requirements. The Portfolio may have to sell securities at a time
when it may be disadvantageous to do so.
A Portfolio may purchase and write put and call options on certain debt
futures contracts, as they become available. Such options are similar to options
on securities except that options on futures contracts give the purchaser the
right, in return for the premium paid, to assume a position in a futures
contract (a long position if the option is a call and a short position if the
option is a put) at a specified exercise price at any time during the period of
the option. As with options on securities, the holder or writer of an option may
terminate his position by selling or purchasing an option of the same series.
There is no guarantee that such closing transactions can be effected. A
Portfolio will be required to deposit initial margin and maintenance margin with
respect to put and call options on futures contracts written by it pursuant to
brokers' requirements, and, in addition, net option premiums received will be
included as initial margin deposits. See "Margin Payments" below. Compared to
the purchase or sale of futures contracts, the purchase of call or put options
on futures contracts involves less potential risk to a Portfolio because the
maximum amount at risk is the premium paid for the options plus transactions
costs. However, there may be circumstances when the purchase of call or put
options on a futures contract would result in a loss to a Portfolio when the
purchase or sale of the futures contracts would not, such as when there is no
movement in the prices of debt securities. The writing of a put or call option
on a futures contract involves risks similar to those risks relating to the
purchase or sale of futures contracts.
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Index Futures Contracts and Options. A Portfolio may invest in debt
index futures contracts and stock index futures contracts, and in related
options. A debt index futures contract is a contract to buy or sell units of a
specified debt index at a specified future date at a price agreed upon when the
contract is made. A unit is the current value of the index. (Debt index futures
in which the Portfolios are presently expected to invest are not now available,
although such futures contracts are expected to become available in the future.)
A stock index futures contract is a contract to buy or sell units of a stock
index at a specified future date at a price agreed upon when the contract is
made. A unit is the current value of the stock index.
For example, the Standard & Poor's 100 Stock Index is composed of 100
selected common stocks, most of which are listed on the New York Stock Exchange.
The S&P 100 Index assigns relative weightings to the common stocks included in
the Index, and the Index fluctuates with changes in the market values of those
common stocks. In the case of the S&P 100 Index, contracts are to buy or sell
100 units. Thus, if the value of the S&P 100 Index were $180, one contract would
be worth $18,000 (100 units x $180). The stock index futures contract specifies
that no delivery of the actual stocks making up the index will take place.
Instead, settlement in cash must occur upon the termination of the contract,
with the settlement being the difference between the contract price and the
actual level of the stock index at the expiration of the contract. For example,
if a Portfolio enters into a futures contract to buy 100 units of the S&P 100
Index at a specified future date at a contract price of $180 and the S&P 100
Index is at $184 on that future date, the Portfolio will gain $400 (100 units x
gain of $4). If the Portfolio enters into a futures contract to sell 100 units
of the stock index at a specified future date at a contract price of $180 and
the S&P 100 Index is at $182 on that future date, the Portfolio will lose $200
(100 units x loss of $2).
A Portfolio may purchase or sell futures contracts with respect to any
securities indexes. Positions in index futures may be closed out only on an
exchange or board of trade which provides a secondary market for such futures.
In order to hedge a Portfolio's investments successfully using futures
contracts and related options, a Portfolio must invest in futures contracts with
respect to indexes or sub-indexes the movements of which will, in its judgment,
have a significant correlation with movements in the prices of the Portfolio's
securities.
Options on stock index futures. Options on index futures contracts are
similar to options on securities except that options on index futures contracts
give the purchaser the right, in return for the premium paid, to assume a
position in an index futures contract (a long position if the option is a call
and a short position if the option is a put) at a specified exercise price at
any time during the period of the option. Upon exercise of the option, the
holder would assume the underlying futures position and would receive a
variation margin payment of cash or securities approximating the increase in the
value of the holder's option position. If an option is exercised on the last
trading day prior to the expiration date of the option, the settlement will be
made entirely in cash based on the difference between the exercise price of the
option and the closing
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level of the index on which the futures contract is based on the expiration
date. Purchasers of options who fail to exercise their options prior to the
exercise date suffer a loss of the premium paid.
Options on Indices. As an alternative to purchasing and selling call
and put options on index futures contracts, each of the Portfolios which may
purchase and sell index futures contracts may purchase and sell call and put
options on the underlying indexes themselves to the extent that such options are
traded on national securities exchanges. Index options are similar to options on
individual securities in that the purchaser of an index option acquires the
right to buy (in the case of a call) or sell (in the case of a put), and the
writer undertakes the obligation to sell or buy (as the case may be), units of
an index at a stated exercise price during the term of the option. Instead of
giving the right to take or make actual delivery of securities, the holder of an
index option has the right to receive a cash "exercise settlement amount". This
amount is equal to the amount by which the fixed exercise price of the option
exceeds (in the case of a put) or is less than (in the case of a call) the
closing value of the underlying index on the date of the exercise, multiplied by
a fixed "index multiplier".
A Portfolio may purchase or sell options on stock indices in order to
close out its outstanding positions in options on stock indices which it has
purchased. A Portfolio may also allow such options to expire unexercised.
Compared to the purchase or sale of futures contracts, the purchase of
call or put options on an index involves less potential risk to a Portfolio
because the maximum amount at risk is the premium paid for the options plus
transactions costs. The writing of a put or call option on an index involves
risks similar to those risks relating to the purchase or sale of index futures
contracts.
Margin Payments. When a Portfolio purchases or sells a futures
contract, it is required to deposit with its custodian an amount of cash, U.S.
Treasury bills, or other permissible collateral equal to a small percentage of
the amount of the futures contract. This amount is known as "initial margin".
The nature of initial margin is different from that of margin in security
transactions in that it does not involve borrowing money to finance
transactions. Rather, initial margin is similar to a performance bond or good
faith deposit that is returned to a Portfolio upon termination of the contract,
assuming a Portfolio satisfies its contractual obligations.
Subsequent payments to and from the broker occur on a daily basis in a
process known as "marking to market". These payments are called "variation
margin" and are made as the value of the underlying futures contract fluctuates.
For example, when a Portfolio sells a futures contract and the price of the
underlying security rises above the delivery price, the Portfolio's position
declines in value. The Portfolio then pays the broker a variation margin payment
equal to the difference between the delivery price of the futures contract and
the market price of the securities underlying the futures contract. Conversely,
if the price of the underlying security falls below the delivery price of the
contract, the Portfolio's futures position increases in value. The
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broker then must make a variation margin payment equal to the difference between
the delivery price of the futures contract and the market price of the
securities underlying the futures contract.
When a Portfolio terminates a position in a futures contract, a final
determination of variation margin is made, additional cash is paid by or to the
Portfolio, and the Portfolio realizes a loss or a gain. Such closing
transactions involve additional commission costs.
Special Risks of Transactions in Futures Contracts and Related Options
Liquidity risks. Positions in futures contracts may be closed out only
on an exchange or board of trade which provides a secondary market for such
futures. Although the Portfolio intends to purchase or sell futures only on
exchanges or boards of trade where there appears to be an active secondary
market, there is no assurance that a liquid secondary market on an exchange or
board of trade will exist for any particular contract or at any particular time.
If there is not a liquid secondary market at a particular time, it may not be
possible to close a futures position at such time and, in the event of adverse
price movements, a Portfolio would continue to be required to make daily cash
payments of variation margin. However, in the event financial futures are used
to hedge portfolio securities, such securities will not generally be sold until
the financial futures can be terminated. In such circumstances, an increase in
the price of the portfolio securities, if any, may partially or completely
offset losses on the financial futures.
In addition to the risks that apply to all options transactions, there
are several special risks relating to options on futures contracts. The ability
to establish and close out positions in such options will be subject to the
development and maintenance of a liquid secondary market. It is not certain that
such a market will develop. Although a Portfolio generally will purchase only
those options for which there appears to be an active secondary market, there is
no assurance that a liquid secondary market on an exchange will exist for any
particular option or at any particular time. In the event no such market exists
for particular options, it might not be possible to effect closing transactions
in such options with the result that a Portfolio would have to exercise the
options in order to realize any profit.
Hedging risks. There are several risks in connection with the use by a
Portfolio of futures contracts and related options as a hedging device. One risk
arises because of the imperfect correlation between movements in the prices of
the futures contracts and options and movements in the underlying securities or
index or movements in the prices of a Portfolio's securities which are the
subject of a hedge. A Portfolio's Adviser will, however, attempt to reduce this
risk by purchasing and selling, to the extent possible, futures contracts and
related options on securities and indexes the movements of which will, in its
judgment, correlate closely with movements in the prices of the underlying
securities or index and the securities sought to be hedged.
Successful use of futures contracts and options by a Portfolio for
hedging purposes is also subject to its Adviser's ability to predict correctly
movements in the direction of the market. It is possible that, where a Portfolio
has purchased puts on futures contracts to hedge its portfolio
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against a decline in the market, the securities or index on which the puts are
purchased may increase in value and the value of securities held in the
portfolio may decline. If this occurred, the Portfolio would lose money on the
puts and also experience a decline in value in its portfolio securities. In
addition, the prices of futures, for a number of reasons, may not correlate
perfectly with movements in the underlying securities or index due to certain
market distortions. First, all participants in the futures market are subject to
margin deposit requirements. Such requirements may cause investors to close
futures contracts through offsetting transactions which could distort the normal
relationship between the underlying security or index and futures markets.
Second, the margin requirements in the futures markets are less onerous than
margin requirements in the securities markets in general, and as a result the
futures markets may attract more speculators than the securities markets do.
Increased participation by speculators in the futures markets may also cause
temporary price distortions. Due to the possibility of price distortion, even a
correct forecast of general market trends by a Portfolio's Adviser may still not
result in a successful hedging transaction over a short time period.
Other Risks. Portfolios will incur brokerage fees in connection with
their futures and options transactions. In addition, while futures contracts and
options on futures will be purchased and sold to reduce certain risks, those
transactions themselves entail certain other risks. Thus, while a Portfolio may
benefit from the use of futures and related options, unanticipated changes in
interest rates or stock price movements may result in a poorer overall
performance for the Portfolio than if it had not entered into any futures
contracts or options transactions. Moreover, in the event of an imperfect
correlation between the futures position and the portfolio position which is
intended to be protected, the desired protection may not be obtained and the
Portfolio may be exposed to risk of loss.
Forward Commitments
A Portfolio may enter into contracts to purchase securities for a fixed
price at a future date beyond customary settlement time ("forward commitments")
if the Portfolio holds, and maintains until the settlement date in a segregated
account, cash or high-grade debt obligations in an amount sufficient to meet the
purchase price, or if the Portfolio enters into offsetting contracts for the
forward sale of other securities it owns. Forward commitments may be considered
securities in themselves, and involve a risk of loss if the value of the
security to be purchased declines prior to the settlement date, which risk is in
addition to the risk of decline in the value of the Portfolio's other assets.
Where such purchases are made through dealers, the Portfolios rely on the dealer
to consummate the sale. The dealer's failure to do so may result in the loss to
the Portfolio of an advantageous yield or price. Although a Portfolio will
generally enter into forward commitments with the intention of acquiring
securities for its portfolio or for delivery pursuant to options contracts it
has entered into, a Portfolio may dispose of a commitment prior to settlement if
its Adviser deems it appropriate to do so. A Portfolio may realize short-term
profits or losses upon the sale of forward commitments.
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Repurchase Agreements
A Portfolio may enter into repurchase agreements. A repurchase
agreement is a contract under which the Portfolio acquires a security subject to
the obligation of the seller to repurchase and the Portfolio to resell such
security at a fixed time and price (representing the Portfolio's cost plus
interest). It is the Trust's present intention to enter into repurchase
agreements only with member banks of the Federal Reserve System and securities
dealers meeting certain criteria as to creditworthiness and financial condition
established by the Trustees of the Trust and only with respect to obligations of
the U.S. government or its agencies or instrumentalities or other high quality
short term debt obligations. Repurchase agreements may also be viewed as loans
made by a Portfolio which are collateralized by the securities subject to
repurchase. A Portfolio's Adviser will monitor such transactions to ensure that
the value of the underlying securities will be at least equal at all times to
the total amount of the repurchase obligation, including the interest factor. If
the seller defaults, a Portfolio could realize a loss on the sale of the
underlying security to the extent that the proceeds of sale including accrued
interest are less than the resale price provided in the agreement including
interest. In addition, if the seller should be involved in bankruptcy or
insolvency proceedings, a Portfolio may incur delay and costs in selling the
underlying security or may suffer a loss of principal and interest if a
Portfolio is treated as an unsecured creditor and required to return the
underlying collateral to the seller's estate.
Loans of Portfolio Securities
A Portfolio may lend its portfolio securities, provided: (1) the loan
is secured continuously by collateral consisting of U.S. Government securities,
cash, or cash equivalents adjusted daily to have market value at least equal to
the current market value of the securities loaned; (2) the Portfolio may at any
time call the loan and regain the securities loaned; (3) a Portfolio will
receive any interest or dividends paid on the loaned securities; and (4) the
aggregate market value of securities loaned will not at any time exceed
one-third (or such other limit as the Trustee may establish) of the total assets
of the Portfolio. In addition, it is anticipated that a Portfolio may share with
the borrower some of the income received on the collateral for the loan or that
it will be paid a premium for the loan. The risks in lending portfolio
securities, as with other extensions of credit, consist of possible delay in
recovery of the securities or possible loss of rights in the collateral should
the borrower fail financially. Although voting rights or rights to consent with
respect to the loaned securities pass to the borrower, a Portfolio retains the
right to call the loans at any time on reasonable notice, and it will do so in
order that the securities may be voted by a Portfolio if the holders of such
securities are asked to vote upon or consent to matters materially affecting the
investment. A Portfolio will not lend portfolio securities to borrowers
affiliated with the Portfolio.
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Collateralized mortgage obligations; other mortgage-related securities
Collateralized mortgage obligations or "CMOs" are debt obligations or
pass-through certificates collateralized by mortgage loans or mortgage
pass-through securities. Typically, CMOs are collateralized by certificates
issued by the Government National Mortgage Association, ("GNMA"), the Federal
National Mortgage Association ("FNMA"), or the Federal Home Loan Mortgage
Corporation ("FHLMC"), but they also may be collateralized by whole loans or
private pass-through certificates (such collateral collectively hereinafter
referred to as "Mortgage Assets"). CMOs may be issued by agencies or
instrumentalities of the U.S. Government, or by private originators of, or
investors in, mortgage loans.
In a CMO, a series of bonds or certificates is generally issued in
multiple classes. Each class of CMOs is issued at a specific fixed or floating
rate coupon and has a stated maturity or final distribution date. Principal
prepayments on the mortgage assets may cause the CMOs to be retired
substantially earlier than their stated maturities or final distribution dates.
Interest is paid or accrues on most classes of the CMOs on a monthly, quarterly,
or semi-annual basis. The principal of and interest on the mortgage assets may
be allocated among the several classes of a series of a CMO in innumerable ways.
In a CMO, payments of principal, including any principal prepayments, on the
mortgage assets are applied to the classes of the series in a pre-determined
sequence.
Residual interests. Residual interests are derivative mortgage
securities issued by agencies or instrumentalities of the U.S. Government or by
private originators of, or investors in, mortgage loans. The cash flow generated
by the mortgage assets underlying a series of mortgage securities is applied
first to make required payments of principal of and interest on the mortgage
securities and second to pay the related administrative expenses of the issuer.
The residual generally represents the right to any excess cash flow remaining
after making the foregoing payments. Each payment of such excess cash flow to a
holder of the related residual represents income and/or a return of capital. The
amount of residual cash flow resulting from a series of mortgage securities will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of the mortgage securities, prevailing interest rates,
the amount of administrative expenses, and the prepayment experience on the
mortgage assets. In particular, the yield to maturity on residual interests may
be extremely sensitive to prepayments on the related underlying mortgage assets
in the same manner as an interest-only class of stripped mortgage-backed
securities. In addition, if a series of mortgage securities includes a class
that bears interest at an adjustable rate, the yield to maturity on the related
residual interest may also be extremely sensitive to changes in the level of the
index upon which interest rate adjustments are based. In certain circumstances,
there may be little or no excess cash flow payable to residual holders. The
Portfolio may fail to recoup fully its initial investment in a residual.
Residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The
residual interest market has only
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recently developed and residuals currently may not have the liquidity of other
more established securities trading in other markets. Residuals may be subject
to certain restrictions on transferability.
Foreign Securities
A Portfolio may invest in foreign securities and in certificates of
deposit issued by United States branches of foreign banks and foreign branches
of United States banks.
Investments in foreign securities may involve considerations different
from investments in domestic securities. There may be less publicly available
information about a foreign company than about a U.S. company, and foreign
companies may not be subject to accounting, auditing and financial reporting
standards and requirements comparable to those applicable to U.S. companies.
Securities of some foreign companies are less liquid or more volatile than
securities of U.S. companies, and foreign brokerage commissions and custodian
fees are generally higher than in the United States. Investments in foreign
securities can involve other risks different from those affecting U.S.
investments, including local political or economic developments, expropriation
or nationalization of assets and imposition of withholding taxes on dividend or
interest payments. It may be more difficult to obtain and enforce a judgment
against a foreign issuer. In addition, foreign investments may be affected
favorably or unfavorably by changes in currency exchange rates or exchange
control regulations. A Portfolio may incur costs in connection with conversion
between currencies.
In determining whether to invest in securities of foreign issuers, the
Adviser of a Portfolio seeking current income will consider the likely impact of
foreign taxes on the net yield available to the Portfolio and its shareholders.
Income received by a Portfolio from sources within foreign countries may be
reduced by withholding and other taxes imposed by such countries. Tax
conventions between certain countries and the United States may reduce or
eliminate such taxes. It is impossible to determine the effective rate of
foreign tax in advance since the amount of a Portfolio's assets to be invested
in various countries is not known, and tax laws and their interpretations may
change from time to time and may change without advance notice. Any such taxes
paid by a Portfolio will reduce its net income available for distribution to
shareholders.
Foreign Currency Transactions
Except as otherwise described in the relevant Prospectus, a Portfolio
may engage without limit in currency exchange transactions, including foreign
currency forward and futures contracts, to protect against uncertainty in the
level of future foreign currency exchange rates. In addition, a Portfolio may
purchase and sell call and put options on foreign currency futures contracts and
on foreign currencies for hedging purposes.
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A Portfolio may engage in both "transaction hedging" and "position
hedging". When a Portfolio engages in transaction hedging, it enters into
foreign currency transactions with respect to specific receivables or payables
of the Portfolio generally arising in connection with the purchase or sale of
its securities. A Portfolio will engage in transaction hedging when it desires
to "lock in" the U.S. dollar price of a security it has agreed to purchase or
sell, or the U.S. dollar equivalent of a dividend or interest payment in a
foreign currency. By transaction hedging a Portfolio will attempt to protect
against a possible loss resulting from an adverse change in the relationship
between the U.S. dollar and the applicable foreign currency during the period
between the date on which the security is purchased or sold or on which the
dividend or interest payment is declared, and the date on which such payments
are made or received.
A Portfolio may purchase or sell a foreign currency on a spot (or cash)
basis at the prevailing spot rate in connection with transaction hedging. A
Portfolio may also enter into contracts to purchase or sell foreign currencies
at a future date ("forward contracts") and purchase and sell foreign currency
futures contracts.
For transaction hedging purposes, a Portfolio may purchase
exchange-listed and over-the-counter call and put options on foreign currency
futures contracts and on foreign currencies. A put option on a futures contract
gives a Portfolio the right to assume a short position in the futures contract
until expiration of the option. A put option on currency gives a Portfolio the
right to sell a currency at an exercise price until the expiration of the
option. A call option on a futures contract gives a Portfolio the right to
assume a long position in the futures contract until the expiration of the
option. A call option on currency gives a Portfolio the right to purchase a
currency at the exercise price until the expiration of the option. A Portfolio
will engage in over-the-counter transactions only when appropriate
exchange-traded transactions are unavailable and when, in the opinion of its
Adviser, the pricing mechanism and liquidity are satisfactory and the
participants are responsible parties likely to meet their contractual
obligations.
When a Portfolio engages in position hedging, it enters into foreign
currency exchange transactions to protect against a decline in the values of the
foreign currencies in which securities held by the Portfolio are denominated or
are quoted in their principle trading markets or an increase in the value of
currency for securities which a Portfolio expects to purchase. In connection
with position hedging, a Portfolio may purchase put or call options on foreign
currency and foreign currency futures contracts and buy or sell forward
contracts and foreign currency futures contracts. A Portfolio may also purchase
or sell foreign currency on a spot basis.
The precise matching of the amounts of foreign currency exchange
transactions and the value of the portfolio securities involved will not
generally be possible since the future value
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of such securities in foreign currencies will change as a consequence of market
movements in the values of those securities between the dates the currency
exchange transactions are entered into and the dates they mature.
It is impossible to forecast with precision the market value of a
Portfolio's securities at the expiration or maturity of a forward or futures
contract. Accordingly, it may be necessary for a Portfolio to purchase
additional foreign currency on the spot market (and bear the expense of such
purchase) if the market value of the security or securities being hedged is less
than the amount of foreign currency a Portfolio is obligated to deliver and if a
decision is made to sell the security or securities and make delivery of the
foreign currency. Conversely, it may be necessary to sell on the spot market
some of the foreign currency received upon the sale of the security or
securities of a Portfolio if the market value of such security or securities
exceeds the amount of foreign currency the Portfolio is obligated to deliver.
To offset some of the costs to a Portfolio of hedging against
fluctuations in currency exchange rates, the Portfolio may write covered call
options on those currencies.
Transaction and position hedging do not eliminate fluctuations in the
underlying prices of the securities which a Portfolio owns or intends to
purchase or sell. They simply establish a rate of exchange which one can achieve
at some future point in time. Additionally, although these techniques tend to
minimize the risk of loss due to a decline in the value of the hedged currency,
they tend to limit any potential gain which might result from the increase in
the value of such currency.
Currency Forward and Futures Contracts. A forward foreign currency
exchange contract involves an obligation to purchase or sell a specific currency
at a future date, which may be any fixed number of days from the date of the
contract as agreed by the parties, at a price set at the time of the contract.
In the case of a cancelable forward contract, the holder has the unilateral
right to cancel the contract at maturity by paying a specified fee. The
contracts are traded in the interbank market conducted directly between currency
traders (usually large commercial banks) and their customers. A forward contract
generally has no deposit requirement, and no commissions are charged at any
stage for trades. A foreign currency futures contract is a standardized contract
for the future delivery of a specified amount of a foreign currency at a future
date at a price set at the time of the contract. Foreign currency futures
contracts traded in the United States are designed by and traded on exchanges
regulated by the CFTC, such as the New York Mercantile Exchange.
Forward foreign currency exchange contracts differ from foreign
currency futures contracts in certain respects. For example, the maturity date
of a forward contract may be any fixed number of days from the date of the
contract agreed upon by the parties, rather than a predetermined date in a given
month. Forward contracts may be in any amounts agreed upon
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by the parties rather than predetermined amounts. Also, forward foreign exchange
contracts are traded directly between currency traders so that no intermediary
is required. A forward contract generally requires no margin or other deposit.
At the maturity of a forward or futures contract, a Portfolio may
either accept or make delivery of the currency specified in the contract, or at
or prior to maturity enter into a closing transaction involving the purchase or
sale of an offsetting contract. Closing transactions with respect to forward
contracts are usually effected with the currency trader who is a party to the
original forward contract. Closing transactions with respect to futures
contracts are effected on a commodities exchange; a clearing corporation
associated with the exchange assumes responsibility for closing out such
contracts.
Positions in foreign currency futures contracts and related options may
be closed out only on an exchange or board of trade which provides a secondary
market in such contracts or options. Although a Portfolio will normally purchase
or sell foreign currency futures contracts and related options only on exchanges
or boards of trade where there appears to be an active secondary market, there
is no assurance that a secondary market on an exchange or board of trade will
exist for any particular contract or option or at any particular time. In such
event, it may not be possible to close a futures or related option position and,
in the event of adverse price movements, a Portfolio would continue to be
required to make daily cash payments of variation margin on its futures
positions.
Foreign Currency Options. Options on foreign currencies operate
similarly to options on securities, and are traded primarily in the
over-the-counter market, although options on foreign currencies have recently
been listed on several exchanges. Such options will be purchased or written only
when a Portfolio's Adviser believes that a liquid secondary market exists for
such options. There can be no assurance that a liquid secondary market will
exist for a particular option at any specific time. Options on foreign
currencies are affected by all of those factors which influence exchange rates
and investments generally.
The value of a foreign currency option is dependent upon the value of
the foreign currency and the U.S. dollar, and may have no relationship to the
investment merits of a foreign security. Because foreign currency transactions
occurring in the interbank market involve substantially larger amounts than
those that may be involved in the use of foreign currency options, investors may
be disadvantaged by having to deal in an odd lot market (generally consisting of
transactions of less than $1 million) for the underlying foreign currencies at
prices that are less favorable than for round lots.
There is no systematic reporting of last sale information for foreign
currencies and there is no regulatory requirement that quotations available
through dealers or other market sources be firm or revised on a timely basis.
Available quotation information is generally representative of very large
transactions in the interbank market and thus may not reflect relatively smaller
transactions (less than $1 million) where rates may be less favorable. The
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interbank market in foreign currencies is a global, around-the-clock market. To
the extent that the U.S. options markets are closed while the markets for the
underlying currencies remain open, significant price and rate movements may take
place in the underlying markets that cannot be reflected in the U.S. options
markets.
Settlement Procedures. Settlement procedures relating to investments in
foreign securities and to foreign currency exchange transactions may be more
complex than settlements with respect to investments in debt or equity
securities of U.S. issuers, and may involve certain risks not present in
domestic investments. For example, settlement of transactions involving foreign
securities or foreign currency may occur within a foreign country, and the
Portfolio may be required to accept or make delivery of the underlying
securities or currency in conformity with any applicable U.S. or foreign
restrictions or regulations, and may be required to pay any fees, taxes or
charges associated with such delivery. Such investments may also involve the
risk that an entity involved in the settlement may not meet its obligations.
Foreign Currency Conversion. Although foreign exchange dealers do not
charge a fee for currency conversion, they do realize a profit based on the
difference (the "spread") between prices at which they buy and sell various
currencies. Thus, a dealer may offer to sell a foreign currency to a Portfolio
at one rate, while offering a lesser rate of exchange should a Portfolio desire
to resell that currency to the dealer.
Zero-Coupon Securities
Zero-coupon securities in which a Portfolio may invest are debt
obligations which are generally issued at a discount and payable in full at
maturity, and which 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 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
-23-
<PAGE>
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 record-keeping 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
record-keeping system in lieu of having to hold certificates or other evidences
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 obligations acquire, in effect,
discount obligations that are economically identical to the zero-coupon
securities issued directly by the obligor.
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 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 a Portfolio on securities in connection with such transactions prior to the
date the Portfolio actually takes 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 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.
-24-
<PAGE>
Bank Instruments
A Portfolio 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, a
Portfolio may invest in: Eurodollar Certificates of Deposit ("ECDs") issued by
foreign branches of U.S. or foreign banks; Eurodollar Time Deposits ("ETDs"),
which are U.S. dollar-denominated deposits in foreign branches of U.S. or
foreign banks; Canadian Time Deposits, which are U.S. dollar-denominated
deposits issued by branches of major Canadian banks located in the U.S.; and
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.
Dollar Rolls and Reverse Repurchase Agreements
A Portfolio may enter into dollar rolls, in which the Portfolio sells
securities and simultaneously contracts to repurchase substantially similar
securities on a specified future date. In the case of dollar rolls involving
mortgage-related securities, the mortgage-related securities that are purchased
typically will be of the same type and will have the same or similar interest
rate and maturity as those sold, but will be supported by different pools of
mortgages. The Portfolio forgoes principal and interest paid during the roll
period on the securities sold in a dollar roll, but it is compensated by the
difference between the current sales price and the price for the future purchase
as well as by any interest earned on the proceeds of the securities sold. A
Portfolio could also be compensated through the receipt of fee income.
A Portfolio may also enter into reverse repurchase agreements in which
the Portfolio sells securities and agrees to repurchase them at a mutually
agreed date and price. Generally, the effect of such a transaction is that the
Portfolio can recover all or most of the cash invested in the portfolio
securities involved during the term of the reverse repurchase agreement, while
it will be able to keep the interest income associated with those portfolio
securities. Such transactions are advantageous if the interest cost to the
Portfolio of the reverse repurchase transaction is less than the cost of
otherwise obtaining the cash.
Dollar rolls and reverse repurchase agreements may be viewed as a
borrowing by the Portfolio, secured by the security which is the subject of the
agreement. In addition to the general risks involved in leveraging, dollar rolls
and reverse repurchase agreements involve the risk that, in the event of the
bankruptcy or insolvency of the Portfolio's counterparty, the Portfolio would be
unable to recover the security which is the subject of the agreement, the amount
of cash or other property transferred by the counterparty to the Portfolio under
the
-25-
<PAGE>
agreement prior to such insolvency or bankruptcy is less than the value of the
security subject to the agreement, or the Portfolio may be delayed or prevented,
due to such insolvency or bankruptcy, from using such cash or property or may be
required to return it to the counterparty or its trustee or receiver.
Convertible Securities
A Portfolio 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 its 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 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 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
A Portfolio 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 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. Warrants acquired in units or attached to securities may
be deemed to be without value for purposes of a Portfolio's policy.
-26-
<PAGE>
Swaps, Caps, Floors and Collars
A Portfolio may enter into interest rate, currency and index swaps and
the purchase or sale of related caps, floors and collars. A 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 Portfolio anticipates purchasing at a
later date. A Portfolio would use these transactions as hedges and not as
speculative investments and would not sell interest rate caps or floors where it
does not own securities or other instruments providing the income stream the
Portfolio may be obligated to pay. Interest rate swaps involve the exchange by a
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 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.
A 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 Portfolio receiving or paying, as the case
may be, only the net amount of the two payments. A 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 another nationally recognized securities rating
organization or is determined to be of equivalent credit quality by the
Portfolio's Adviser. If there is a default by the counterparty, a Portfolio may
have contractual remedies pursuant to the agreements related to the transaction.
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.
Lower-rated Securities
A Portfolio may invest in lower-rated fixed-income securities (commonly
known as "junk bonds") to the extent described in the relevant Prospectus. The
lower ratings of certain securities held by a Portfolio reflect a greater
possibility that adverse changes in the financial condition of the issuer or in
general economic conditions, or both, or an unanticipated rise in interest
rates, may impair the ability of the issuer to make payments of interest and
principal.
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<PAGE>
The inability (or perceived inability) of issuers to make timely payment of
interest and principal would likely make the values of securities held by a
Portfolio more volatile and could limit the Portfolio's ability to sell its
securities at prices approximating the values the Portfolio had placed on such
securities. In the absence of a liquid trading market for securities held by it,
a Portfolio may be unable at times to establish the fair value of such
securities. The rating assigned to a security by Moody's Investors Service, Inc.
or Standard & Poor's (or by any other nationally recognized securities rating
organization) does not reflect an assessment of the volatility of the security's
market value or the liquidity of an investment in the security.
Like those of other fixed-income securities, the values of lower-rated
securities fluctuate in response to changes in interest rates. Thus, a decrease
in interest rates will generally result in an increase in the value of the
Portfolio's assets. Conversely, during periods of rising interest rates, the
value of the Portfolio's assets will generally decline. In addition, the values
of such securities are also affected by changes in general economic conditions
and business conditions affecting the specific industries of their issuers.
Changes by recognized rating services in their ratings of any fixed-income
security and in the ability of an issuer to make payments of interest and
principal may also affect the value of these investments. Changes in the value
of portfolio securities generally will not affect cash income derived from such
securities, but will affect the Portfolio's net asset value. A Portfolio will
not necessarily dispose of a security when its rating is reduced below its
rating at the time of purchase, although its Adviser will monitor the investment
to determine whether its retention will assist in meeting the Portfolio's
investment objective.
The amount of information about the financial condition of an issuer of
tax exempt securities may not be as extensive as that which is made available by
corporations whose securities are publicly traded. Therefore, to the extent a
Portfolio invests in tax exempt securities in the lower rating categories, the
achievement of the Portfolio's goals is more dependent on its Adviser's
investment analysis than would be the case if the Portfolio were investing in
securities in the higher rating categories.
Indexed Securities
A Portfolio may invest in indexed securities, the values of which are
linked to currencies, interest rates, commodities, indices or other 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
a 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
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<PAGE>
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.
To reduce the effect of currency fluctuations on the value of existing
or anticipated holdings of portfolio securities, a 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 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 Portfolio's securities denominated in linked
currencies. For example, if a Portfolio's Adviser considers that the Austrian
schilling is linked to the German deutschmark (the "Dmark"), the Portfolio holds
securities denominated in schillings and the Adviser believes that the value of
schillings will decline against the U.S. dollar, the Adviser may enter into a
contract to sell D-marks and buy dollars.
Eurodollar Instruments
A 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. A 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.
Segregation of Assets
A Portfolio may at times segregate assets in respect of certain
transactions in which the Portfolio enters into a commitment to pay money or
deliver securities at some future date (such as futures contracts or reverse
repurchase agreements, to the extent not used for
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<PAGE>
leverage). Any such segregated account will be maintained by the Trust's
custodian and may contain cash, U.S. government securities, liquid high grade
debt obligations, or other appropriate assets.
MANAGEMENT OF THE TRUST
Officers and Trustees
The officers and Trustees of the Trust are listed below, along with
their addresses, principal occupations, and present positions, including any
positions held with affiliated persons or Mentor Distributors, LLC.
<TABLE>
<CAPTION>
Positions with
Name and Address the Trust Principal Occupations During Past Five Years
<S> <C>
Daniel J. Ludeman(1) Chairman and Trustee Chairman and Chief Executive Officer, Mentor
901 East Byrd Street Investment Group, LLC; Director, Wheat, First
Richmond, Virginia 23219 Securities, Inc.; Managing Director, Wheat First
Butcher Singer, Inc.; Director, Mentor Income Fund,
Inc. and America's Utility Fund, Inc.; Chairman and
Trustee, Cash Resource Trust and Mentor Institutional
Trust.
Peter J. Quinn, Jr.(1) Trustee President, Mentor Distributors, LLC; Managing
901 E. Byrd Street Director, Mentor Investment Group, LLC; Managing
Richmond, Virginia 23219 Director, Wheat First Butcher Singer, Inc.; formerly,
Senior Vice President/Director of Mutual Funds, Wheat
First Butcher Singer, Inc.; Trustee, Cash Resource
Trust; formerly, President of the Trust.
Stanley F. Pauley Trustee Chairman and Chief Executive Officer, E.R. Carpenter
P. O. Box 27205 Company Incorporated; Trustee, Cash Resource Trust
Richmond, Virginia 23261 and Mentor Institutional Trust.
Louis W. Moelchert, Jr. Trustee Vice President of Business and Finance, University of
University of Richmond Richmond; Trustee, Cash Resource Trust and Mentor
Richmond, Virginia 23173 Institutional Trust; Director, America's Utility
Fund, Inc.
Thomas F. Keller Trustee Former Dean, Fuqua School of Business, Duke
Duke University University; Trustee, Cash Resource Trust and Mentor
Durham, North Carolina Institutional Trust.
27706
Arnold H. Dreyfuss Trustee Retired. Formerly, Chairman and Chief Executive
5100 Cary Street Road Officer, Hamilton Beach/Proctor-Silex, Inc. Trustee,
Richmond, Virginia 23225 Cash Resource Trust and Mentor Institutional Trust.
Troy A. Peery, Jr. Trustee President, Heilig-Meyers Company. Trustee, Cash
2235 Staples Mill Road Resource Trust and Mentor Institutional Trust.
Richmond, Virginia 23230
Paul F. Costello President Managing Director, Wheat First Butcher Singer, Inc.
901 East Byrd Street and Mentor Investment Group, LLC; President, Cash
Richmond, Virginia 23219 Resource Trust, Mentor Income Fund, Inc., and Mentor
Institutional Trust; Managing Director, Mentor
Investment Advisors, LLC; Executive Vice President
and Chief Administrative Officer, America's Utility
Fund, Inc.; Director, Mentor Perpetual Advisors, LLC
and Mentor Trust Company; formerly, President, Mentor
Series Trust; 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.
<PAGE>
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Terry L. Perkins Treasurer Senior Vice President, Mentor Investment Group, LLC;
901 East Byrd Street Treasurer, Cash Resource Trust, Mentor Income Fund,
Richmond, Virginia 23219 Inc., Mentor Institutional Trust and America's
Utility Fund; formerly, Treasurer and Comptroller,
Ryland Capital Management, Inc.
Michael Wade Assistant Treasurer Vice President, Mentor Investment Group, LLC;
901 East Byrd Street Assistant Treasurer, Cash Resource Trust, Mentor
Richmond, Virginia 23219 Income Fund, Inc., Mentor Institutional Trust and
America's Utility Fund; formerly, Senior Accountant,
Wheat First Butcher Singer, Inc.; Audit Senior, BDO
Seidman.
John M. Ivan Secretary Managing Director, Director of Compliance, Senior
901 East Byrd Street Vice President, and Assistant General Counsel, Wheat,
Richmond, Virginia 23219 First Securities, Inc.; Clerk, Cash Resource Trust,
Mentor Institutional Trust.
</TABLE>
(1) This Trustee is deemed to be an "interested person" of the Trust as defined
in the Investment Company Act of 1940.
Trustees' Compensation
The table below shows the fees paid to each Trustee by the Trust for
fiscal 1995 and the estimated fees to be paid to each Trustee by all funds in
the Mentor family (including the Trust) during the 1996 calendar year.
<TABLE>
<CAPTION>
Total compensation
Aggregate compensation from all
Trustees from the Trust complex funds
<S> <C>
Daniel J. Ludeman $0 $0
Arnold H. Dreyfuss 6,000 12,200
Thomas F. Keller 5,500 11,175
Louis W. Moelchert, Jr. 6,000 12,200
Stanley F. Pauley 6,000 12,200
Troy A. Peery, Jr. 5,500 11,175
Peter J. Quinn, Jr. 0 0
</TABLE>
- --------------------
The Trustees do not receive pension or retirement benefits from the
Trust.
The Trust's Declaration of Trust provides that the Trustees will be
liable for their willful misfeasance, bad faith, gross negligence, or reckless
disregard of the duties involved in the conduct of their office.
PRINCIPAL HOLDERS OF SECURITIES
As of November 1, 1996, the officers and Trustees of the Trust owned as
a group less than 1% of the outstanding shares of any class of each Portfolio.
To the knowledge of the Trust, no person owned of record or beneficially more
than 5% of the outstanding shares of any class of a Portfolio as of that date,
except as set forth below:
<TABLE>
<CAPTION>
Portfolio Holder Percentage Ownership
<S> <C>
Growth-Class A Bank of New York TTEE 52.72%
Wheat First Butcher Singer 401K
New York, NY 10286-1010
Growth-Class A Wheat First Butcher Singer FBO 8.37%
Plumbers & Pipe Fitters Local
Pittsburgh, PA 15212-5844
Strategy-Class A Bank of New York TTEE 30.93%
Wheat First Butcher Singer 401K
New York, NY 10286-1010
Strategy-Class A Wheat First Butcher Singer FBO 14.01%
Plumbers & Pipe Fitters Local
Pittsburgh, PA 15212-5844
Global-Class A Wheat First Butcher Singer FBO 5.68%
FBO Fundsource
Glen Allen, VA 23058-6540
Short Duration-Class A Wheat First Butcher Singer FBO 13.29%
Citizens General Hospital Corp
New Kensington, PA 15068-6591
Short Duration-Class A Wheat First Butcher Singer FBO 26.69%
Northern Virginia Electric Co-Op
Manassas, VA 22110-0875
Short Duration-Class A Wheat First Butcher Singer FBO 13.69%
Arnold Borinsky
Deal, NJ 07723-0424
Short Duration-Class B Wheat First Butcher Singer FBO 7.41%
Charles W Langford JR PSC
Profit Sharing Plan & Trust
Owensboro, KY 42301-7481
<PAGE>
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Balanced-Class B Wheat First Butcher Singer FBO 95.73%
WFBS Foundation
Glen Allen, VA 23058-6540
</TABLE>
INVESTMENT ADVISORY SERVICES
Mentor Investment Advisors, LLC ("Mentor Advisors") serves as
investment adviser to each Portfolio other than the Global Portfolio. Van Kampen
American Capital Management, Inc. ("Van Kampen") serves as sub-adviser to the
Municipal Income Portfolio; Wellington Management Company, LLP ("Wellington
Management") serves as sub-adviser to the Income and Growth Portfolio. Each of
these sub-advisers has complete discretion to purchase and sell portfolio
securities for its respective Portfolio consistent with the particular
Portfolio's investment objective, restrictions, and policies. Mentor Perpetual
Advisors, LLC ("Mentor Perpetual") serves as investment adviser to the Global
Portfolio.
Mentor Advisors is a wholly-owned subsidiary of Mentor Investment
Group, LLC, ("Mentor Investment Group") which is a subsidiary of Wheat First
Butcher Singer, Inc. ("WFBS"). Mentor Perpetual is owned equally by Mentor
Advisors and Perpetual plc, a diversified financial services holding company.
EVEREN Capital Corporation has a 20% ownership in Mentor Investment Group and
may acquire additional ownership based principally on the amount of Mentor
Investment Group's revenues derived from assets attributable to clients of
EVEREN Securities, Inc. and its affiliates.
On October 31, 1996, Commonwealth Investment Counsel, Inc., the
investment adviser to the Short-Duration Income and Balanced Portfolios, was
reorganized as Mentor Investment Advisors, LLC. Also on October 31, 1996, each
of Commonwealth Advisors, Inc., the investment adviser to the Capital Growth,
Income and Growth, Municipal Income, and Quality Income Portfolios, Charter
Asset Management, Inc., the investment adviser to the Growth Portfolio, and
Wellesley Advisors, Inc., the investment adviser to the Strategy Portfolio,
transferred its rights and obligations under its respective advisory contract
with the Trust to Mentor Investment Advisors, LLC. In addition, Mentor
Investment Group, Inc. and Mentor Distributors, Inc. were reorganized as Mentor
Investment Group, LLC and Mentor Distributors, LLC, respectively.
On October 29, 1996, shareholders of the Municipal Income Portfolio
approved a new sub-advisory agreement with Van Kampen American Capital
Management, Inc., which became a subsidiary of Morgan Stanley Group Inc.
Subject to the general oversight of the Trustees, each investment
adviser and/or subadviser manages the applicable Portfolio in accordance with
the stated policies of that Portfolio and of the Trust. Each makes investment
decisions for the Portfolio and places the purchase and sale orders for
portfolio transactions. The investment advisers and sub-advisers bear all their
expenses in connection with the performance of their services (except as may be
approved from time to time by the Trustees) and pay the salaries of all officers
and employees who are employed by them and the Trust.
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<PAGE>
Each Portfolio's investment adviser and/or sub-adviser provides the
Trust with investment officers who are authorized to execute purchases and sales
of securities. Investment decisions for the Trust and for the other investment
advisory clients of the investment advisers and sub-advisers and their
affiliates are made with a view to achieving their respective investment
objectives. Investment decisions are the product of many factors in addition to
basic suitability for the particular client involved. Thus, a particular
security may be bought or sold for certain clients even though it could have
been bought or sold for other clients at the same time. Likewise, a particular
security may be bought for one or more clients when one or more other clients
are selling the security. In some instances, one client may sell a particular
security to another client. It also sometimes happens that two or more clients
simultaneously purchase or sell the same security, in which event each day's
transactions in such security are, insofar as possible, averaged as to price and
allocated between such clients in a manner which in the investment adviser's or
sub-adviser's opinion is equitable to each and in accordance with the amount
being purchased or sold by each. There may be circumstances when purchases or
sales of securities for one or more clients will have an adverse effect on other
clients. In the case of short-term investments, the Treasury area of Mentor
Investment Group handles purchases and sales under guidelines approved by
investment officers of the Trust. Each investment adviser and sub-adviser
employs professional staffs of portfolio managers who draw upon a variety of
resources for research information for the Trust.
Expenses incurred in the operation of a Portfolio or otherwise
allocated to a Portfolio, including but not limited to taxes, interest,
brokerage fees and commissions, compensation paid under a Portfolio's 12b-1 plan
and the Shareholder Service Plan, fees to Trustees who are not officers,
directors, stockholders, or employees of Wheat, First Securities, Inc. and its
subsidiaries, SEC fees and related expenses, state Blue Sky qualification fees,
charges of the custodian and transfer and dividend disbursing agents, outside
auditing, accounting, and legal services, charges for the printing of
prospectuses and statements of additional information for regulatory purposes or
for distribution, and certain costs incurred by Mentor Investment Group in
responding to shareholder inquiries as approved by the Trustees from time to
time, to shareholders, certain shareholder report charges and charges relating
to corporate matters are borne by the Portfolio.
Each Management Contract provides that Mentor Advisors or Mentor
Perpetual, as the case may be, shall not be subject to any liability to a
Portfolio or to any shareholder of a Portfolio for any act or omission in the
course of or connected with rendering services to a Portfolio in the absence of
its willful misfeasance, bad faith, gross negligence, or reckless disregard of
its duties.
Each of the Management Contracts is subject to annual approval by (i)
the Trustees or (ii) vote of a majority (as defined in the 1940 Act) of the
outstanding voting securities of the affected Portfolio, provided that in either
event the continuance is also approved by a majority of the Trustees who are not
"interested persons" (as defined in the 1940 Act) of the Trust or the investment
adviser in question, by vote cast in person at a meeting called for the purpose
of voting
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<PAGE>
on such approval. The Management Contracts are terminable without penalty, on
not more than sixty days' notice and not less than thirty days' notice, by the
Trustees, by vote of the holders of a majority of the affected Portfolio's
shares, or by the applicable investment adviser. Each terminates automatically
in the event of its assignment (as defined in the 1940 Act).
Management Fees
The investment adviser of each Portfolio receives an annual management
fee from such Portfolio (which is described in the relevant Prospectus). The
investment adviser pays a portion of that fee to any sub-adviser to the
Portfolio.
The Portfolios paid investment advisory fees in the amounts and for the
periods indicated below (amounts shown reflect fee waivers where applicable):
<TABLE>
<CAPTION>
Fiscal year Fiscal Fiscal year
1994 1995 1996
---- ---- ----
<S> <C>
Balanced Portfolio.......................... -- -- $ 6,790
Capital Growth Portfolio.................... $ 590,693 $ 465,031 728,536
Global Portfolio............................ 69,515 174,547 368,592
Growth Portfolio............................ 1,327,384 1,143,696 2,313,470
Income and Growth Portfolio................. 374,462 460,486 575,647
Municipal Income Portfolio.................. 387,074 380,281 344,784
Quality Income Portfolio.................... 893,139 563,032 278,216
Short-Duration Income Portfolio -- -- 54,833
Strategy Portfolio.......................... 1,368,325 1,262,809 2,287,369
</TABLE>
The investment advisers of the following Portfolios waived investment
advisory fees in the following amounts for the periods indicated below:
<TABLE>
<CAPTION>
Fiscal year Fiscal Fiscal year
1994 1995 1996
---- ---- ----
<S> <C>
Balanced Portfolio.......................... $ 48,884 $ 14,563 $ 18,976
Capital Growth Portfolio.................... -- -- --
Global Portfolio............................ 69,515 10,545 --
Municipal Income Portfolio.................. 81,713 -- --
Quality Income Portfolio.................... -- -- 217,329
Short-Duration Income Portfolio 11,536 65,901 83,567
</TABLE>
The investment advisers of the following Portfolios paid sub-advisory
fees to the Portfolios' sub-advisers in the following amounts for the periods
indicated below:
<TABLE>
<CAPTION>
Fiscal year Fiscal year Fiscal year
1994 1995 1996
---- ---- ----
<S> <C>
Capital Growth Portfolio (1) $295,347 $126,880 --
Global Portfolio (2) 34,757 49,880 --
Income and Growth Portfolio 187,231 193,845 $236,071
Municipal Income Portfolio 234,393 190,141 172,392
Quality Income Portfolio (3) 419,570 157,161 --
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<PAGE>
- --------------------
</TABLE>
(1) Prior to April 13, 1995, Phoenix Investment Counsel, Inc. ("Phoenix")
served as sub-adviser to the Capital Growth Portfolio. Commonwealth
Advisors paid subadvisory fees of $126,880 to Phoenix for fiscal year
1995.
(2) Prior to April 13, 1995, Scudder, Stevens & Clark ("Scudder") served as
sub-adviser to the Global Portfolio. Commonwealth Advisors paid
subadvisory fees of $49,880 to Scudder for fiscal year 1995.
(3) Prior to April 13, 1995, Pacific Investment Management Company
("Pacific") served as sub-adviser to the Quality Income Portfolio
(formerly the Cambridge Government Income Portfolio). Commonwealth
Advisors paid $157,161 in subadvisory fees to Pacific for fiscal year
1995.
ADMINISTRATIVE SERVICES
Mentor Investment Group, LLC serves as administrator to each of the
Portfolios pursuant to an Administration Agreement. Prior to June 1, 1994,
Cambridge Administrative Services ("CAS") provided administrative services to
the Capital Growth, Quality Income, Municipal Income, Income and Growth, and
Global Portfolios.
Pursuant to the Administration Agreement, Mentor Investment Group
provides continuous business management services to the Portfolios and, subject
to the general oversight of the Trustees, manages all of the business and
affairs of the Portfolios subject to the provisions of the Trust's Declaration
of Trust, By-laws and the 1940 Act, and other policies and instructions the
Trustees may from time to time establish. Mentor Investment Group pays the
compensation of all officers and executive employees of the Trust (except those
employed by or serving at the request of an investment adviser or sub-adviser)
and makes available to the Trust the services of its directors, officers, and
employees as elected by the Trustees or officers of the Trust. In addition,
Mentor Investment Group provides all clerical services relating to the
Portfolios' business. As compensation for its services, Mentor Investment Group
receives a fee from each Portfolio calculated daily at the annual rate of .10%
of a Portfolio's average daily net assets.
The Administration Agreement must be approved at least annually with
respect to each Portfolio by a vote of a majority of the Trustees who are not
interested persons of Mentor Investment Group or the Trust. The Agreement may be
terminated at any time without penalty on 30 days notice by Mentor Investment
Group, or immediately in respect of any Portfolio upon notice by the Trustees or
by vote of a majority of the outstanding voting securities of that Portfolio.
The Agreement terminates automatically in the event of any assignment (as
defined in the 1940 Act).
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<PAGE>
The Portfolios paid administrative service fees in the following
amounts for the periods indicated below (amounts shown reflect fee waivers where
applicable):
<TABLE>
<CAPTION>
Fiscal year Fiscal year Fiscal year
1994 1995 1996
---- ---- ----
<S> <C>
Balanced Portfolio.......................... -- -- --
Capital Growth Portfolio.................... $ 92,278 $ 66,032 $ 91,067
Global Portfolio............................ 7,140 19,082 33,508
Growth Portfolio............................ -- 108,285 330,496
Income and Growth Portfolio................. 151,234 69,316 76,753
Municipal Income Portfolio.................. 97,653 72,055 57,464
Quality Income Portfolio.................... 47,282 65,234 82,591
Short-Duration Income Portfolio -- -- --
Strategy Portfolio.......................... 29,422 146,572 269,102
</TABLE>
The administrators waived administrative fees in the amounts and for
the periods indicated below:
<TABLE>
<CAPTION>
Fiscal year Fiscal year Fiscal year
1994 1995 1996
---- ---- ----
<S> <C>
Balanced Portfolio.......................... $ 2,307 -- --
Capital Growth Portfolio.................... -- -- --
Global Portfolio............................ 530 -- --
Growth Portfolio............................ -- -- --
Income and Growth Portfolio................. 15,033 -- --
Municipal Income Portfolio.................. -- -- --
Quality Income Portfolio.................... 23,563 $ 41,651 --
Short-Duration Income Portfolio 9,776 -- $ 27,680
Strategy Portfolio.......................... 131,557 -- --
</TABLE>
During fiscal 1995, the Growth and Strategy Portfolios reimbursed
amounts of $6,579 and $6,117, respectively, to Mentor Investment Group for
certain accounting and operations related costs not covered by their respective
administration arrangements. During fiscal year 1996, the Growth Portfolio,
Global Portfolio, Capital Growth Portfolio, Strategy Portfolio, Income and
Growth Portfolio, Municipal Income Portfolio, Quality Income Portfolio and
Short-Duration Income Portfolio paid $23,289, $2,752, $5,901, $17,744, $5,210,
$3,465, $5,005, and $1,842 respectively to Mentor Investment Group for these
direct reimbursements.
SHAREHOLDER SERVICING PLAN
The Trust has adopted a Shareholder Servicing Plan (the "Service Plan")
with Mentor Distributors, LLC with respect to 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 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
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<PAGE>
Portfolio or Portfolios owned by the financial institution's customers for whom
it is the 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 personnel 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.
In addition to receiving payments under the Service Plan, financial
institutions may be compensated by the investment adviser, a sub-adviser, and/or
Mentor Investment Group, 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 Mentor Investment Group, as applicable, and will not be made from the
assets of any of the Portfolios.
Shareholder Services Fees
During fiscal year 1996, the Portfolios incurred shareholder service
fees under the Service Plan as follows (amounts shown reflect fee waivers where
applicable):
<TABLE>
<S> <C>
Balanced Portfolio..................................... --
Capital Growth Portfolio............................... $227,668
Global Portfolio....................................... 83,771
Growth Portfolio....................................... 826,239
Income and Growth Portfolio............................ 191,882
Municipal Income Portfolio............................. 143,660
Quality Income Portfolio............................... 206,477
Short-Duration Income Portfolio 69,200
Strategy Portfolio..................................... 672,756
</TABLE>
During fiscal year 1996, shareholder services fees of $8,589 were
waived in respect of the Balanced Portfolio.
BROKERAGE TRANSACTIONS
Transactions on U.S. stock exchanges, commodities markets, and futures
markets and other agency transactions involve the payment by a Portfolio of
negotiated brokerage commissions. Such commissions vary among different brokers.
A particular broker may charge different commissions according to such factors
as the difficulty and size of the transaction. Transactions in foreign
investments often involve the payment of fixed brokerage commissions, which may
be higher than those in the United States. There is generally no stated
commission in
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<PAGE>
the case of securities traded in the over-the-counter markets, but the price
paid by the Trust usually includes an undisclosed dealer commission or mark-up.
In underwritten offerings, the price paid by the Trust includes a disclosed,
fixed commission or discount retained by the underwriter or dealer. It is
anticipated that most purchases and sales of securities by funds investing
primarily in certain fixed-income securities will be with the issuer or with
underwriters of or dealers in those securities, acting as principal.
Accordingly, those funds would not ordinarily pay significant brokerage
commissions with respect to securities transactions.
It has for many years been a common practice in the investment advisory
business for advisers of investment companies and other institutional investors
to receive brokerage and research services (as defined in the Securities
Exchange Act of 1934, as amended (the "1934 Act")) from broker-dealers that
execute portfolio transactions for the clients of such advisers and from third
parties with which such broker-dealers have arrangements. Consistent with this
practice, each investment adviser or sub-adviser may receive brokerage and
research services and other similar services from many broker-dealers with which
such investment adviser or sub-adviser places a Portfolio's portfolio
transactions and from third parties with which these broker-dealers have
arrangements. These services include such matters as general economic and market
reviews, industry and company reviews, evaluations of investments,
recommendations as to the purchase and sale of investments, newspapers,
magazines, pricing services, quotation services, news services and personal
computers utilized by the investment adviser's or sub-adviser's managers and
analysts. Where the services referred to above are not used exclusively by the
investment adviser or sub-adviser for research purposes, the investment adviser
or sub-adviser, based upon its own allocations of expected use, bears that
portion of the cost of these services which directly relates to its non-research
use. Some of these services are of value to the investment adviser or
sub-adviser and its affiliates in advising various of its clients (including the
Portfolios), although not all of these services are necessarily useful and of
value in managing all or any of the Portfolios. The management fee paid by a
Portfolio is not reduced because its investment adviser or sub-adviser or any of
their affiliates receive these services even though the investment adviser or
sub-adviser might otherwise be required to purchase some of these services for
cash.
A Portfolio's investment adviser or sub-adviser, as the case may be,
places all orders for the purchase and sale of portfolio investments for the
Portfolio and buys and sells investments for the Portfolio through a substantial
number of brokers and dealers. The investment adviser or sub-adviser seeks the
best overall terms available for the Portfolio, except to the extent the
investment adviser or sub-adviser may be permitted to pay higher brokerage
commissions as described below. In doing so, the investment adviser or
subadviser, having in mind the Portfolio's best interests, considers all factors
it deems relevant, including, by way of illustration, price, the size of the
transaction, the nature of the market for the security or other investment, the
amount of the commission, the timing of the transaction taking into account
market prices and trends, the reputation, experience and financial stability of
the broker-dealer involved and the quality of service rendered by the
broker-dealer in other transactions.
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<PAGE>
As permitted by Section 28(e) of the 1934 Act, and by the advisory and
sub-advisory agreements, a Portfolio's investment adviser or sub-adviser may
cause the Portfolio to pay a broker-dealer which provides "brokerage and
research services" (as defined in the 1934 Act) to that adviser an amount of
disclosed commission for effecting securities transactions on stock exchanges
and other transactions for the Portfolio on an agency basis in excess of the
commission which another broker-dealer would have charged for effecting that
transaction. The investment adviser's or sub-adviser's authority to cause a
Portfolio to pay any such greater commissions is also subject to such policies
as the Trustees may adopt from time to time. It is the position of the staff of
the Securities and Exchange Commission that Section 28(e) does not apply to the
payment of such greater commissions in "principal" transactions. Accordingly,
each investment adviser and sub-adviser will use its best efforts to obtain the
best overall terms available with respect to such transactions, as described
above.
Consistent with the Rules of Fair Practice of the National Association
of Securities Dealers, Inc. and subject to such other policies as the Trustees
may determine, an investment adviser or sub-adviser may consider sales of shares
of a Portfolio (and, if permitted by law, of the other funds in the Mentor
family) as a factor in the selection of broker-dealers to execute portfolio
transactions for a Portfolio.
The Trustees have determined that portfolio transactions for the Trust
may be effected through Wheat, First Securities, Inc. ("Wheat"), and EVEREN
Securities, Inc. ("EVEREN"), broker-dealers affiliated with Mentor Advisors and
Mentor Perpetual. The Trustees have adopted certain policies incorporating the
standards of Rule 17e-l issued by the SEC under the 1940 Act which requires,
among other things, that the commissions paid to Wheat and EVEREN must be
reasonable and fair compared to the commissions, fees, or other remuneration
received by other brokers in connection with comparable transactions involving
similar securities during a comparable period of time. Wheat and EVEREN will not
participate in brokerage commissions given by a Portfolio to other brokers or
dealers. Over-the-counter purchases and sales are transacted directly with
principal market makers except in those cases in which better prices and
executions may be obtained elsewhere. A Portfolio will in no event effect
principal transactions with Wheat and EVEREN in over-the-counter securities in
which Wheat or EVEREN makes a market.
Under rules adopted by the SEC, Wheat and EVEREN may not execute
transactions for a Portfolio on the floor of any national securities exchange,
but may effect transactions for a Portfolio by transmitting orders for execution
and arranging for the performance of this function by members of the exchange
not associated with them. Wheat and EVEREN will be required to pay fees charged
to those persons performing the floor brokerage elements out of the brokerage
compensation they receive from a Portfolio. The Trust has been advised by Wheat
that on most transactions, the floor brokerage generally constitutes from 5% and
10% of the total commissions paid.
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<PAGE>
Brokerage Commissions
The Portfolios paid brokerage commissions on brokerage transactions in
the following aggregate amounts for the periods indicated:
<TABLE>
<CAPTION>
Fiscal year Fiscal Fiscal year
1994 1995 1996
---- ---- ----
<S> <C>
Balanced Portfolio.......................... $ 1,641 $ 3,436 $ 7,385
Capital Growth Portfolio.................... 195,086 416,744 299,554
Global Portfolio............................ 45,449 148,625 359,217
Growth Portfolio............................ 374,267 1,354,359 1,864,300
Income and Growth Portfolio................. 116,782 125,986 146,323
Municipal Income Portfolio.................. -- 4,037 2,422
Quality Income Portfolio.................... -- 20,250 24,990
Short-Duration Income Portfolio 1,307 2,717 1,560
Strategy Portfolio.......................... 651,172 1,297,178 1,144,804
</TABLE>
The following table shows brokerage commissions paid by each of the
Portfolios to Wheat for the periods indicated:
<TABLE>
<CAPTION>
Fiscal year Fiscal Fiscal year
1994 1995 1996
---- ---- ----
<S> <C>
Balanced Portfolio.......................... -- -- --
Capital Growth Portfolio.................... $ 78,085 $ 22,411 $ 54,642
Global Portfolio............................ -- -- --
Growth Portfolio............................ 34,881 53,120 72,923
Income and Growth Portfolio................. 22,606 47,723 52,534
Municipal Income Portfolio.................. -- -- --
Quality Income Portfolio.................... -- -- --
Short-Duration Income Portfolio -- -- --
Strategy Portfolio.......................... 1,757 1,138 87,458
</TABLE>
The brokerage commissions paid to Wheat for fiscal year 1996 amounted
to the following percentages of the aggregate brokerage commissions and
brokerage transactions paid by each Portfolio:
<TABLE>
<CAPTION>
Percent of aggregate
Percent of aggregate dollar amount of
commissions brokerage transactions
<S> <C> ----------- ----------------------
Balanced Portfolio.......................... -- --
Capital Growth Portfolio.................... 18.24% 19.57%
Global Portfolio............................ -- --
Growth Portfolio............................ 3.91% 3.51%
Income and Growth Portfolio................. 35.90% 19.48%
Municipal Income Portfolio.................. -- --
Quality Income Portfolio.................... -- --
Short-Duration Income Portfolio -- --
Strategy Portfolio.......................... 7.64% 7.71%
</TABLE>
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<PAGE>
HOW TO BUY SHARES
Except under certain circumstances described in the Trust's or an
individual Portfolio's 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 (where
applicable) 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 relevant Prospectus
under the section entitled "How to Buy Shares."
DISTRIBUTION
Each of the Portfolios makes payments to Mentor Distributors, LLC in
accordance with its respective Distribution Plan adopted pursuant to Rule 12b-1
under the Investment Company Act of 1940.
During fiscal year 1996, the Portfolios paid the following 12b-1 fees
to Mentor Distributors as shown below:
Balanced Portfolio.......................... --
Capital Growth Portfolio.................... $ 458,606
Global Portfolio............................ 183,636
Growth Portfolio............................ 2,260,899
Income and Growth Portfolio 411,096
Municipal Income Portfolio 190,043
Quality Income Portfolio.................... 298,041
Short-Duration Income Portfolio 70,827
Strategy Portfolio.......................... 1,910,928
During fiscal year 1996, 12b-1 Fees of $25,766 were waived in respect
of the Balanced Portfolio.
Contingent Deferred Sales Charges
During fiscal year 1996, Mentor Distributors received the following
contingent deferred sales charges:
Balanced Portfolio.......................... --
Capital Growth Portfolio.................... $ 13,725
Global Portfolio............................ 12,547
Growth Portfolio............................ 182,754
Income and Growth Portfolio................. 10,261
Municipal Income Portfolio.................. 7,099
Quality Income Portfolio.................... 15,091
Short-Duration Income Portfolio 44,511
Strategy Portfolio.......................... 511,034
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<PAGE>
Underwriting Commissions
The following table shows the approximate amount of underwriting
commissions retained by Mentor Distributors (and any predecessor) for each
Portfolio for the periods indicated:
<TABLE>
<CAPTION>
Fiscal year Fiscal Fiscal year
1994 1995 1996
---- ---- ----
<S> <C>
Balanced Portfolio.......................... -- -- --
Capital Growth Portfolio.................... $ 17,055 $ 1,314 $ 10,477
Global Portfolio............................ 6,354 1,829 23,038
Growth Portfolio............................ -- -- 38,398
Income and Growth Portfolio................. 32,761 2,708 15,762
Municipal Income Portfolio.................. 12,958 247 4,110
Quality Income Portfolio.................... 7,951 559 9,062
Short-Duration Income Portfolio -- -- 186
Strategy Portfolio.......................... -- -- 31,801
</TABLE>
DETERMINING NET ASSET VALUE
A Portfolio determines its net asset value per share once each day the
New York Exchange (the "Exchange") is open as of the close of regular trading on
the Exchange. Currently, the Exchange is closed Saturdays, Sundays and the
following holidays: New Year's Day, Presidents' Day, Good Friday, Memorial Day,
the Fourth of July, Labor Day, Thanksgiving and Christmas.
Securities for which market quotations are readily available are valued
at prices which, in the opinion of a Portfolio's investment adviser or
sub-adviser, most nearly represent the market values of such securities.
Currently, such prices are determined using the last reported sale price or, if
no sales are reported (as in the case of some securities traded
over-the-counter), the last reported bid price, except that certain U.S.
Government securities are stated at the mean between the last reported bid and
asked prices. Short-term investments having remaining maturities of 60 days or
less are stated at amortized cost, which approximates market value. All other
securities and assets are valued at their fair value following procedures
approved by the Trustees. Liabilities are deducted from the total, and the
resulting amount is divided by the number of shares of the class outstanding.
Reliable market quotations are not considered to be readily available
for long-term corporate bonds and notes, certain preferred stocks, tax-exempt
securities, or certain foreign securities. These investments are stated at fair
value on the basis of valuations furnished by pricing services approved by the
Trustees, which determine valuations for normal, institutional-size trading
units of such securities using methods based on market transactions for
comparable securities and various relationships between securities which are
generally recognized by institutional traders.
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<PAGE>
If any securities held by a Portfolio are restricted as to resale, the
Portfolio's investment adviser or sub-adviser determines their fair values. The
fair value of such securities is generally determined as the amount which a
Portfolio could reasonably expect to realize from an orderly disposition of such
securities over a reasonable period of time. The valuation procedures applied
in any specific instance are likely to vary from case to case. However,
consideration is generally given to the financial position of the issuer and
other fundamental analytical data relating to the investment and to the nature
of the restrictions on disposition of the securities (including any registration
expenses that might be borne by the Portfolio in connection with such
disposition). In addition, specific factors are also generally considered, such
as the cost of the investment, the market value of any unrestricted securities
of the same class (both at the time of purchase and at the time of valuation),
the size of the holding, the prices of any recent transactions or offers with
respect to such securities and any available analysts' reports regarding the
issuer.
In the case of certain fixed-income securities, including certain less
common mortgage-backed securities, market quotations are not readily available
to the Portfolios on a daily basis, and pricing services may not provide price
quotations. In such cases, the Portfolio's investment adviser or sub-adviser is
typically able to obtain dealer quotations for each of the securities on at
least a weekly basis. On any day when it is not practicable for the investment
adviser or sub-adviser to obtain an actual dealer quotation for a security, the
investment adviser or sub-adviser may reprice the securities based on changes in
the value of a U.S. Treasury security of comparable duration. When the next
dealer quotation is obtained, the investment adviser or sub-adviser compares the
dealer quote against the price obtained by it using its U.S. Treasury-spread
calculation, and makes any necessary adjustments to its calculation methodology.
The investment adviser or sub-adviser attempts to obtain dealer quotes for each
security at least weekly, and on any day when there has been an unusual
occurrence affecting the securities which, in the investment adviser or
sub-adviser's view, makes pricing the securities on the basis of U.S. Treasuries
unlikely to provide a fair value of the securities.
Generally, trading in certain securities (such as foreign securities)
is substantially completed each day at various times prior to the close of the
Exchange. The values of these securities used in determining the net asset value
of a Portfolio's shares are computed as of such times. Also, because of the
amount of time required to collect and process trading information as to large
numbers of securities issues, the values of certain securities (such as
convertible bonds, U.S. Government securities, and tax-exempt securities) are
determined based on market quotations collected earlier in the day at the latest
practicable time prior to the close of the Exchange. Occasionally, events
affecting the value of such securities may occur between such times and the
close of the Exchange which will not be reflected in the computation of a
Portfolio's net asset value. If events materially affecting the value of such
securities occur during such period, then these securities will be valued at
their fair value following procedures approved by the Trustees.
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
-43-
<PAGE>
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 a Portfolio's net asset
value is not calculated. A 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 a Portfolio's net asset value
is calculated, such securities will be valued at fair value as determined in
good faith by procedures approved as required by the Trustees.
REDEMPTIONS IN KIND
Although each Portfolio 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 its investment
portfolio. Redemptions 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 a Portfolio 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.
TAXES
Each Portfolio intends to qualify each year and elect to be taxed as a
regulated investment company under Subchapter M of the United States Internal
Revenue Code of 1986, as amended (the "Code").
As a regulated investment company qualifying to have its tax liability
determined under Subchapter M, a Portfolio will not be subject to federal income
tax on any of its net investment income or net realized capital gains that are
distributed to shareholders. A Portfolio will not under present law be subject
to any excise or income taxes in Massachusetts.
In order to qualify as a "regulated investment company," a Portfolio
must, among other things, (a) derive at least 90% of its gross income from
dividends, interest, payments with respect to securities loans, gains from the
sale or other dispositions of stock, securities, or foreign currencies, and
other income (including but not limited to gains from options, futures, or
forward contracts) derived with respect to its business of investing in such
stock, securities, or currencies; (b) derive less than 30% of its gross income
from the sale or other disposition of certain assets (including stock or
securities and certain options, futures contracts, forward contracts, and
foreign currencies) held less than three months; (c) distribute with respect to
each taxable year at least 90% of the sum of its taxable net investment income,
its net tax-exempt income, and the
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<PAGE>
excess, if any, of net short-term capital gains over net long-term capital
losses for such year; and (d) diversify its holdings so that, at the close of
each quarter of its taxable year, (i) at least 50% of the market value of its
total assets consists of cash and cash items, U.S. Government Securities,
securities of other regulated investment companies, and other securities limited
generally with respect to any one issuer to not more than 5% of the value of its
total assets and not more than 10% of the outstanding voting securities of such
issuer, and (ii) not more than 25% of the value of its assets is invested in the
securities (other than those of the U.S. Government or other regulated
investment companies) of any issuer or of two or more issuers which the
Portfolio controls and which are engaged in the same, similar, or related trades
or businesses. In order to receive the favorable tax treatment accorded
regulated investment companies and their shareholders, moreover, a Portfolio
must in general distribute at least 90% of its interest, dividends, net
short-term capital gain, and certain other income each year.
If a Portfolio failed to qualify as a regulated investment company
accorded special tax treatment in any taxable year, the Portfolio would be
subject to tax on its taxable income at corporate rates, and all distributions
from earnings and profits, including any distributions of net tax-exempt income
and net long-term capital gains, would be taxable to shareholders as ordinary
income. In addition, a Portfolio could be required to recognize unrealized
gains, pay substantial taxes and interest and make substantial distributions
before requalifying as a regulated investment company that is accorded special
tax treatment.
If a Portfolio fails to distribute in a calendar year substantially all
of its ordinary income for such year and substantially all of its capital gain
net income for the one-year period ending October 31 (or later if the Portfolio
is permitted so to elect and so elects), plus any retained amount from the prior
year, the Portfolio will be subject to a 4% excise tax on the undistributed
amounts. A dividend paid to shareholders by a Portfolio in January of a year
generally is deemed to have been paid by the Portfolio on December 31 of the
preceding year, if the dividend was declared and payable to shareholders of
record on a date in October, November or December of that preceding year. A
Portfolio intends generally to make distributions sufficient to avoid imposition
of the 4% excise tax.
Exempt-interest dividends. A Portfolio will be qualified to pay
exempt-interest dividends to its shareholders only if, at the close of each
quarter of the Portfolio's taxable year, at least 50% of the total value of the
Portfolio's assets consists of obligations the interest on which is exempt form
federal income tax. Distributions that the Portfolio properly designates as
exempt-interest dividends are treated by shareholders as interest excludable
from their gross income for federal income tax purposes but may be taxable for
federal alternative minimum tax purposes and for state and local purposes. If
the Portfolio intends to be qualified to pay exempt-interest dividends, the
Portfolio may be limited in its ability to enter into taxable transactions
involving forward commitments, or repurchase agreements, financial futures, and
options contracts on financial futures, tax-exempt bond indices, and other
assets.
Part or all of the interest on indebtedness, if any, incurred or
continued by a shareholder to purchase or carry shares of a Portfolio paying
exempt-interest dividends is not deductible. The
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<PAGE>
portion of interest that is not deductible is equal to the total interest paid
or accrued on the indebtedness, multiplied by the percentage of a Portfolio's
total distributions (not including distributions from net long-term capital
gains) paid to the shareholder that are exempt-interest dividends. Under rules
used by the Internal Revenue Service for determining when borrowed funds are
considered used for the purpose of purchasing or carrying particular assets, the
purchase of shares may be considered to have been made with borrowed funds even
though such funds are not directly traceable to the purchase of shares.
In general, exempt-interest dividends, if any, attributable to interest
received on certain private activity obligations and certain industrial
development bonds will not be tax-exempt to any shareholders who are
"substantial users" of the facilities financed by such obligations or bonds or
who are "related persons" of such substantial users.
A Portfolio which is qualified to pay exempt-interest dividends will
inform investors within 60 days of the Portfolio's fiscal year-end of the
percentage of its income distributions designated as tax-exempt. The percentage
is applied uniformly to all distributions made during the year. The percentage
of income designated as tax-exempt for any particular distribution may be
substantially different from the percentage of the Portfolio's income that was
tax-exempt during the period covered by the distribution.
Hedging transactions. If a Portfolio engages in transactions, including
hedging transactions in options, futures contracts, and straddles, or other
similar transactions, it will be subject to special tax rules (including
mark-to-market, straddle, wash sale, and short sale rules), the effect of which
may be to accelerate income to the Portfolio, defer losses to the Portfolio,
cause adjustments in the holding periods of the Portfolio's securities, or
convert short-term capital losses into long-term capital losses. These rules
could therefore affect the amount, timing and character of distributions to
shareholders. A Portfolio will endeavor to make any available elections
pertaining to such transactions in a manner believed to be in the best interests
of the Portfolio.
Under the 30% of gross income test described above, a Portfolio will be
restricted in selling assets held or considered under Code rules to have been
held for less than three months, and in engaging in certain hedging transactions
(including hedging transactions in options and futures) that in some
circumstances could cause certain Portfolio assets to be treated as held for
less than three months.
Certain of a Portfolio's hedging activities (including its
transactions, if any, in foreign currencies or foreign currency-denominated
instruments) are likely to produce a difference between its book income and its
taxable income. If a Portfolio's book income exceeds its taxable income, the
distribution (if any) of such excess will be treated as a dividend to the extent
of the Portfolio's remaining earnings and profits (including earnings and
profits arising from tax-exempt income), and thereafter as a return of capital
or as gain from the sale or exchange of a capital asset, as the case may be. If
a Portfolio's book income is less than its taxable income, the
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<PAGE>
Portfolio could be required to make distributions exceeding book income to
qualify as a regulated investment company that is accorded special tax
treatment.
Return of capital distributions. If a Portfolio makes a distribution to
you in excess of its current and accumulated "earnings and profits" in any
taxable year, the excess distribution will be treated as a return of capital to
the extent of your tax basis in your shares, and thereafter as capital gain. A
return of capital is not taxable, but it reduces your tax basis in your shares,
thus reducing any loss or increasing any gain on a subsequent taxable
disposition by you or your shares.
Securities issued or purchased at a discount. A Portfolio's investment
in securities issued at a discount and certain other obligations will (and
investments in securities purchased at a discount may) require the Portfolio to
accrue and distribute income not yet received. In order to generate sufficient
cash to make the requisite distributions, a Portfolio may be required to sell
securities in its portfolio that it otherwise would have continued to hold.
Foreign currency-denominated securities and related hedging
transactions. A Portfolio's transactions in foreign currencies, foreign
currency-denominated debt securities and certain foreign currency options,
futures contracts, and forward contacts (and similar instruments) may give rise
to ordinary income or loss to the extent such income or loss results from
fluctuations in the value of the foreign currency concerned.
If more than 50% of a Portfolio's assets at year end consists of the
debt and equity securities of foreign corporations, the Portfolio may elect to
permit shareholders to claim a credit or deduction on their income tax returns
for their pro rata portion of qualified taxes paid by the Portfolio to foreign
countries. In such a case, shareholders will include in gross income from
foreign sources their pro rata shares of such taxes. A shareholder's ability to
claim a foreign tax credit or deduction in respect of foreign taxes paid by the
Portfolio may be subject to certain limitations imposed by the Code, as a result
of which a shareholder may not get a full credit or deduction for the amount of
such taxes. Shareholders who do not itemize on their federal income tax returns
may claim a credit (but no deduction) for such foreign taxes.
Investment by a Portfolio in certain "passive foreign investment
companies" could subject the Portfolio to a U.S. federal income tax or other
charge on the proceeds from the sale of its investment in such a company;
however, this tax can be avoided by making an election to mark such investments
to market annually or to treat the passive foreign investment company as a
"qualified electing fund."
Sale or redemption of shares. The sale, exchange or redemption of
Portfolio shares may give rise to a gain or loss. In general, any gain or loss
realized upon a taxable disposition of shares will be treated as long-term
capital gain or loss if the shares have been held for more than 12 months, and
otherwise as short-term capital gain or loss. However, if a shareholder sells
shares at a loss within six months of purchase, any loss will be disallowed for
federal income tax purposes to the extent of any exempt-interest dividends
received on such shares. In addition, any loss (not already disallowed as
provided in the preceding sentence) realized upon a taxable
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<PAGE>
disposition of shares held for six months or less will be treated as long-term,
rather than short-term, to the extent of any long-term capital gain
distributions received by the shareholder with respect to the shares. All or a
portion of any loss realized upon a taxable disposition of Portfolio shares will
be disallowed if other Portfolio shares are purchased within 30 days before or
after the disposition. In such a case, the basis of the newly purchased shares
will be adjusted to reflect the disallowed loss.
Shares purchased through tax-qualified plans. Special tax rules apply
to investments through defined contribution plans and other tax-qualified plans.
Shareholders should consult their tax adviser to determine the suitability of
shares of a Portfolio as an investment through such plans and the precise effect
of an investment on their particular tax situation.
Backup withholding. A Portfolio generally is required to withhold and
remit to the U.S. Treasury 31% of the taxable dividends and other distributions
paid to any individual shareholder who fails to furnish the Portfolio with a
correct taxpayer identification number (TIN), who has under reported dividends
or interest income, or who fails to certify to the Portfolio that he or she is
not subject to such withholding. Shareholders who fail to furnish their current
TIN are subject to a penalty of $50 for each such failure unless the failure is
due to reasonable cause and not wilful neglect. An individual's taxpayer
identification number is his or her social security number.
If a Portfolio invests in stock of certain foreign investment
companies, the 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 a Portfolio's holding period for the
stock. The distribution or gain so allocated to any taxable year of a Portfolio,
other than the taxable year of the excess distribution or disposition, would be
taxed to the 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 a
Portfolio's investment company taxable income and, accordingly, would not be
taxable to the Portfolio to the extent distributed by the Portfolio as a
dividend to its shareholders.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and related regulations currently in effect. For the
complete provisions, reference should be made to the pertinent Code sections and
regulations. The Code and regulations are subject to change by legislative or
administrative actions. Dividends and distributions also may be subject to state
and federal taxes. Shareholders are urged to consult their tax advisers
regarding specific questions as to federal, state or local taxes. The foregoing
discussion relates solely to U.S. federal income tax law. Non-U.S. investors
should consult their tax advisers concerning the tax consequences of ownership
of shares of the Portfolio, including the possibility that distributions may be
subject to a 30% United States withholding tax (or a reduced rate of withholding
provided by treaty).
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<PAGE>
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 relevant prospectus in respect
of taxes.
INDEPENDENT ACCOUNTANTS
KPMG Peat Marwick LLP, located at 99 High Street, Boston, Massachusetts
02110, are the Trust's independent accountants, providing audit services, tax
return review and other tax consulting services and assistance and consultation
in connection with the review of various Securities and Exchange Commission
filings.
CUSTODIAN
Investors Fiduciary Trust Company, located at 127 West 10th Street,
Kansas City, Missouri, is the custodian of each Portfolio, except that State
Street Bank & Trust Company, P.O. Box 8602, Boston, Massachusetts serves as
custodian to the Global Portfolio and as the foreign custodian to each of the
other Portfolios in respect of foreign assets. A custodian's responsibilities
include generally safeguarding and controlling a Portfolio's cash and
securities, handling the receipt and delivery of securities, and collecting
interest and dividends on a Portfolio's investments.
PERFORMANCE INFORMATION (shown through September 30, 1996)
The table below shows the average annual total return for the one-,
five- and ten-year periods (or for the life of the Portfolios if shorter):
<TABLE>
<CAPTION>
Class A Shares 1 Year 5 Years Since Inception
-------------- ------ ------- ---------------
<S> <C>
Capital Growth Portfolio..................... 17.45% -- 9.89%
Global Portfolio............................. 11.58% -- 9.30%
Growth Portfolio*............................ 21.73% -- 33.35%
Income and Growth Portfolio.................. 12.00% -- 12.35%
Municipal Income Portfolio................... 1.42% -- 5.99%
Quality Income Portfolio..................... (0.83)% -- 3.58%
Short-Duration Income Portfolio* 3.73% -- 4.08%
Strategy Portfolio*.......................... 12.50% -- 20.14%
</TABLE>
<TABLE>
<CAPTION>
Class B Shares 1 Year 5 Years 10 Years Since Inception
-------------- ------ ------- -------- ---------------
<S> <C>
Balanced Portfolio*.......................... 13.00% -- -- 15.76%
Capital Growth Portfolio..................... 19.64% -- -- 10.46%
Global Portfolio............................. 13.39% -- -- 9.91%
Growth Portfolio*............................ 24.18% 18.17% 13.68% 13.68%
Income and Growth Portfolio.................. 14.26% -- -- 13.11%
Municipal Income Portfolio................... 1.87% -- -- 6.45%
Quality Income Portfolio..................... (0.31)% -- -- 4.03%
Short-Duration Income Portfolio* 0.59% -- -- 4.87%
Strategy Portfolio*.......................... 14.48% -- -- 12.51%
</TABLE>
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<PAGE>
- ------------------
* Prior to May 30, 1995, the Balanced, Growth, Short-Duration Income,
and Strategy Portfolios only offered one class of shares. Total return
information for this period is shown under the Class B share table. As a
result, the annual total return information beyond the one-year period shown
above for the Balanced, Growth, Short-Duration Income, and Strategy Portfolios
reflects various sales charges currently not applicable to the Portfolios. The
Balanced, Growth, Short-Duration, and Strategy Portfolios are the successors to
Mentor Balanced Fund, Mentor Growth Fund, Mentor Short-Duration Income Fund, and
Mentor Strategy Fund, respectively, each of which was previously a series of
shares of beneficial interest of Mentor Series Trust. For fiscal 1994, none of
these Funds bore a front-end sales charge, but each of them was subject to a
maximum contingent deferred sales charge of 5%. The Balanced Portfolio currently
offers only one class of shares. Total return information for this Portfolio is
shown under the Class B share table.
- - - - - -
Total return for the one-, five-, and ten-year periods for each class
of shares (or for the life of a class, if shorter) is determined by calculating
the actual dollar amount of investment return on a $1,000 investment in the
Portfolio at the beginning of the period, and then calculating the annual
compounded rate of return which would produce that amount. Total return for a
period of one year is equal to the actual return of the Portfolio during that
period. Total return calculations assume deduction of a Portfolio's maximum
front-end or contingent deferred sales charge, if applicable, and reinvestment
of all Portfolio distributions at net asset value on their respective
reinvestment dates.
All data are based on past performance and do not predict future
results.
Yield and Tax-Equivalent Yield
The thirty-day yield for both classes of shares of certain of the
Portfolios for the period ending September 30, 1996, was as follows:
<TABLE>
<CAPTION>
Class A Class B
<S> <C>
Quality Income Portfolio 6.64% 6.48%
Municipal Income Portfolio 4.91% 4.66%
Income and Growth Portfolio 2.33% 1.57%
</TABLE>
A Portfolio's yield is presented for a specified thirty-day period (the
"base period"). Yield is based on the amount determined by (i) calculating the
aggregate amount of dividends and interest earned by the Portfolio during the
base period less expenses accrued for that period, and
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<PAGE>
(ii) dividing that amount by the product of (A) the average daily number of
shares of the Portfolio outstanding during the base period and entitled to
receive dividends and (B) the net asset value per share on the last day of the
base period. The result is annualized on a compounding basis to determine the
yield. For this calculation, interest earned on debt obligations held by a
Portfolio is generally calculated using the yield to maturity (or first expected
call date) of such obligations based on their market values (or, in the case of
receivables-backed securities such as GNMA's, based on costs). Dividends on
equity securities are accrued daily at their stated dividend rates.
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.
The tax-equivalent yield for Class A shares of the Municipal Income
Portfolio for the thirty-day period ending September 30, 1996, was 8.13%. The
tax-equivalent yield for that Portfolio's Class B shares was 7.72% 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
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.
The Municipal Income 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. (Some portion of the
Portfolio's income may be subject to federal alternative minimum tax and state
and local taxes.) Capital gains, if any, are subject to federal, state and local
tax.
At times, a Portfolio's investment adviser or sub-adviser may reduce
its compensation or assume expenses of the Portfolio in order to reduce the
Portfolio's expenses. Any such fee reduction or assumption of expenses would
increase a Portfolio's yield and total return during the period of the fee
reduction or assumption of expenses.
Total return may be presented for other periods or without giving
effect to any contingent deferred sales charge. Any quotation of total return or
yield not reflecting the front-end or contingent deferred sales charge would be
reduced if such sales charges were reflected.
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<PAGE>
EQUIVALENT YIELDS: TAX-EXEMPT VERSUS TAXABLE SECURITIES FOR THE MUNICIPAL
INCOME PORTFOLIO
The table below shows the effect of the tax status of tax-exempt securities on
the effective yield received by their individual holders under the federal
income tax laws currently in effect for 1996. It gives the approximate yield a
taxable security must earn at various income levels to produce after-tax yields
equivalent to those of tax-exempt securities yielding from 2.0% to 10.0%.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
Marginal
Taxable Income* federal
______________ income
tax**
Joint Single Rate
- ---------------------------------------------------------------------
- ---------------------------------------------------------------------
<S> <C>
$0 - 40,100 $0 - 24,000 15.00%
40,101 - 96,900 24,001 - 58,150 28.00%
96,901 - 147,700 58,151 - 121,300 31.00%
147,701 - 263,750 121,301 - 263,750 36.00%
over 263,750 over 263,750 39.60%
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------
Tax-exempt yield
______________________________________________________________________________________________
2% 3% 4% 5% 6% 7% 8% 9% 10%
- -------------------------------------------------------------------------------------------------------------
Equivalent taxable yield
- -------------------------------------------------------------------------------------------------------------
<S> <C>
- 2.35% 3.53% 4.71% 5.88% 7.06% 8.24% 9.41% 10.59% 11.76%
- 2.78% 4.17% 5.56% 6.94% 8.33% 9.72% 11.11% 12.50% 13.89%
- 2.90% 4.35% 5.80% 7.25% 8.70% 10.14% 11.59% 13.04% 14.49%
- 3.13% 4.69% 6.25% 7.81% 9.38% 10.94% 12.50% 14.06% 15.63%
3.31% 4.97% 6.62% 8.28% 9.93% 11.59% 13.25% 14.90% 16.56%
</TABLE>
- ------------------
* This amount represents taxable income as defined in the Internal
Revenue Code of 1986, as amended (the "Code"), after any deduction for
personal exemptions and the greater of the standard deduction or
itemized deductions. Income in the higher brackets may be affected by
the phase-out of personal exemptions and the limitation of itemized
deductions, based on Adjusted Gross Income, under the Code.
** These rates are the marginal federal income tax rates on taxable income
currently in effect for 1996 under the Code.
Of course, there is no assurance that the Municipal Income Portfolio
will achieve any specific tax-exempt yield. While it is expected that the
Portfolio will invest principally in obligations which pay interest exempt from
federal income tax, other income received by the Portfolio may be taxable. The
table does not take into account any state or local taxes payable on Portfolio
distributions.
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<PAGE>
MEMBERS OF INVESTMENT MANAGEMENT TEAMS
The following persons are investment personnel of the Portfolio's
investment advisers, as indicated.
Mentor Investment Advisors, LLC
Large Capitalization Quality Equity Growth
John G. Davenport, CFA -- Managing Director, Chief Investment Officer
Mr. Davenport has twelve years of investment management experience. He joined
the Mentor organization after heading equity research for Lowe, Brockenbrough,
Tierney, & Tattersall. He earned his undergraduate business degree from the
University of Richmond and his graduate degree in business from the University
of Virginia.
Richard H. Skeppstrom II -- Vice President, Portfolio Manager
Mr. Skeppstrom has six years of investment management experience. He has earned
both his undergraduate degree and masters of business administration from the
University of Virginia.
Richard L. Rice, CFA -- Vice President, Portfolio Manager
Mr. Rice has twenty-three years' experience in the securities industry. Prior to
joining the Mentor organization in 1993, he was a partner in the equity
management software firm, Parata Analytics Research, which was acquired by the
Mentor organization. His previous responsibilities include director of Research
for Signet Asset Management, Senior Research Analyst for Capitoline Investment
Services, and research positions at First Atlanta Corp. and Southeast Banking.
He earned his undergraduate business degree from the University of Florida.
Active Fixed-Income
P. Michael Jones, CFA -- Managing Director, Chief Investment Officer
Mr. Jones has eleven years of investment management experience. Mr. Jones is
responsible for the design and implementation of the fixed-income group's
proprietary analytical system. He earned his undergraduate degree from the
College of William and Mary.
Steven C. Henderson -- Associate Vice President, Portfolio Manager
Mr. Henderson has seven years of investment management experience. He has an
undergraduate degree from the University of Richmond and a masters in business
administration from George Washington University.
Stephen R. McClelland -- Vice President, Portfolio Manager
Mr. McClelland has six years of investment management experience, all of which
have been at Commonwealth. He is a Certified Public Accountant and received his
undergraduate
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<PAGE>
degree in accounting from Iowa State University and his graduate business degree
from Virginia Commonwealth University.
Keith Wantling
Mr. Wantling has five years of experience. Mr. Wantling performs analysis and
screening for credit sensitive private label mortgage-backed securities and
directs the firm's portfolio analysis effort. He holds his undergraduate degree
in accounting information systems from Virginia Polytechnic Institute.
Small-to-Medium Capitalization Equity Growth
Theodore W. Price, CFA -- Managing Director, Chief Investment Officer
Mr. Price has over thirty years of investment management experience, with over
twenty-three years' tenure at Charter Asset Management, the predecessor to
Mentor Advisors. He has managed Mentor Growth Portfolio since its inception. He
earned both his undergraduate degree and masters of business administration from
the University of Virginia.
Linda A. Ziglar, CFA -- Portfolio Manager
Ms. Ziglar has seventeen years of investment management experience. Ms. Ziglar
joined Charter from Federated Investors, where she managed $300 million in
equity assets. She holds an undergraduate degree from Randolph-Macon Woman's
College where she graduated summa cum laude. She also holds a graduate degree
in business administration from the University of Pittsburgh.
Jeffrey S. Drummond, CFA -- Vice President, Portfolio Manager
Mr. Drummond has eight years of investment management experience. Mr. Drummond
began his career as a portfolio analyst in the Investment Strategy Department at
Wheat First Butcher Singer, where he shared responsibility for directing $100
million in assets following the Strategic Sectors Portfolio. He received his
undergraduate degree in finance from the University of Richmond, where he
graduated cum laude.
Edward Rick IV
Mr. Rick has two years of investment management experience. He received his
undergraduate degree in finance from the University of Richmond, where he
graduated cum laude.
Tactical Asset Allocation
Don R. Hays -- Chief Investment Officer
Mr. Hays has over twenty-seven years of investment experience and is Director of
Investment Strategy for Wheat First Butcher Singer, Inc., a position he has held
since 1984. Mr. Hays began his career as an engineer with the Von Braun
rocket-development team in 1968. He is regarded as one of the country's leading
investment strategists and his market outlook is quoted regularly in the Wall
Street Journal, Investor's Business Daily, USA Today, and other major
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<PAGE>
media. He has been a guest on the PBS series Wall $treet Week with Louis
Rukeyser and is regularly featured by Dow Jones, Reuters and Bloomberg News
Services.
Asa W. Graves VII, CFA -- Portfolio Manager
Mr. Graves has five years of investment management experience and works closely
with Mr. Hays to develop the analytical framework used in managing the Strategy
Portfolio. He earned his undergraduate degree from the University of Richmond.
William P. Ryder -- Research Analyst
Mr. Ryder joined Wheat First Butcher Singer in 1991 as a member of its
Investment Strategy Group, working as a research analyst on its growth and
growth and income model portfolios. In 1995 he became part of the team
responsible for managing the Mentor Strategy Portfolio. In that capacity he
focuses primarily on conducting economic analysis, industry group studies, and
asset allocation modeling. Mr. Ryder attended Virginia Commonwealth University
and has five years' investment experience.
Mentor Perpetual Advisors, LLC
Scott McGlashan -- Far East Specialist, Portfolio Manager
Mr. McGlashan has nineteen years of investment management experience, twelve
years specializing in the Far East, and ten years' tenure in the Perpetual
organization. He has earned degrees from Yale University and Cambridge
University.
Robert Yerbury -- American Specialist, Portfolio Manager
Mr. Yerbury has twenty-four years of investment management experience, with over
twenty years experience in North American stock markets, and has been part of
the Perpetual team for twelve years. He received his undergraduate degree in
mathematics from Cambridge University.
Stephen Whittaker -- United Kingdom Specialist, Portfolio Manager
Mr. Whittaker has sixteen years of investment management experience. Prior to
his employment at Perpetual, Mr. Whittaker was responsible for a wide range of
UK equity funds for the Save & Prosper Group. He earned a law degree from
Manchester University.
Margaret Roddan -- European Specialist, Portfolio Manager
Ms. Roddan has eleven years of investment management experience. Ms. Roddan
joined the Perpetual organization from Mercury Asset Management, where she
shared responsibility for managing more than $750 million in continental
European equity holdings. She is a graduate of the Investment Management
Programme at the London Business School, studied Finance at City University, and
holds an undergraduate degree in economic history from Bristol University.
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<PAGE>
PERFORMANCE COMPARISONS
The performance of Class A and Class B shares, where applicable, of
each Portfolio depends upon such variables as: portfolio quality; average
portfolio maturity; type of instruments in which the particular Portfolio is
invested; changes in the expenses of a particular Portfolio; and 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.
Independent statistical agencies measure a Portfolio's investment
performance and publish comparative information showing how a Portfolio, and
other investment companies, performed in specified time periods. Agencies whose
reports are commonly used for such comparisons are set forth below. From time to
time, a Portfolio may distribute these comparisons to its shareholders or to
potential investors. The agencies listed below measure performance based on
their own criteria rather than on the standardized performance measures
described in the preceding section.
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.
Morningstar, Inc. distributes mutual fund ratings twice a month. The
ratings are divided into five groups: highest, above average, neutral, below
average, and lowest. They represent a Portfolio's historical risk/reward ratio
relative to other funds with similar objectives. The performance factor is a
weighted-average assessment of the Portfolio's 3- year, 5-year, and 10-year
total return performance (if available) reflecting deduction of expenses and
sales charges. Performance is adjusted using quantitative techniques to reflect
the risk profile of the Portfolio. The ratings are derived from a purely
quantitative system that does not utilize the subjective criteria customarily
employed by rating agencies such as Standard & Poor's Corporation and Moody's
Investor Service, Inc.
Weisenberger's Management Results publishes mutual fund rankings and is
distributed monthly. The rankings are based entirely on total return calculated
by Weisenberger for periods such as year-to-date, 1-year, 3-year, 5-year and
10-year performance. Mutual funds are ranked in general categories (e.g.,
international bond, international equity, municipal bond, and maximum capital
gain). Weisenberger rankings do not reflect deduction of sales charges or fees.
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<PAGE>
A Portfolio's shares also may be compared to the following indices:
Dow Jones Industrial Average ("DJIA") is an unmanaged index
representing share prices of major industrial corporations, public utilities,
and transportation companies. Produced by Dow Jones & Company, it is cited as a
principal indicator of market conditions.
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 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.
Consumer Price Index is generally considered to be a measure of
inflation.
CDA Mutual Fund Growth Index is a weighted performance average of other
mutual funds with growth of capital objectives.
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.
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 quasifederal 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.
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.
Russell Growth 1000 (Russell 1000 Index) is a broadly diversified index
consisting of approximately 1,000 common stocks of companies with market 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.
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
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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.
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).
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, certain of the Portfolios that invest in foreign
securities may advertise the performance of both classes of their shares
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). A 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 or an individual Portfolio's prospectus to obtain a more complete view of
a particular Portfolio's performance before investing. Of course, when comparing
a 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 portfolios using reporting
services, or total return and yield, investors should take into consideration
any relevant differences in portfolios, such as permitted portfolio compositions
and methods used to value portfolio securities and compute net asset value.
Advertisements and other sales literature for a Portfolio may quote
total returns which are calculated on non-standardized base periods. These total
returns also represent the historic
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change in the value of an investment in a Portfolio 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 monthly 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.
Independent publications may also evaluate a Portfolio's performance.
Certain of those publications are listed below, at the request of Mentor
Distributors, which bears full responsibility for their use and the descriptions
appearing below. From time to time any or all of the Portfolios may distribute
evaluations by or excerpts from these publications to its shareholders or to
potential investors. The following illustrates the types of information provided
by these publications.
Business Week publishes mutual fund rankings in its Investment Figures
of the Week column. The rankings are based on 4-week and 52-week total return
reflecting changes in net asset value and the reinvestment of all distributions.
They do not reflect deduction of any sales charges. Funds are not categorized;
they compete in a large universe of over 2,000 funds. The source for rankings is
data generated by Morningstar, Inc.
Investor's Business Daily publishes mutual fund rankings on a daily
basis. The rankings are depicted as the top 25 funds in a given category. The
categories are based loosely on the type of fund, e.g., growth funds, balanced
funds, U.S. government funds, GNMA funds, growth and income funds, corporate
bond funds, etc. Performance periods for sector equity funds can vary from 4
weeks to 39 weeks; performance periods for other fund groups vary from 1 year to
3 years. Total return performance reflects changes in net asset value and
reinvestment of dividends and capital gains. The rankings are based strictly on
total return. They do not reflect deduction of any sales charges Performance
grades are conferred from A+ to E. An A+ rating means that the fund has
performed within the top 5% of a general universe of over 2000 funds; an A
rating denotes the top 10%; an A- is given to the top 15%, etc.
Barron's periodically publishes mutual fund rankings. The rankings are
based on total return performance provided by Lipper Analytical Services. The
Lipper total return data reflects changes in net asset value and reinvestment of
distributions, but does not reflect deduction of any sales charges. The
performance periods vary from short-term intervals (current quarter or
year-to-date, for example) to long-term periods (five-year or ten-year
performance, for example). Barron's classifies the funds using the Lipper mutual
fund categories, such as Capital Appreciation Funds, Growth Funds, U.S.
Government Funds, Equity Income Funds, Global Funds, etc. Occasionally, Barron's
modifies the Lipper information by ranking the funds in asset
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classes. "Large funds" may be those with assets in excess of $25 million; "small
funds" may be those with less than $25 million in assets.
The Wall Street Journal publishes its Mutual Fund Scorecard on a daily
basis. Each Scorecard is a ranking of the top-15 funds in a given Lipper
Analytical Services category. Lipper provides the rankings based on its total
return data reflecting changes in net asset value and reinvestment of
distributions and not reflecting any sales charges. The Scorecard portrays
4-week, year-to-date, one-year and 5-year performance; however, the ranking is
based on the one-year results. The rankings for any given category appear
approximately once per month.
Fortune magazine periodically publishes mutual fund rankings that have
been compiled for the magazine by Morningstar, Inc. Funds are placed in stock or
bond fund categories (for example, aggressive growth stock funds, growth stock
funds, small company stock funds, junk bond funds, Treasury bond funds etc.),
with the top-10 stock funds and the top-5 bond funds appearing in the rankings.
The rankings are based on 3-year annualized total return reflecting changes in
net asset value and reinvestment of distributions and not reflecting sales
charges. Performance is adjusted using quantitative techniques to reflect the
risk profile of the fund.
Money magazine periodically publishes mutual fund rankings on a
database of funds tracked for performance by Lipper Analytical Services. The
funds are placed in 23 stock or bond fund categories and analyzed for five-year
risk adjusted return. Total return reflects changes in net asset value and
reinvestment of all dividends and capital gains distributions and does not
reflect deduction of any sales charges. Grades are conferred (from A to E): the
top 20% in each category receive an A, the next 20% a B, etc. To be ranked, a
fund must be at least one year old, accept a minimum investment of $25,000 or
less and have had assets of at least $25 million as of a given date.
Financial World publishes its monthly Independent Appraisals of Mutual
Funds, a survey of approximately 1000 mutual funds. Funds are categorized as to
type, e.g., balanced funds, corporate bond funds, global bond funds, growth and
income funds, U.S. government bond funds, etc. To compete, funds must be over
one year old, have over $1 million in assets, require a maximum of $10,000
initial investment, and should be available in at least 10 states in the United
States. The funds receive a composite past performance rating, which weighs the
intermediate - and long-term past performance of each fund versus its category,
as well as taking into account its risk, reward to risk, and fees. An A+ rated
fund is one of the best, while a D- rated fund is one of the worst. The source
for Financial World rating is Schabacker investment management in Rockville,
Maryland.
Forbes magazine periodically publishes mutual fund ratings based on
performance over at least two bull and bear market cycles. The funds are
categorized by type, including stock and balanced funds, taxable bond funds,
municipal bond funds, etc. Data sources include Lipper Analytical Services and
CDA Investment Technologies. The ratings are based strictly on performance at
net asset value over the given cycles. Funds performing in the top 5% receive
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an A+ rating; the top 15% receive an A rating; and so on until the bottom 5%
receive an F rating. Each fund exhibits two ratings, one for performance in "up"
markets and another for performance in "down" markets.
Kiplinger's Personal Finance Magazine (formerly Changing Times),
periodically publishes rankings of mutual funds based on one-, three- and
five-year total return performance reflecting changes in net asset value and
reinvestment of dividends and capital gains and not reflecting deduction of any
sales charges. Funds are ranked by tenths: a rank of 1 means that a fund was
among the highest 10% in total return for the period; a rank of 10 denotes the
bottom 10%. Funds compete in categories of similar funds -- aggressive growth
funds, growth and income funds, sector funds, corporate bond funds, global
governmental bond funds, mortgage-backed securities funds, etc. Kiplinger's also
provides a risk-adjusted grade in both rising and falling markets. Funds are
graded against others with the same objective. The average weekly total return
over two years is calculated. Performance is adjusted using quantitative
techniques to reflect the risk profile of the fund.
U.S. News and World Report periodically publishes mutual fund rankings
based on an overall performance index (OPI) devised by Kanon Bloch Carre & Co.,
a Boston research firm. Over 2000 funds are tracked and divided into 10 equity,
taxable bond and tax-free bond categories. Funds compete within the 10 groups
and three broad categories. The OPI is a number from 0-100 that measures the
relative performance of funds at least three years old over the last 1, 3, 5 and
10 years and the last six bear markets. Total return reflects changes in net
asset value and the reinvestment of any dividends and capital gains
distributions and does not reflect deduction of any sales charges. Results for
the longer periods receive the most weight.
The 100 Best Mutual Funds You Can Buy authored by Gordon K. Williamson.
The author's list of funds is divided into 12 equity and bond fund categories,
and the 100 funds are determined by applying four criteria. First, equity funds
whose current management teams have been in place for less than five years are
eliminated. (The standard for bond funds is three years.) Second, the author
excludes any fund that ranks in the bottom 20 percent of its category's risk
level. Risk is determined by analyzing how many months over the past three years
the fund has underperformed a bank CD or a U.S. Treasury bill. Third, a fund
must have demonstrated strong results for current three-year and five-year
performance. Fourth, the fund must either possess, in Mr. Williamson's judgment,
"excellent" risk-adjusted return or "superior" return with low levels of risk.
Each of the 100 funds is ranked in five categories: total return,
risk/volatility, management, current income and expenses. The rankings follow a
five-point system: zero designates "poor"; one point means "fair"; two points
denote "good"; three points qualify as a "very good"; four points rank as
"superior"; and five points mean "excellent."
SHAREHOLDER LIABILITY
Under Massachusetts law, shareholders could, under certain
circumstances, be held personally liable for the obligations of the Trust.
However, the Agreement and Declaration of
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Trust disclaims shareholder liability for acts or obligations of the Trust and
requires that notice of such disclaimer be given in each agreement, obligation,
or instrument entered into or executed by the Trust or the Trustees. The
Agreement and Declaration of Trust provides for indemnification out of a
Portfolio's property for all loss and expense of any shareholder held personally
liable for the obligations of a Portfolio. Thus the risk of a shareholder's
incurring financial loss on account of shareholder liability is limited to
circumstances in which the Portfolio would be unable to meet its obligations.
FINANCIAL STATEMENTS
The Report of Independent Auditors, financial highlights, and financial
statements in respect of each Portfolio other than the Balanced Portfolio,
included in the Mentor Funds' Annual Report for the fiscal year ended September
30, 1996, and the Report of Independent Auditors, financial highlights, and
financial statements included in the Balanced Portfolio's Annual Report for the
fiscal year ended September 30, 1996, each filed electronically on November 27,
1996 (File No. 811-6550), are incorporated by reference into this Statement of
Additional Information.
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