<PAGE> 1
As filed with the Securities and Exchange Commission on or about April 25, 1997
Securities Act Registration No. 33-45321
Investment Company Act Registration No. 811-6553
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [ ]
Pre-Effective Amendment No. [ ]
----
Post-Effective Amendment No. 14 [X]
----
and/or
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [ ]
Amendment No. 15 [X]
----
(Check appropriate box or boxes)
STRONG VARIABLE INSURANCE FUNDS, INC.
(Exact Name of Registrant as Specified in Charter)
100 Heritage Reserve
Menomonee Falls, Wisconsin 53051
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, including Area Code: (414) 359-3400
Thomas P. Lemke
Strong Capital Management, Inc.
100 Heritage Reserve
Menomonee Falls, Wisconsin 53051
(Name and Address of Agent for Service)
Registrant has registered an indefinite amount of securities pursuant to
Rule 24f-2 under the Securities Act of 1933; the Registrant's Rule 24f-2 Notice
for the fiscal year ended December 31, 1996 was filed on or about February 19,
1997.
It is proposed that this filing will become effective (check appropriate
box):
[ ] immediately upon filing pursuant to paragraph (b) of Rule 485
[X] on May 1, 1997 pursuant to paragraph (b) of Rule 485
[ ] 60 days after filing pursuant to paragraph (a)(1) of Rule 485
[ ] on (date) pursuant to paragraph (a)(1) of Rule 485
[ ] 75 days after filing pursuant to paragraph (a)(2) of Rule 485
[ ] on (date) pursuant to paragraph (a)(2) of Rule 485
If appropriate, check the following box:
[ ] this post-effective amendment designates a new effective
date for a previously filed post-effective amendment.
<PAGE> 2
STRONG VARIABLE INSURANCE FUNDS, INC.
CROSS REFERENCE SHEET
For Strong Discovery Fund II
Strong Asset Allocation Fund II
Strong International Stock Fund II
Strong Advantage Fund II
Strong Growth Fund II
Strong Government Securities Fund II
(Pursuant to Rule 481 showing the location in the Prospectus and the
Statement of Additional Information of the responses to the Items of Parts A
and B of Form N-1A.)
<TABLE>
<CAPTION>
Caption or Subheading in Prospectus or
Item No. on Form N-1A Statement of Additional Information
--------------------- -----------------------------------
<S> <C>
PART A - Information Required in Prospectus
1. Cover Page Cover Page
2. Synopsis Inapplicable
3. Condensed Financial Information Financial Highlights
4. General Description of Registrant The Fund; Investment Objective and
Policies; Implementation of Policies and
Risks; Special Considerations;
Additional Information
5. Management of the Fund Management, Additional Information
5A. Management's Discussion of Fund Performance *
6. Capital Stock and Other Securities Additional Information
7. Purchase of Securities Being Offered Additional Information
8. Redemption or Repurchase Additional Information
9. Pending Legal Proceedings Inapplicable
PART B - Information Required in Statement of Additional Information
10. Cover Page Cover page
11. Table of Contents Table of Contents
12. General Information and History **
13. Investment Objectives and Policies Investment Restrictions; Investment
Policies and Techniques
14. Management of the Fund Directors and Officers of the Corporation
</TABLE>
<PAGE> 3
<TABLE>
<CAPTION>
Caption or Subheading in Prospectus or
Item No. on Form N-1A Statement of Additional Information
--------------------- -----------------------------------
<S> <C>
15. Control Persons and Principal Holders of Principal Shareholders; Directors and Officers of the
Securities Corporation; Investment Advisor and Distributor
16. Investment Advisory and Other Services Investment Advisor and Distributor; Management (in
Prospectus); Custodian; Transfer Agent and
Dividend-Disbursing Agent; Administrative Services;
Independent Accountants; Legal Counsel
17. Brokerage Allocation and Other Practices Portfolio Transactions and Brokerage
18. Capital Stock and Other Securities Included in Prospectus under the heading Additional
Information
19. Purchase, Redemption and Pricing of Securities Included in Prospectus under the headings:
Being Offered Additional Information; and in the Statement of
Additional Information under the headings
Investment Advisor and Distributor; and
Determination of Net Asset Value
20. Tax Status Included in Prospectus under the heading Additional
Information; and Special Considerations; and in the
Statement of Additional Information under the
heading Taxes
21. Underwriters Investment Advisor and Distributor
22. Calculation of Performance Data Performance Information
23. Financial Statements Financial Statements
</TABLE>
* Complete answer to Item is contained in each Fund's Annual Report.
** Complete answer to Item is contained in each Fund's Prospectus.
<PAGE> 4
STRONG DISCOVERY FUND II
Strong Discovery Fund II (the "Fund") is a diversified series of the Strong
Variable Insurance Funds, Inc. (the "Corporation"), an open-end management
investment company, commonly called a mutual fund. The Fund seeks capital
growth. The Fund's Advisor seeks to identify emerging investment trends and
attractive growth opportunities. While the Fund normally emphasizes equity
investments, it also has the flexibility to invest in debt obligations and
short-term fixed-income securities.
Shares of the Fund are only offered and sold to the separate accounts of
certain insurance companies for the purpose of funding variable annuity and
variable life insurance contracts. This Prospectus should be read together with
the prospectus of the separate account of the specific insurance product which
preceded or accompanies this Prospectus.
This Prospectus contains information that you should consider before you
invest. Please read it carefully and keep it for future reference. A Statement
of Additional Information for the Fund, dated May 1, 1997, which contains
further information, is incorporated by reference into this Prospectus, and has
been filed with the Securities and Exchange Commission ("SEC"). This Statement,
which may be revised from time to time, is available upon request and without
charge by writing to the Fund at P.O. Box 2936, Milwaukee, Wisconsin 53201 or by
calling 1-800-368-1683.
============================================================================
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
- ----------------------------------------------------------------------------
May 1, 1997
-------------------
PROSPECTUS PAGE 1
<PAGE> 5
TABLE OF CONTENTS
<TABLE>
<S> <C>
THE FUND................................. 2
FINANCIAL HIGHLIGHTS..................... 3
INVESTMENT OBJECTIVE AND POLICIES........ 4
IMPLEMENTATION OF POLICIES AND RISKS..... 5
SPECIAL CONSIDERATIONS................... 12
MANAGEMENT............................... 14
ADDITIONAL INFORMATION................... 16
</TABLE>
No person has been authorized to give any information or to make any
representations other than those contained in this Prospectus and the Statement
of Additional Information and, if given or made, such information or
representations may not be relied upon as having been authorized by the Fund.
This Prospectus does not constitute an offer to sell securities to any person in
any state or jurisdiction in which such offering may not lawfully be made.
THE FUND
The Fund is a diversified series of the Corporation, which is an open-end
management investment company. The Fund offers and sells its shares only to
separate accounts of insurance companies for the purpose of funding variable
annuity and variable life insurance contracts. The Fund does not impose any
sales or redemption charges. Strong Capital Management, Inc., (the "Advisor") is
the investment advisor for the Fund.
-------------------
PROSPECTUS PAGE 2
<PAGE> 6
FINANCIAL HIGHLIGHTS
The following annual Financial Highlights for the Fund have been audited by
Coopers & Lybrand L.L.P., independent certified public accountants. Their report
for the fiscal year ended December 31, 1996 is included in the Fund's Annual
Report that is contained in the Fund's Statement of Additional Information. The
Financial Highlights should be read in conjunction with the Financial Statements
and related notes included in the Fund's Annual Report. Additional information
about the performance of the Fund is contained in the Fund's Annual Report,
which may be obtained without charge by calling or writing Strong Funds. Please
note that the total return shown in the Financial Highlights does not reflect
expenses that apply to the separate account or the related insurance policies.
Inclusion of these charges would reduce the total return for the periods shown.
The following presents information relating to a share of common stock
outstanding for the entire period ended as indicated.
<TABLE>
<CAPTION>
12-31-96 12-31-95 12-31-94 12-31-93 12-31-92(1)
-------- -------- -------- -------- -----------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF
PERIOD $ 13.44 $ 10.07 $ 11.54 $ 10.15 $ 10.00
INCOME FROM INVESTMENT
OPERATIONS
Net Investment Income (Loss) (0.05) (0.03) 0.10 0.05 0.04
Net Realized and Unrealized
Gains (Losses) on
Investments 0.04 3.58 (0.71) 2.09 0.78
-------- -------- -------- ------- --------
Total from Investment Operations (0.01) 3.55 (0.61) 2.14 0.82
LESS DISTRIBUTIONS
From Net Investment Income -- -- (0.10) (0.05) (0.04)
In Excess of Net Investment
Income (1.05) (0.18) (0.43) (0.70) --
From Net Realized Gains (1.58) -- (0.33) -- (0.63)(3)
-------- -------- -------- ------- --------
Total Distributions (2.63) (0.18) (0.86) (0.75) (0.67)
-------- -------- -------- ------- --------
NET ASSET VALUE, END OF PERIOD $ 10.80 $ 13.44 $ 10.07 $ 11.54 $ 10.15
======== ======== ======== ======= ========
TOTAL RETURN +0.8% +35.3% -5.4% +22.0% +8.9%
RATIOS AND SUPPLEMENTAL DATA
Net Assets, End of Period (In
Thousands) $229,412 $245,047 $118,927 $71,938 $ 26,739
Ratio of Expenses to Average Net
Assets 1.2% 1.3% 1.2% 1.3% 1.7%*
Ratio of Net Investment Income
to Average Net Assets (0.3%) (0.3%) 1.1% 0.5% 0.5%*
Portfolio Turnover Rate 970.0% 542.1% 662.5% 976.5% 1,149.6%
Average Commission Rate Paid(2) $ 0.0292
</TABLE>
*Calculated on an annualized basis.
(1)Inception date is May 8, 1992. Total return and portfolio turnover rate are
not annualized.
(2)Disclosure required, effective for reporting periods beginning after
September 1, 1995.
(3)Ordinary income distribution for tax purposes.
-------------------
PROSPECTUS PAGE 3
<PAGE> 7
INVESTMENT OBJECTIVE AND POLICIES
The Fund has adopted certain fundamental investment restrictions that are set
forth in the Fund's Statement of Additional Information ("SAI"). Those
restrictions, the Fund's investment objective and any other investment policies
identified as "fundamental" cannot be changed without shareholder approval. To
further guide investment activities, the Fund has also instituted a number of
non-fundamental operating policies, which are described throughout this
Prospectus and in the SAI. Although these additional policies may be changed by
the Corporation's Board of Directors without shareholder approval, the Fund will
promptly notify shareholders of any material change in operating policies.
The Fund seeks capital growth. The Fund invests in securities that the
Advisor believes represent attractive growth opportunities.
The Fund normally emphasizes equity securities, although it has the
flexibility to invest in any type of security that the Advisor believes has the
potential for capital appreciation. The Fund may invest up to 100% of its total
assets in equity securities, including common stocks, preferred stocks, and
securities that are convertible into common or preferred stocks, such as
warrants and convertible bonds. The Fund may also invest up to 100% of its total
assets in debt obligations, including intermediate- to long-term corporate or
U.S. government debt securities. When the Advisor determines that market
conditions warrant a temporary defensive position, the Fund may invest without
limitation in cash and short-term fixed-income securities. Although the debt
obligations in which it invests will be primarily investment grade, the Fund may
invest up to 5% of its net assets in non-investment-grade debt obligations. (See
"Implementation of Policies and Risks - Debt Obligations.")
The Fund may invest up to 25% of its net assets in foreign securities,
including both direct investments and investments made through depositary
receipts. (See "Implementation of Policies and Risks - Foreign Securities and
Currencies" for the special risks associated with foreign investments.)
The Advisor seeks to uncover emerging investment trends and attractive growth
opportunities. In its search for potential investments, the Advisor attempts to
identify companies that are poised for accelerated earnings growth due to
innovative products or services, new management, or favorable economic or market
cycles. These companies may be small, unseasoned firms in the early stages of
development, or they may be mature organizations. (See "Implementation of
Policies and Risks - Small and Medium Companies.") Whatever their size, history,
or industry, the Advisor believes their potential earnings growth is not yet
reflected in their market value and that, over time, the market prices of these
securities will move higher.
For the past three years of investment experience (1994, 1995, and 1996), the
Fund has been engaging in substantial short-term trading which has caused the
average annual turnover rate to be above 700% (see page 12
-------------------
PROSPECTUS PAGE 4
<PAGE> 8
regarding portfolio turnover). THESE PRACTICES MAY BE DEEMED SPECULATIVE AND MAY
CAUSE THE FUND'S NET ASSET VALUE TO BE MORE VOLATILE THAN THE NET ASSET VALUE OF
A FUND THAT DOES NOT ENGAGE IN THESE ACTIVITIES. In the Advisor's opinion,
however, the Fund's turnover rate is appropriate in light of the Fund's
disclosed investment objective and policies, applicable regulatory requirements
(which may, in some cases, cause the Fund's portfolio turnover rate to be
artificially increased) and the Advisor's active management style.
IMPLEMENTATION OF POLICIES AND RISKS
In addition to the Fund's investment policies described above (and subject to
certain restrictions described herein), the Fund may invest in some or all of
the following securities and employ some or all of the following investment
techniques, some of which may present special risks as described below. The Fund
may also engage in reverse repurchase agreements and mortgage dollar roll
transactions. A more complete discussion of these securities and investment
techniques and their associated risks is contained in the Fund's SAI.
FOREIGN SECURITIES AND CURRENCIES
The Fund may invest in foreign securities either directly or indirectly
through the use of depositary receipts. Depositary receipts are generally issued
by banks or trust companies and evidence ownership of underlying foreign
securities. Foreign investments involve special risks, including:
- - expropriation, confiscatory taxation, and withholding taxes on dividends and
interest;
- - less extensive regulation of foreign brokers, securities markets, and issuers;
- - less publicly available information and different accounting standards;
- - costs incurred in conversions between currencies, possible delays in
settlement in foreign securities markets, limitations on the use or transfer
of assets (including suspension of the ability to transfer currency from a
given country), and difficulty of enforcing obligations in other countries;
and
- - diplomatic developments and political or social instability.
Foreign economies may differ favorably or unfavorably from the U.S. economy
in various respects, including growth of gross domestic product, rates of
inflation, currency depreciation, capital reinvestment, resource
self-sufficiency, and balance-of-payments positions. Many foreign securities may
be less liquid and their prices more volatile than comparable U.S. securities.
Although the Fund generally invests only in securities that are regularly traded
on recognized exchanges or in over-the-counter markets, from time to time
foreign securities may be difficult to liquidate rapidly without adverse price
effects.
-------------------
PROSPECTUS PAGE 5
<PAGE> 9
Certain costs attributable to foreign investing, such as custody charges and
brokerage costs, may be higher than those attributable to domestic investing.
The Fund may invest in securities of issuers in developing or emerging
markets and economies. Risks of investing in developing or emerging markets
include:
- - less social, political, and economic stability;
- - smaller securities markets and lower trading volume, which may result in a
lack of liquidity and greater price volatility;
- - certain national policies that may restrict the Fund's investment
opportunities, including restrictions on investments in issuers or industries
deemed sensitive to national interests, or expropriation or confiscation of
assets or property, which could result in the Fund's loss of its entire
investment in that market; and
- - less developed legal structures governing private or foreign investment or
allowing for judicial redress for injury to private property.
In addition, brokerage commissions, custodial services, withholding taxes,
and other costs relating to investment in emerging markets generally are more
expensive than in the U.S. and certain more established foreign markets.
Economies in emerging markets generally are heavily dependent upon international
trade and, accordingly, have been and may continue to be affected adversely by
trade barriers, exchange controls, managed adjustments in relative currency
values, and other protectionist measures negotiated or imposed by the countries
with which they trade.
Because most foreign securities are denominated in non-U.S. currencies, the
investment performance of the Fund could be affected by changes in foreign
currency exchange rates to some extent. The value of the Fund's assets
denominated in foreign currencies will increase or decrease in response to
fluctuations in the value of those foreign currencies relative to the U.S.
dollar. Currency exchange rates can be volatile at times in response to supply
and demand in the currency exchange markets, international balances of payments,
governmental intervention, speculation, and other political and economic
conditions.
The Fund may purchase and sell foreign currency on a spot basis and may
engage in forward currency contracts, currency options, and futures transactions
for hedging or any other lawful purpose. (See "Derivative Instruments.")
FOREIGN INVESTMENT COMPANIES
The Fund may invest, to a limited extent, in foreign investment companies.
Some of the countries in which the Fund invests may not permit direct investment
by outside investors. Investments in such countries may only be permitted
through foreign government-approved or -authorized investment vehicles, which
may include other investment companies. In addition, it may be less expensive
and more expedient for the Fund to invest in a foreign investment
-------------------
PROSPECTUS PAGE 6
<PAGE> 10
company in a country which permits direct foreign investment. Investing through
such vehicles may involve frequent or layered fees or expenses and may also be
subject to limitation under the Investment Company Act of 1940 (the "1940 Act").
The Fund does not intend to invest in such investment companies unless, in the
judgment of the Advisor, the potential benefits of such investments justify the
payment of any associated fees or expenses.
DERIVATIVE INSTRUMENTS
The Fund may use derivative instruments for any lawful purpose consistent
with the Fund's investment objective such as hedging or managing risk.
Derivative instruments are commonly defined to include securities or contracts
whose values depend on (or "derive" from) the value of one or more other assets,
such as securities, currencies, or commodities. These "other assets" are
commonly referred to as "underlying assets."
A derivative instrument generally consists of, is based upon, or exhibits
characteristics similar to options or forward contracts. Options and forward
contracts are considered to be the basic "building blocks" of derivatives. For
example, forward-based derivatives include forward contracts, swap contracts, as
well as exchange-traded futures. Option-based derivatives include privately
negotiated, over-the-counter (OTC) options (including caps, floors, collars, and
options on forward and swap contracts) and exchange-traded options on futures.
Diverse types of derivatives may be created by combining options or forward
contracts in different ways, and by applying these structures to a wide range of
underlying assets.
An option is a contract in which the "holder" (the buyer) pays a certain
amount (the "premium") to the "writer" (the seller) to obtain the right, but not
the obligation, to buy from the writer (in a "call") or sell to the writer (in a
"put") a specific asset at an agreed upon price at or before a certain time. The
holder pays the premium at inception and has no further financial obligation.
The holder of an option-based derivative generally will benefit from favorable
movements in the price of the underlying asset but is not exposed to
corresponding losses due to adverse movements in the value of the underlying
asset. The writer of an option-based derivative generally will receive fees or
premiums but generally is exposed to losses due to changes in the value of the
underlying asset.
A forward is a sales contract between a buyer (holding the "long" position)
and a seller (holding the "short" position) for an asset with delivery deferred
until a future date. The buyer agrees to pay a fixed price at the agreed future
date and the seller agrees to deliver the asset. The seller hopes that the
market price on the delivery date is less than the agreed upon price, while the
buyer hopes for the contrary. The change in value of a forward-based derivative
generally is roughly proportional to the change in value of the underlying
asset.
-------------------
PROSPECTUS PAGE 7
<PAGE> 11
Derivative instruments may include (i) options; (ii) futures; (iii) options
on futures; (iv) short sales against the box, in which the Fund sells a security
it owns for delivery at a future date; (v) swaps, in which two parties agree to
exchange a series of cash flows in the future, such as interest-rate payments;
(vi) interest-rate caps, under which, in return for a premium, one party agrees
to make payments to the other to the extent that interest rates exceed a
specified rate, or "cap"; (vii) interest-rate floors, under which, in return for
a premium, one party agrees to make payments to the other to the extent that
interest rates fall below a specified level, or "floor"; (viii) forward currency
contracts and foreign currency exchange-related securities; and (ix) structured
instruments which combine the foregoing in different ways.
Derivatives may be exchange-traded or traded in OTC transactions between
private parties. OTC transactions are subject to additional risks, such as the
credit risk of the counterparty to the instrument and are less liquid than
exchanged-traded derivatives since they often can only be closed out with the
other party to the transaction. Derivative instruments may include elements of
leverage and, accordingly, the fluctuation of the value of the derivative
instrument in relation to the underlying asset may be magnified. When required
by SEC guidelines, the Fund will set aside permissible liquid assets in a
segregated account to secure its obligations under the derivative. In order to
maintain its required cover for a derivative, the Fund may need to sell
portfolio securities at disadvantageous prices or times since it may not be
possible to liquidate a derivative position.
The successful use of derivatives by the Fund is dependent upon a variety of
factors, particularly the Advisor's ability to correctly anticipate trends in
the underlying asset. In a hedging transaction, if the Advisor incorrectly
anticipates trends in the underlying asset, the Fund may be in a worse position
than if no hedging had occurred. In addition, there may be imperfect correlation
between the Fund's derivative transactions and the instruments being hedged. To
the extent that the Fund is engaging in derivative transactions for risk
management, the Fund's successful use of such transactions is more dependent
upon the Advisor's ability to correctly anticipate such trends, since losses in
these transactions may not be offset in gains in the Fund's portfolio or in
lower purchase prices for assets it intends to acquire. The Advisor's prediction
of trends in underlying assets may prove to be inaccurate, which could result in
substantial losses to the Fund.
In addition to the derivative instruments and strategies described above, the
Advisor expects to discover additional derivative instruments and other trading
techniques. The Advisor may utilize these new derivative instruments and
techniques to the extent that they are consistent with the Fund's investment
objective and permitted by the Fund's investment limitations, operating
policies, and applicable regulatory authorities.
-------------------
PROSPECTUS PAGE 8
<PAGE> 12
ILLIQUID SECURITIES
The Fund may invest up to 15% of its net assets in illiquid securities.
Illiquid securities are those securities that are not readily marketable,
including restricted securities and repurchase obligations maturing in more than
seven days. Certain restricted securities that may be resold to institutional
investors pursuant to Rule 144A under the Securities Act of 1933 and Section
4(2) commercial paper may be determined to be liquid under guidelines adopted by
the Fund's Board of Directors.
SMALL AND MEDIUM COMPANIES
The Fund may invest a substantial portion of its assets in small and medium
companies. While small and medium companies generally have potential for rapid
growth, investments in small and medium companies often involve greater risks
than investments in larger, more established companies because small and medium
companies may lack the management experience, financial resources, product
diversification, and competitive strengths of larger companies. In addition, in
many instances the securities of small and medium companies are traded only
over-the-counter or on a regional securities exchange, and the frequency and
volume of their trading is substantially less than is typical of larger
companies. Therefore, the securities of small and medium companies may be
subject to greater and more abrupt price fluctuations. When making large sales,
the Fund may have to sell portfolio holdings at discounts from quoted prices or
may have to make a series of small sales over an extended period of time due to
the trading volume of small and medium company securities. Investors should be
aware that, based on the foregoing factors, an investment in the Fund may be
subject to greater price fluctuations than an investment in a fund that invests
primarily in larger, more established companies. The Advisor's research efforts
may also play a greater role in selecting securities for the Fund than in a fund
that invests in larger, more established companies.
DEBT OBLIGATIONS
Debt obligations in which the Fund may invest will be primarily investment-
grade debt obligations, although the Fund may invest up to 5% of its net assets
in non-investment-grade debt obligations. The market value of all debt
obligations is affected by changes in the prevailing interest rates. The market
value of such instruments generally reacts inversely to interest rate changes.
If the prevailing interest rates decline, the market value of debt obligations
generally increases. If the prevailing interest rates increase, the market value
of debt obligations generally decreases. In general, the longer the maturity of
a debt obligation, the greater its sensitivity to changes in interest rates.
---------------------
PROSPECTUS PAGE 9
<PAGE> 13
Investment-grade debt obligations include:
- - U.S. government securities (as defined below);
- - bonds or bank obligations rated in one of the four highest rating categories
e.g., BBB or higher by Standard & Poor's Ratings Group or "S&P");
- - short-term notes rated in one of the two highest rating categories (e.g., Sp-2
or higher by S&P);
- - short-term bank obligations rated in one of the three highest rating
categories (e.g., A-3 or higher by S&P), with respect to obligations maturing
in one year or less;
- - commercial paper rated in one of the three highest rating categories of any
NRSRO (e.g., A-3 or higher by S&P);
- - unrated debt obligations determined by the Advisor to be of comparable
quality; and
- - repurchase agreements involving investment-grade debt obligations.
Investment-grade debt obligations are generally believed to have relatively
low degrees of credit risk. All ratings are determined at the time of
investment. Any subsequent rating downgrade of a debt obligation will be
monitored by the Advisor to consider what action, if any, the Fund should take
consistent with its investment objective. For purposes of determining whether a
security is investment grade, the Advisor may use the highest rating assigned to
that security by any nationally recognized statistical rating organization
("NRSRO"). Securities rated in the fourth-highest category (e.g., BBB by S&P),
although considered investment grade, have speculative characteristics and may
be subject to greater fluctuations in value than higher-rated securities.
Non-investment-grade debt obligations include:
- - securities rated as low as C by S&P or their equivalents;
- - commercial paper rated as low as C by S&P or its equivalents; and
- - unrated debt obligations judged to be of comparable quality by the Advisor.
GOVERNMENT SECURITIES
U.S. government securities are issued or guaranteed by the U.S. government or
its agencies or instrumentalities. Securities issued by the government include
U.S. Treasury obligations, such as Treasury bills, notes, and bonds. Securities
issued by government agencies or instrumentalities include, for example,
obligations of the following:
- - the Federal Housing Administration, Farmers Home Administration, Export-Import
Bank of the United States, Small Business Administration, and the Government
National Mortgage Association, including GNMA pass-through certificates, whose
securities are supported by the full faith and credit of the United States;
---------------------
PROSPECTUS PAGE 10
<PAGE> 14
- - the Federal Home Loan Banks, Federal Intermediate Credit Banks, and the
Tennessee Valley Authority, whose securities are supported by the right of the
agency to borrow from the U.S. Treasury;
- - the Federal National Mortgage Association, whose securities are supported by
the discretionary authority of the U.S. government to purchase certain
obligations of the agency or instrumentality; and
- - the Student Loan Marketing Association, the Interamerican Development Bank,
and International Bank for Reconstruction and Development, whose securities
are supported only by the credit of such agencies.
Although the U.S. government provides financial support to such U.S.
government-sponsored agencies or instrumentalities, no assurance can be given
that it will always do so. The U.S. government and its agencies and
instrumentalities do not guarantee the market value of their securities;
consequently, the value of such securities will fluctuate.
WHEN-ISSUED SECURITIES
The Fund may invest without limitation in securities purchased on a when-
issued or delayed-delivery basis. Although the payment and interest terms of
these securities are established at the time the purchaser enters into the
commitment, these securities may be delivered and paid for at a future date,
generally within 45 days. Purchasing when-issued securities allows the Fund to
lock in a fixed price or yield on a security it intends to purchase. However,
when the Fund purchases a when-issued security, it immediately assumes the risk
of ownership, including the risk of price fluctuation.
The greater the Fund's outstanding commitments for these securities, the
greater the exposure to potential fluctuations in the net asset value of the
Fund. Purchasing when-issued securities may involve the additional risk that the
yield available in the market when the delivery occurs may be higher or the
market price lower than that obtained at the time of commitment. Although the
Fund may be able to sell these securities prior to the delivery date, it will
purchase when-issued securities for the purpose of actually acquiring the
securities, unless after entering into the commitment a sale appears desirable
for investment reasons. When required by SEC guidelines, the Fund will set aside
permissible liquid assets in a segregated account to secure its outstanding
commitments for when-issued securities.
CASH MANAGEMENT
The Fund may invest directly in cash and short-term fixed-income securities,
including, for this purpose, shares of one or more money market funds managed by
the Advisor (collectively, the "Strong Money Funds"). The Strong Money Funds
seek current income, a stable share price of $1.00, and daily liquidity. All
money market instruments can change in value when interest rates or an issuer's
creditworthiness change dramatically. The Strong Money
---------------------
PROSPECTUS PAGE 11
<PAGE> 15
Funds cannot guarantee that they will always be able to maintain a stable net
asset value of $1.00 per share.
PORTFOLIO TURNOVER
The Fund's historical portfolio turnover rate is listed under "Financial
Highlights." The annual portfolio turnover rate indicates changes in the Fund's
portfolio. The turnover rate may vary from year to year, as well as within a
year. It may also be affected by sales of portfolio securities necessary to meet
cash requirements for redemption of shares. High portfolio turnover in any year
will result in the payment by the Fund of above-average amounts of transaction
costs. The Fund may engage in substantial short-term trading that involves
substantial risks and may be considered speculative.
The following information is required to be disclosed by the California
Department of Insurance due to the significantly high turnover rate of the Fund:
For 1994, 1995, and 1996, the percentage of brokerage commissions paid by the
Fund to net asset value were 1.55%, 1.47%, and 1.52%, respectively. THE
BROKERAGE COMMISSIONS ARE NOT INCLUDED IN THE PORTFOLIO ANNUAL EXPENSES
DISCLOSED UNDER THE INFORMATION CONCERNING FEES AND CHARGES.
Brokerage commissions are not included as an expense of the Fund because, as
is the case with all SEC-registered mutual funds, the SEC's formula for
calculating the portfolio annual expenses excludes brokerage commissions.
Rather, under current accounting treatment, brokerage commissions increase the
cost basis of a purchased security or reduce the proceeds received from the sale
of a security and are not accounted for as an "expense" of the Fund.
SPECIAL CONSIDERATIONS
The Fund is designed as an investment vehicle for variable annuity and
variable life insurance contracts funded by separate accounts of certain
insurance companies. Section 817(h) of the Internal Revenue Code of 1986, as
amended (the "Code") and the regulations thereunder impose certain
diversification standards on the investments underlying variable annuity and
variable life insurance contracts in order for such contracts to be treated for
tax purposes as annuities or life insurance. Section 817(h) of the Code provides
that a variable annuity and variable life insurance contract based on a separate
account shall not be treated as an annuity or life insurance contract for any
period (and any subsequent period) for which the account's investments are not
adequately diversified. These diversification requirements are in addition to
the diversification requirements applicable to the Fund under Subchapter M of
the Code and the Investment Company Act of 1940 (the "1940 Act") and may affect
the composition of the Fund's investments.
Since the shares of the Fund are currently sold to segregated asset accounts
underlying such variable annuity and variable life insurance contracts,
---------------------
PROSPECTUS PAGE 12
<PAGE> 16
the Fund intends to comply with the diversification requirements as set forth in
the regulations. The Secretary of the Treasury may in the future issue
additional regulations or revenue rulings that may prescribe the circumstances
in which a contract owner's control of the investments of a separate account may
cause the contract owner, rather than the insurance company, to be treated as
the owner of assets of the separate account. Failure to comply with Section
817(h) of the Code or any regulation thereunder, or with any future regulations
or revenue rulings on contract owner control, would cause earnings regarding a
contract owner's interest in an insurance company's separate account to be
includible in the contract owner's gross income in the year earned. Such
standards may apply only prospectively, although retroactive application is
possible. In the event that any such regulations or revenue rulings are adopted,
the Fund may not be able to continue to operate as currently described in this
prospectus, or maintain its investment program.
The Fund will be managed in such a manner as to comply with the requirements
of Subchapter L of the Code. It is possible that in order to comply with such
requirements, less desirable investment decisions may be made which would affect
the investment performance of the Fund.
The Fund may sell its shares to the separate accounts of various insurance
companies, which are not affiliated with each other, for the purpose of funding
variable annuity and variable life insurance contracts. The Fund currently does
not foresee any disadvantages to contract owners arising out of the fact that it
offers its shares to separate accounts of various insurance companies, which are
not affiliated with each other, to serve as an investment medium for their
variable products. However, it is theoretically possible that the interests of
owners of various contracts participating in the Fund through the separate
accounts might at some time be in conflict. The Board of Directors of the Fund,
however, will monitor events in order to identify any material irreconcilable
conflicts which may possibly arise and to determine what action, if any, should
be taken in response to such conflicts. If such a conflict were to occur, one or
more insurance companies' separate accounts might be required to withdraw its
investments in the Fund, and shares of another Fund may be substituted. This
might force the Fund to sell securities at disadvantageous prices. In addition,
the Board of Directors may refuse to sell Fund shares to any separate account or
may suspend or terminate the offering of Fund shares if such action is required
by law or regulatory authority or is in the best interest of the shareholders of
the Fund.
Except for the organizational shares of the Fund, the Fund's shares may be
held of record only by insurance company separate accounts. As of March 31,
1997, Nationwide Life Insurance Company owned approximately 96% of the Fund.
Nationwide Life Insurance Company's ownership of greater than 25% of the Fund's
shares may result in it being deemed to be the controlling entity of the Fund.
It may continue to be deemed as such until other insurance companies, if any,
selling significant numbers of variable annuity and variable life insurance
contracts, have made substantial investments in the Fund's shares.
---------------------
PROSPECTUS PAGE 13
<PAGE> 17
MANAGEMENT
The Board of Directors of the Fund is responsible for managing its business
and affairs. The Fund has entered into an investment advisory agreement (an
"Advisory Agreement") with the Advisor. Under the terms of the Advisory
Agreement, the Advisor manages the Fund's investments and business affairs,
subject to the supervision of the Board of Directors.
The Advisor began conducting business in 1974. Since then, its principal
business has been providing continuous investment supervision for individuals
and institutional accounts, such as pension funds and profit-sharing plans, as
well as mutual funds, several of which are funding vehicles for variable
insurance products. As of March 31, 1997, the Advisor had over $23 billion under
management. The Advisor's principal mailing address is P.O. Box 2936, Milwaukee,
Wisconsin 53201. Mr. Richard S. Strong, the Chairman of the Board of the Fund,
is the controlling shareholder of the Advisor.
As compensation for its services, the Fund pays the Advisor a monthly
management fee. The annual fee is 1.00% of the average daily net asset value of
the Fund. Under the terms of the Advisory Agreement, the Advisor provides office
space and all necessary office facilities, equipment, and personnel for
servicing the investments of the Fund. From time to time, the Advisor may
voluntarily waive all or a portion of its management fee and/or absorb certain
expenses for the Fund without further notification of the commencement or
termination of any such waiver or absorption. Any such waiver or absorption will
have the effect of lowering the overall expense ratio of the Fund and increasing
the Fund's return to investors at the time such amounts were waived and/or
absorbed.
The Advisor permits portfolio managers and other persons who may have access
to information about the purchase or sale of securities in the Fund's portfolio
("access persons") to purchase and sell securities for their own accounts,
subject to the Advisor's policy governing personal investing. The policy
requires access persons to conduct their personal investment activities in a
manner that the Advisor believes is not detrimental to the Fund or to the
Advisor's other advisory clients. Among other things, the policy requires access
persons to obtain preclearance before executing personal trades and prohibits
access persons from keeping profits derived from the purchase or sale of the
same security within 60 calendar days. See the SAI for more information.
PRIOR PERFORMANCE OF SIMILAR FUND MANAGED BY THE ADVISOR. The Strong
Discovery Fund II, which commenced operations on May 8, 1992, has been modeled
after the Strong Discovery Fund, an existing retail fund managed by the Advisor.
The Strong Discovery Fund began operations on December 31, 1987 and, as of March
31, 1997, had 360 million in assets. The investment objective, policies, and
strategies of the Strong Discovery Fund are identical to those of the Strong
Discovery Fund II and the Funds have
---------------------
PROSPECTUS PAGE 14
<PAGE> 18
substantially comparable expense ratios. The average annual and cumulative total
returns for the Strong Discovery Fund II and Strong Discovery Fund as of March
31, 1997 are presented in the table below. These performance returns have been
audited through December 31, 1996 and are unaudited thereafter.
<TABLE>
<CAPTION>
PERFORMANCE STRONG DISCOVERY STRONG DISCOVERY
RETURNS(1) FUND II FUND
<S> <C> <C>
Average Annual Returns
1 Year -6.42% -6.01%
5 Year -- 7.98%
Since Inception 9.25% 14.97%
Cumulative Returns 54.24% 263.37%
- --------------------------------------------------------------------
</TABLE>
(1)Average annual and cumulative total returns reflect changes in share prices
and reinvestment of dividends and distributions and are net of fund expenses.
Historical performance does not indicate future performance. THE STRONG
DISCOVERY FUND IS A SEPARATE FUND AND ITS HISTORICAL PERFORMANCE IS NOT
INDICATIVE OF THE PRESENT OR FUTURE PERFORMANCE OF THE STRONG DISCOVERY FUND II.
THE PERFORMANCE OF THE STRONG DISCOVERY FUND II MAY BE GREATER OR LESS THAN THE
PERFORMANCE OF THE STRONG DISCOVERY FUND DUE TO, AMONG OTHER THINGS, DIFFERENCES
IN EXPENSES AND CASH FLOWS. Share prices and investment returns will fluctuate.
PORTFOLIO MANAGERS. The following individuals serve as portfolio managers for
the Fund.
RICHARD S. STRONG. Mr. Strong founded the Advisor in 1974. He began his
investment career at Employers Insurance of Wausau in 1966, after receiving his
master's degree in Finance from the University of Wisconsin-Madison that
January. He received his undergraduate degree in 1963 from Baldwin-Wallace
College. Mr. Strong has managed the Strong Discovery Fund II since its inception
in May 1992. In addition to his role as a portfolio manager, he is currently the
Chairman of the Board, Director, and Chief Investment Officer of the Advisor.
CHARLES A. PAQUELET. Mr. Paquelet joined the Advisor, as a securities analyst
in 1988 from the B.F. Goodrich Company, where he began his career as a financial
analyst earlier in 1987. Since 1990, he has been a portfolio manager of separate
accounts for individual and institutional investors. Mr. Paquelet was awarded
his M.B.A. in 1989 from Indiana University. He received his bachelor's degree in
Finance in 1987 from Case Western Reserve University. Mr. Paquelet is a
Chartered Financial Analyst. Mr. Paquelet served as the portfolio manager of the
Strong Small Cap Fund from December 1995 until August 1996. Mr. Paquelet has
co-managed the Fund since August 1996.
---------------------
PROSPECTUS PAGE 15
<PAGE> 19
ADDITIONAL INFORMATION
HOW TO INVEST. Investments in the Fund may only be made by separate accounts
established and maintained by insurance companies for purposes of funding
variable annuity and variable life insurance contracts. For instructions on how
to direct a separate account to purchase shares in the Fund, please refer to the
prospectus of the insurance company's separate account. The Fund does not impose
any sales charge or 12b-1 fee. Certain sales charges may apply to the variable
annuity or variable life insurance contract, which should be described in the
prospectus of the insurance company's separate account. The Fund may decline to
accept a purchase order upon receipt when, in the judgment of the Advisor, it
would not be in the best interest of the existing shareholders to accept the
order. Shares of the Fund will be sold at the net asset value next determined
after receipt by the Fund of a purchase order in proper form placed by an
insurance company investing in the Fund. Certificates for shares in the Fund
will not be issued.
CALCULATION OF NET ASSET VALUE. The net asset value ("NAV") per share for the
Fund is determined as of the close of trading on the New York Stock Exchange
(the "Exchange"), currently 3:00 p.m. Central Time, on days the Exchange is open
for business. The NAV will not be determined for the Fund on days during which
the Fund receives no orders to purchase shares and no shares are tendered for
redemption. The Fund's NAV is calculated by taking the fair value of the Fund's
total assets, subtracting all liabilities, and dividing by the total number of
outstanding shares. Expenses are accrued and applied daily when determining the
NAV.
The Fund's portfolio securities are valued based on market quotations or at
fair value as determined by the method selected by the Board of Directors.
Equity securities traded on a national securities exchange or NASDAQ are valued
at the last sales price on the national securities exchange or NASDAQ on which
such securities are primarily traded. Securities traded on NASDAQ for which
there were no transactions on a given day or securities not listed on an
exchange or NASDAQ are valued at the average of the most recent bid and asked
prices. Other exchange-traded securities (generally foreign securities) will be
valued based on market quotations.
Debt securities are valued by a pricing service that utilizes electronic data
processing techniques to determine values for normal institutional-sized trading
units of debt securities without regard to sale or bid prices when such
valuations are believed to more accurately reflect the fair market value for
such securities. Otherwise, sale or bid prices are used. Any securities or other
assets for which market quotations are not readily available are valued at fair
value as determined in good faith by the Board of Directors. Debt securities of
the Fund having remaining maturities of 60 days or less are valued by the
amortized cost method when the fair value of such securities is their amortized
cost.
---------------------
PROSPECTUS PAGE 16
<PAGE> 20
HOW TO REDEEM SHARES. Shares of the Fund may be redeemed on any business day.
The price received upon redemption will be the net asset value next determined
after the redemption request in proper form is received by the Fund. (See
"Calculation of Net Asset Value.") Contract owners should refer to the
withdrawal or surrender instructions in the prospectus of the separate account
for instructions on how to redeem shares. Once the redemption request is
received in proper form, the Fund will ordinarily forward payment to the
separate account no later than seven days after receipt.
The right of redemption may be suspended during any period in which: (i)
trading on the Exchange is restricted, as determined by the SEC, or the Exchange
is closed for other than weekends and holidays; (ii) the SEC has permitted such
suspension by order; or (iii) an emergency, as determined by the SEC, exists
which makes disposal of portfolio securities or valuation of net assets of the
Fund not reasonably practicable.
DISTRIBUTIONS AND TAXES. The policy of the Fund is to pay dividends to the
insurance company's separate accounts from net investment income quarterly and
to distribute substantially all net realized capital gains, after using any
available capital loss carryovers, annually. All dividends and capital gain
distributions paid to the insurance company's separate accounts will be
automatically reinvested in additional Fund shares.
The Fund intends to continue to qualify for treatment as a Regulated
Investment Company or "RIC" under Subchapter M of the Code and, if so qualified,
will not be liable for federal income tax on earnings and gains distributed to
its shareholders in a timely manner. If the Fund does not so qualify, however,
it would be treated for tax purposes as an ordinary corporation and would
receive no tax deduction for distributions made to its shareholders. For more
information regarding tax implications for owners of variable annuity or
variable life insurance contracts investing in the Fund, please refer to the
prospectus of your insurance company's separate account. (See "Special
Considerations" for a discussion of special tax considerations relating to the
Fund's compliance with Subchapter L of the Code, as an investment vehicle for
variable annuity and variable life insurance contracts of certain insurance
companies.)
This section is not intended to be a full discussion of present or proposed
federal income tax law and its effect on the Fund and investors. (See the SAI
for a further discussion.) Investors are urged to consult their own tax adviser.
ORGANIZATION. The Fund is a series of common stock of the Corporation, which
is a Wisconsin corporation. The Corporation is authorized to issue an indefinite
number of shares of common stock and series and classes of series of shares of
common stock. All holders of shares of the Corporation would vote on each matter
presented to shareholders for action except with respect to any matter which
affects only one or more series or classes, in which case only the shares of the
affected series or class shall be entitled to vote.
---------------------
PROSPECTUS PAGE 17
<PAGE> 21
All shares participate equally in dividends and other capital gains
distributions by the Fund and in the residual assets of the Fund in the event of
liquidation. Generally, the Corporation will not hold an annual meeting of
shareholders unless required by the 1940 Act.
The insurance company separate accounts, as the record shareholders in the
Fund, have the right to vote on matters submitted for a shareholder vote. Under
current interpretations of the 1940 Act, these insurance companies must solicit
voting instructions from contract owners and vote Fund shares in accordance with
the instructions received or, for Fund shares for which no voting instructions
were received, in the same proportion as those Fund shares for which
instructions were received. Contract owners should refer to the prospectus of
the insurance company's separate account for a complete description of their
voting rights.
TRANSFER AGENT, DIVIDEND-DISBURSING AGENT, AND DISTRIBUTOR. The Advisor, P.O.
Box 2936, Milwaukee, Wisconsin 53201, acts as transfer agent and
dividend-disbursing agent for the Fund. Strong Funds Distributors, Inc., P.O.
Box 2936, Milwaukee, Wisconsin 53201, an indirect subsidiary of the Advisor,
acts as distributor of the shares of the Fund.
PERFORMANCE INFORMATION. The Fund may advertise a variety of types of
performance information, including "average annual total return," "total
return," and "cumulative total return." Each of these figures is based upon
historical results and does not represent the future performance of the Fund.
Average annual total return and total return figures measure both the net
investment income generated by, and the effect of any realized and unrealized
appreciation or depreciation of, the underlying investments in the Fund assuming
the reinvestment of all dividends and distributions. Total return figures are
not annualized and simply represent the aggregate change of the Fund's
investments over a specified period of time.
The Fund's shares are sold at the net asset value per share of the Fund.
Returns and net asset value will fluctuate. Shares of the Fund are redeemable by
the separate accounts of insurance companies at the then current net asset value
per share for the Fund, which may be more or less than the original cost. TOTAL
RETURNS CONTAINED IN ADVERTISEMENTS INCLUDE THE EFFECT OF DEDUCTING THE FUND'S
EXPENSES, BUT MAY NOT INCLUDE CHARGES AND EXPENSES ATTRIBUTABLE TO ANY
PARTICULAR INSURANCE PRODUCT. SINCE SHARES MAY ONLY BE PURCHASED BY THE SEPARATE
ACCOUNTS OF CERTAIN INSURANCE COMPANIES, CONTRACT OWNERS SHOULD CAREFULLY REVIEW
THE PROSPECTUS OF THE SEPARATE ACCOUNT FOR INFORMATION ON FEES AND EXPENSES.
Excluding such fees and expenses from the Fund's total return quotations has the
effect of increasing the performance quoted. The Fund will not use information
concerning its investment performance in advertisements or sales materials
unless appropriate information concerning the relevant separate account is also
included. Additional information concerning the Fund's performance appears in
the SAI.
---------------------
PROSPECTUS PAGE 18
<PAGE> 22
NOTES
---------------------
<PAGE> 23
NOTES
---------------------
<PAGE> 24
STATEMENT OF ADDITIONAL INFORMATION
STRONG DISCOVERY FUND II
P.O. Box 2936
Milwaukee, Wisconsin 53201
Toll-Free: (800) 368-1683
Strong Discovery Fund II (the "Fund") is a diversified series of the
Strong Variable Insurance Funds, Inc. (the "Corporation"), an open-end
management investment company designed to provide an investment vehicle for
variable annuity and variable life insurance contracts of certain insurance
companies. Shares in the Fund are only offered and sold to the separate
accounts of such insurance companies. The Fund is described herein and in the
Prospectus for the Fund dated May 1, 1997.
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the Prospectus for the Fund dated May 1, 1997 and the
prospectus for the separate account of the specific insurance product.
Requests for copies of the Fund's Prospectus may be made by calling one of the
numbers listed above. The financial statements appearing in the Fund's Annual
Report, which accompanies this Statement of Additional Information, are
incorporated herein by reference.
This Statement of Additional Information is dated May 1, 1997.
<PAGE> 25
STRONG DISCOVERY FUND II
<TABLE>
<S> <C>
TABLE OF CONTENTS PAGE
INVESTMENT RESTRICTIONS...................................... 3
INVESTMENT POLICIES AND TECHNIQUES........................... 4
Borrowing.................................................. 5
Convertible Securities..................................... 5
Debt Obligations........................................... 5
Depositary Receipts........................................ 6
Derivative Instruments..................................... 7
Foreign Investment Companies.............................. 16
Foreign Securities........................................ 16
High-Yield (High-Risk) Securities......................... 17
Illiquid Securities....................................... 18
Lending of Portfolio Securities........................... 19
Mortgage- and Asset-Backed Securities..................... 19
Mortgage Dollar Rolls and Reverse Repurchase Agreements... 20
Repurchase Agreements..................................... 21
Short Sales Against the Box............................... 21
Small and Medium Companies................................ 21
Temporary Defensive Position.............................. 22
Warrants.................................................. 22
When-Issued Securities.................................... 22
Zero-Coupon, Step-Coupon and Pay-in-Kind Securities....... 22
DIRECTORS AND OFFICERS OF THE CORPORATION................... 23
PRINCIPAL SHAREHOLDERS...................................... 25
INVESTMENT ADVISOR AND DISTRIBUTOR.......................... 26
PORTFOLIO TRANSACTIONS AND BROKERAGE........................ 28
CUSTODIAN................................................... 30
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT................ 31
ADMINISTRATIVE SERVICES..................................... 31
TAXES....................................................... 31
DETERMINATION OF NET ASSET VALUE............................ 33
FUND ORGANIZATION........................................... 34
PERFORMANCE INFORMATION..................................... 34
GENERAL INFORMATION......................................... 38
PORTFOLIO MANAGEMENT........................................ 39
INDEPENDENT ACCOUNTANTS..................................... 40
LEGAL COUNSEL............................................... 40
FINANCIAL STATEMENTS........................................ 40
APPENDIX................................................... A-1
</TABLE>
______________________________
No person has been authorized to give any information or to make any
representations other than those contained in this Statement of Additional
Information and the Prospectus dated May 1, 1997 and, if given or made, such
information or representations may not be relied upon as having been authorized
by the Fund.
This Statement of Additional Information does not constitute an offer to sell
securities.
2
<PAGE> 26
INVESTMENT RESTRICTIONS
The investment objective of the Fund is to seek capital growth. The
Fund's investment objective and policies are described in detail in the
Prospectus under the caption "Investment Objective and Policies." The
following are the Fund's fundamental investment limitations which cannot be
changed without shareholder approval.
The Fund:
1. May not with respect to 75% of its total assets, purchase the securities
of any issuer (except securities issued or guaranteed by the U.S.
government or its agencies or instrumentalities) if, as a result, (i) more
than 5% of the Fund's total assets would be invested in the securities of
that issuer, or (ii) the Fund would hold more than 10% of the outstanding
voting securities of that issuer.
2. May (i) borrow money from banks and (ii) make other investments or engage
in other transactions permissible under the Investment Company Act of 1940
(the "1940 Act") which may involve a borrowing, provided that the
combination of (i) and (ii) shall not exceed 33 1/3% of the value of the
Fund's total assets (including the amount borrowed), less the Fund's
liabilities (other than borrowings), except that the Fund may borrow up to
an additional 5% of its total assets (not including the amount borrowed)
from a bank for temporary or emergency purposes (but not for leverage or
the purchase of investments). The Fund may also borrow money from the
other Strong Funds or other persons to the extent permitted by applicable
law.
3. May not issue senior securities, except as permitted under the 1940 Act.
4. May not act as an underwriter of another issuer's securities, except to
the extent that the Fund may be deemed to be an underwriter within the
meaning of the Securities Act of 1933 in connection with the purchase and
sale of portfolio securities.
5. May not purchase or sell physical commodities unless acquired as a result
of ownership of securities or other instruments (but this shall not
prevent the Fund from purchasing or selling options, futures contracts, or
other derivative instruments, or from investing in securities or other
instruments backed by physical commodities).
6. May not make loans if, as a result, more than 33 1/3% of the Fund's total
assets would be lent to other persons, except through (i) purchases of
debt securities or other debt instruments, or (ii) engaging in repurchase
agreements.
7. May not purchase the securities of any issuer if, as a result, more than
25% of the Fund's total assets would be invested in the securities of
issuers, the principal business activities of which are in the same
industry.
8. May not purchase or sell real estate unless acquired as a result of
ownership of securities or other instruments (but this shall not prohibit
the Fund from purchasing or selling securities or other instruments backed
by real estate or of issuers engaged in real estate activities).
9. May, notwithstanding any other fundamental investment policy or
restriction, invest all of its assets in the securities of a single
open-end management investment company with substantially the same
fundamental investment objective, policies, and restrictions as the Fund.
3
<PAGE> 27
The following are the Fund's non-fundamental operating policies which may
be changed by the Board of Directors of the Corporation without shareholder
approval.
The Fund may not:
1. Sell securities short, unless the Fund owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short, or
unless it covers such short sale as required by the current rules and
positions of the Securities and Exchange Commission or its staff, and
provided that transactions in options, futures contracts, options on
futures contracts, or other derivative instruments are not deemed to
constitute selling securities short.
2. Purchase securities on margin, except that the Fund may obtain such
short-term credits as are necessary for the clearance of transactions; and
provided that margin deposits in connection with futures contracts,
options on futures contracts, or other derivative instruments shall not
constitute purchasing securities on margin.
3. Invest in illiquid securities if, as a result of such investment, more
than 15% of its net assets would be invested in illiquid securities, or
such other amounts as may be permitted under the 1940 Act.
4. Purchase securities of other investment companies except in compliance
with the 1940 Act and applicable state law.
5. Invest all of its assets in the securities of a single open-end
investment management company with substantially the same fundamental
investment objective, restrictions and policies as the Fund.
6. Engage in futures or options on futures transactions which are
impermissible pursuant to Rule 4.5 under the Commodity Exchange Act and,
in accordance with Rule 4.5, will use futures or options on futures
transactions solely for bona fide hedging transactions (within the meaning
of the Commodity Exchange Act), provided, however, that the Fund may, in
addition to bona fide hedging transactions, use futures and options on
futures transactions if the aggregate initial margin and premiums required
to establish such positions, less the amount by which any such options
positions are in the money (within the meaning of the Commodity Exchange
Act), do not exceed 5% of the Fund's net assets.
7. Borrow money except (i) from banks or (ii) through reverse repurchase
agreements or mortgage dollar rolls, and will not purchase securities when
bank borrowings exceed 5% of its total assets.
8. Make any loans other than loans of portfolio securities, except through
(i) purchases of debt securities or other debt instruments, or (ii)
engaging in repurchase agreements.
Except for the fundamental investment limitations listed above and the
Fund's investment objective, the other investment policies described in the
Prospectus and this Statement of Additional Information are not fundamental and
may be changed with approval of the Corporation's Board of Directors. Unless
noted otherwise, if a percentage restriction is adhered to at the time of
investment, a later increase or decrease in percentage resulting from a change
in the Fund's assets (i.e., due to cash inflows or redemptions) or in market
value of the investment or the Fund's assets will not constitute a violation of
that restriction.
INVESTMENT POLICIES AND TECHNIQUES
The following information supplements the discussion of the Fund's
investment objective, policies, and techniques that are described in detail in
the Prospectus under the captions "Investment Objective and Policies" and
"Implementation of Policies and Risks."
4
<PAGE> 28
BORROWING
The Fund may borrow money from banks and make other investments or engage
in other transactions permissible under the 1940 Act which may be considered a
borrowing (such as mortgage dollar rolls and reverse repurchase agreements) as
discussed under "Investment Restrictions." However, the Fund may not purchase
securities when bank borrowings exceed 5% of the Fund's total assets.
Presently, the Fund only intends to borrow from banks for temporary or
emergency purposes.
The Fund has established a line-of-credit (LOC) with certain banks by
which they may borrow funds for temporary or emergency purposes. A borrowing
is presumed to be for temporary or emergency purposes if it is repaid by the
Fund within sixty days and is not extended or renewed. The Fund intends to use
the LOC to meet large or unexpected redemptions that would otherwise force the
Fund to liquidate securities under circumstances which are unfavorable to the
Fund's remaining shareholders. The Fund pays a commitment fee to the banks for
the LOC.
CONVERTIBLE SECURITIES
The Fund may invest in convertible securities, which are bonds,
debentures, notes, preferred stocks, or other securities that may be converted
into or exchanged for a specified amount of common stock of the same or a
different issuer within a particular period of time at a specified price or
formula. A convertible security entitles the holder to receive interest
normally paid or accrued on debt or the dividend paid on preferred stock until
the convertible security matures or is redeemed, converted, or exchanged.
Convertible securities have unique investment characteristics in that they
generally (i) have higher yields than common stocks, but lower yields than
comparable non-convertible securities, (ii) are less subject to fluctuation in
value than the underlying stock since they have fixed income characteristics,
and (iii) provide the potential for capital appreciation if the market price of
the underlying common stock increases. Most convertible securities currently
are issued by U.S. companies, although a substantial Eurodollar convertible
securities market has developed, and the markets for convertible securities
denominated in local currencies are increasing.
The value of a convertible security is a function of its "investment
value" (determined by its yield in comparison with the yields of other
securities of comparable maturity and quality that do not have a conversion
privilege) and its "conversion value" (the security's worth, at market value,
if converted into the underlying common stock). The investment value of a
convertible security is influenced by changes in interest rates, with
investment value declining as interest rates increase and increasing as
interest rates decline. The credit standing of the issuer and other factors
also may have an effect on the convertible security's investment value. The
conversion value of a convertible security is determined by the market price of
the underlying common stock. If the conversion value is low relative to the
investment value, the price of the convertible security is governed principally
by its investment value. Generally, the conversion value decreases as the
convertible security approaches maturity. To the extent the market price of
the underlying common stock approaches or exceeds the conversion price, the
price of the convertible security will be increasingly influenced by its
conversion value. A convertible security generally will sell at a premium over
its conversion value by the extent to which investors place value on the right
to acquire the underlying common stock while holding a fixed income security.
A convertible security may be subject to redemption at the option of the
issuer at a price established in the convertible security's governing
instrument. If a convertible security held by the Fund is called for
redemption, the Fund will be required to permit the issuer to redeem the
security, convert it into the underlying common stock, or sell it to a third
party.
DEBT OBLIGATIONS
The Fund may invest a portion of its assets in debt obligations. Issuers
of debt obligations have a contractual obligation to pay interest at a
specified rate on specified dates and to repay principal on a specified
maturity date. Certain debt obligations (usually intermediate- and long-term
bonds) have provisions that allow the issuer to redeem or "call" a bond before
its maturity. Issuers are most likely to call such securities during periods
of falling interest rates and the Fund may have to replace such securities with
lower yielding securities, which could result in a lower return for the Fund.
5
<PAGE> 29
PRICE VOLATILITY. The market value of debt obligations is affected
primarily by changes in prevailing interest rates. The market value of a debt
obligation generally reacts inversely to interest-rate changes, meaning, when
prevailing interest rates decline, an obligation's price usually rises, and
when prevailing interest rates rise, an obligation's price usually declines.
MATURITY. In general, the longer the maturity of a debt obligation, the
higher its yield and the greater its sensitivity to changes in interest rates.
Conversely, the shorter the maturity, the lower the yield but the greater the
price stability. Commercial paper is generally considered the shortest form of
debt obligation.
CREDIT QUALITY. The values of debt obligations may also be affected by
changes in the credit rating or financial condition of their issuers.
Generally, the lower the quality rating of a security, the higher the degree of
risk as to the payment of interest and return of principal. To compensate
investors for taking on such increased risk, those issuers deemed to be less
creditworthy generally must offer their investors higher interest rates than do
issuers with better credit ratings.
In conducting its credit research and analysis, the Advisor considers both
qualitative and quantitative factors to evaluate the creditworthiness of
individual issuers. The Advisor also relies, in part, on credit ratings
compiled by a number of Nationally Recognized Statistical Rating Organizations
("NRSROs"). Refer to the Appendix for a discussion of securities ratings.
DEPOSITARY RECEIPTS
The Fund may invest in foreign securities by purchasing depositary
receipts, including American Depositary Receipts ("ADRs") and European
Depositary Receipts ("EDRs"), or other securities convertible into securities
of foreign issuers. These securities may not necessarily be denominated in the
same currency as the securities into which they may be converted. Generally,
ADRs, in registered form, are denominated in U.S. dollars and are designed for
use in the U.S. securities markets, while EDRs, in bearer form, may be
denominated in other currencies and are designed for use in the European
securities markets. ADRs are receipts typically issued by a U.S. bank or
trust company evidencing ownership of the underlying securities. EDRs are
European receipts evidencing a similar arrangement. For purposes of the Fund's
investment policies, ADRs and EDRs are deemed to have the same classification
as the underlying securities they represent, except that ADRs and EDRs shall be
treated as indirect foreign investments. Thus, an ADR or EDR representing
ownership of common stock will be treated as common stock. ADR and EDR
depositary receipts do not eliminate all of the risks associated with directly
investing in the securities of foreign issuers.
ADR facilities may be established as either "unsponsored" or "sponsored."
While ADRs issued under these two types of facilities are in some respects
similar, there are distinctions between them relating to the rights and
obligations of ADR holders and the practices of market participants.
A depositary may establish an unsponsored facility without participation
by (or even necessarily the acquiescence of) the issuer of the deposited
securities, although typically the depositary requests a letter of
non-objection from such issuer prior to the establishment of the facility.
Holders of unsponsored ADRs generally bear all the costs of such facilities.
The depositary usually charges fees upon the deposit and withdrawal of the
deposited securities, the conversion of dividends into U.S. dollars, the
disposition of non-cash distributions, and the performance of other services.
The depositary of an unsponsored facility frequently is under no obligation to
pass through voting rights to ADR holders in respect of the deposited
securities. In addition, an unsponsored facility is generally not obligated to
distribute communications received from the issuer of the deposited securities
or to disclose material information about such issuer in the U.S. and thus
there may not be a correlation between such information and the market value of
the depositary receipts.
Sponsored ADR facilities are created in generally the same manner as
unsponsored facilities, except that the issuer of the deposited securities
enters into a deposit agreement with the depositary. The deposit agreement
sets out the rights and responsibilities of the issuer, the depositary, and the
ADR holders. With sponsored facilities, the issuer of the deposited securities
generally will bear some of the costs relating to the facility (such as
dividend payment fees of the depositary), although ADR holders continue to bear
certain other costs (such as deposit and withdrawal fees). Under the terms of
most sponsored arrangements, depositories agree to distribute notices of
shareholder meetings and voting instructions, and to provide shareholder
communications and other information to the ADR holders at the request of the
issuer of the deposited securities.
6
<PAGE> 30
DERIVATIVE INSTRUMENTS
IN GENERAL. The Fund may use derivative instruments for any lawful
purpose consistent with the Fund's investment objective such as hedging or
managing risk. Derivative instruments are commonly defined to include
securities or contracts whose values depend on (or "derive" from) the value of
one or more other assets, such as securities, currencies, or commodities.
These "other assets" are commonly referred to as "underlying assets."
A derivative instrument generally consists of, is based upon, or exhibits
characteristics similar to options or forward contracts. Options and forward
contracts are considered to be the basic "building blocks" of derivatives. For
example, forward-based derivatives include forward contracts, swap contracts,
as well as exchange-traded futures. Option-based derivatives include privately
negotiated, over-the-counter (OTC) options (including caps, floors, collars,
and options on forward and swap contracts) and exchange-traded options on
futures. Diverse types of derivatives may be created by combining options or
forward contracts in different ways, and by applying these structures to a wide
range of underlying assets.
An option is a contract in which the "holder" (the buyer) pays a certain
amount (the "premium") to the "writer" (the seller) to obtain the right, but
not the obligation, to buy from the writer (in a "call") or sell to the writer
(in a "put") a specific asset at an agreed upon price at or before a certain
time. The holder pays the premium at inception and has no further financial
obligation. The holder of an option-based derivative generally will benefit
from favorable movements in the price of the underlying asset but is not
exposed to corresponding losses due to adverse movements in the value of the
underlying asset. The writer of an option-based derivative generally will
receive fees or premiums but generally is exposed to losses due to changes in
the value of the underlying asset.
A forward is a sales contract between a buyer (holding the "long"
position) and a seller (holding the "short" position) for an asset with
delivery deferred until a future date. The buyer agrees to pay a fixed price
at the agreed future date and the seller agrees to deliver the asset. The
seller hopes that the market price on the delivery date is less than the agreed
upon price, while the buyer hopes for the contrary. The change in value of a
forward-based derivative generally is roughly proportional to the change in
value of the underlying asset.
HEDGING. The Fund may use derivative instruments to protect against
possible adverse changes in the market value of securities held in, or are
anticipated to be held in, the Fund's portfolio. Derivatives may also be used
by the Fund to "lock-in" the Fund's realized but unrecognized gains in the
value of its portfolio securities. Hedging strategies, if successful, can
reduce the risk of loss by wholly or partially offsetting the negative effect
of unfavorable price movements in the investments being hedged. However,
hedging strategies can also reduce the opportunity for gain by offsetting the
positive effect of favorable price movements in the hedged investments.
MANAGING RISK. The Fund may also use derivative instruments to manage the
risks of the Fund's portfolio. Risk management strategies include, but are not
limited to, facilitating the sale of portfolio securities, managing the
effective maturity or duration of debt obligations in the Fund's portfolio,
establishing a position in the derivatives markets as a substitute for buying
or selling certain securities, or creating or altering exposure to certain
asset classes, such as equity, debt, and foreign securities. The use of
derivative instruments may provide a less expensive, more expedient or more
specifically focused way for the Fund to invest than "traditional" securities
(i.e., stocks or bonds) would.
EXCHANGE OR OTC DERIVATIVES. Derivative instruments may be
exchange-traded or traded in OTC transactions between private parties.
Exchange-traded derivatives are standardized options and futures contracts
traded in an auction on the floor of a regulated exchange. Exchange contracts
are generally very liquid. The exchange clearinghouse is the counterparty of
every contract. Thus, each holder of an exchange contract bears the credit
risk of the clearinghouse (and has the benefit of its financial strength)
rather than that of a particular counterparty. Over-the-counter transactions
are subject to additional risks, such as the credit risk of the counterparty to
the instrument and are less liquid than exchange-traded derivatives since they
often can only be closed out with the other party to the transaction.
7
<PAGE> 31
RISKS AND SPECIAL CONSIDERATIONS. The use of derivative instruments
involves risks and special considerations as described below. Risks pertaining
to particular derivative instruments are described in the sections that follow.
(1) MARKET RISK. The primary risk of derivatives is the same as the risk
of the underlying assets, namely that the value of the underlying asset may go
up or down. Adverse movements in the value of an underlying asset can expose
the Fund to losses. Derivative instruments may include elements of leverage
and, accordingly, the fluctuation of the value of the derivative instrument in
relation to the underlying asset may be magnified. The successful use of
derivative instruments depends upon a variety of factors, particularly Strong
Capital Management, Inc.'s (the "Advisor") ability to predict movements of the
securities, currencies, and commodity markets, which requires different skills
than predicting changes in the prices of individual securities. There can be
no assurance that any particular strategy adopted will succeed. The Advisor's
decision to engage in a derivative instrument will reflect the Advisor's
judgment that the derivative transaction will provide value to the Fund and its
shareholders and is consistent with the Fund's objectives, investment
limitations, and operating policies. In making such a judgment, the Advisor
will analyze the benefits and risks of the derivative transaction and weigh
them in the context of the Fund's entire portfolio and investment objective.
(2) CREDIT RISK. The Fund will be subject to the risk that a loss may be
sustained by the Fund as a result of the failure of a counterparty to comply
with the terms of a derivative instrument. The counterparty risk for
exchange-traded derivative instruments is generally less than for
privately-negotiated or OTC derivative instruments, since generally a clearing
agency, which is the issuer or counterparty to each exchange-traded instrument,
provides a guarantee of performance. For privately-negotiated instruments,
there is no similar clearing agency guarantee. In all transactions, the Fund
will bear the risk that the counterparty will default, and this could result in
a loss of the expected benefit of the derivative transaction and possibly other
losses to the Fund. The Fund will enter into transactions in derivative
instruments only with counterparties that the Advisor reasonably believes are
capable of performing under the contract.
(3) CORRELATION RISK. When a derivative transaction is used to completely
hedge another position, changes in the market value of the combined position
(the derivative instrument plus the position being hedged) result from an
imperfect correlation between the price movements of the two instruments. With
a perfect hedge, the value of the combined position remains unchanged for any
change in the price of the underlying asset. With an imperfect hedge, the
values of the derivative instrument and its hedge are not perfectly correlated.
Correlation risk is the risk that there might be imperfect correlation, or
even no correlation, between price movements of an instrument and price
movements of investments being hedged. For example, if the value of a
derivative instruments used in a short hedge (such as writing a call option,
buying a put option, or selling a futures contract) increased by less than the
decline in value of the hedged investments, the hedge would not be perfectly
correlated. Such a lack of correlation might occur due to factors unrelated to
the value of the investments being hedged, such as speculative or other
pressures on the markets in which these instruments are traded. The
effectiveness of hedges using instruments on indices will depend, in part, on
the degree of correlation between price movements in the index and price
movements in the investments being hedged.
(4) LIQUIDITY RISK. Derivatives are also subject to liquidity risk.
Liquidity risk is the risk that a derivative instrument cannot be sold, closed
out, or replaced quickly at or very close to its fundamental value. Generally,
exchange contracts are very liquid because the exchange clearinghouse is the
counterparty of every contract. OTC transactions are less liquid than
exchange-traded derivatives since they often can only be closed out with the
other party to the transaction. The Fund might be required by applicable
regulatory requirement to maintain assets as "cover," maintain segregated
accounts, and/or make margin payments when it takes positions in derivative
instruments involving obligations to third parties (i.e., instruments other
than purchased options). If the Fund was unable to close out its positions in
such instruments, it might be required to continue to maintain such assets or
accounts or make such payments until the position expired, matured, or was
closed out. The requirements might impair the Fund's ability to sell a
portfolio security or make an investment at a time when it would otherwise be
favorable to do so, or require that the Fund sell a portfolio security at a
disadvantageous time. The Fund's ability to sell or close out a position in an
instrument prior to expiration or maturity depends on the existence of a liquid
secondary market or, in the absence of such a market, the ability and
willingness of the counterparty to enter into a transaction closing out the
position. Therefore, there is no assurance that any derivatives position can
be sold or closed out at a time and price that is favorable to the Fund.
8
<PAGE> 32
(5) LEGAL RISK. Legal risk is the risk of loss caused by the legal
unenforcibility of a party's obligations under the derivative. While a party
seeking price certainty agrees to surrender the potential upside in exchange
for downside protection, the party taking the risk is looking for a positive
payoff. Despite this voluntary assumption of risk, a counterparty that has
lost money in a derivative transaction may try to avoid payment by exploiting
various legal uncertainties about certain derivative products.
(6) SYSTEMIC OR "INTERCONNECTION" RISK. Interconnection risk is the risk
that a disruption in the financial markets will cause difficulties for all
market participants. In other words, a disruption in one market will spill
over into other markets, perhaps creating a chain reaction. Much of the OTC
derivatives market takes place among the OTC dealers themselves, thus creating
a large interconnected web of financial obligations. This interconnectedness
raises the possibility that a default by one large dealer could create losses
at other dealers and destabilize the entire market for OTC derivative
instruments.
GENERAL LIMITATIONS. The use of derivative instruments is subject to
applicable regulations of the Securities and Exchange Commission (the "SEC"),
the several options and futures exchanges upon which they may be traded, the
Commodity Futures Trading Commission ("CFTC"), and various state regulatory
authorities. In addition, the Fund's ability to use derivative instruments may
be limited by certain tax considerations. For a discussion of the federal
income tax treatment of the Fund's derivative instruments, see "Taxes -
Derivative Instruments."
The Fund has filed a notice of eligibility for exclusion from the
definition of the term "commodity pool operator" with the CFTC and the National
Futures Association, which regulate trading in the futures markets. In
accordance with Rule 4.5 of the regulations under the Commodity Exchange Act
(the "CEA"), the notice of eligibility for the Fund includes representations
that the Fund will use futures contracts and related options solely for bona
fide hedging purposes within the meaning of CFTC regulations, provided that the
Fund may hold other positions in futures contracts and related options that do
not qualify as a bona fide hedging position if the aggregate initial margin
deposits and premiums required to establish these positions, less the amount by
which any such futures contracts and related options positions are "in the
money," do not exceed 5% of the Fund's net assets. Adherence to these
guidelines does not limit the Fund's risk to 5% of the Fund's assets.
The SEC has identified certain trading practices involving derivative
instruments that involve the potential for leveraging the Fund's assets in a
manner that raises issues under the 1940 Act. In order to limit the potential
for the leveraging of the Fund's assets, as defined under the 1940 Act, the SEC
has stated that the Fund may use coverage or the segregation of the Fund's
assets. To the extent required by SEC guidelines, the Fund will not enter into
any such transactions unless it owns either: (i) an offsetting ("covered")
position in securities, options, futures, or derivative instruments; or (ii)
cash or liquid securities positions with a value sufficient at all times to
cover its potential obligations to the extent that the position is not
"covered". The Fund will also set aside cash and/or appropriate liquid assets
in a segregated custodial account if required to do so by the SEC and CFTC
regulations. Assets used as cover or held in a segregated account cannot be
sold while the derivative position is open, unless they are replaced with
similar assets. As a result, the commitment of a large portion of the Fund's
assets to segregated accounts could impede portfolio management or the Fund's
ability to meet redemption requests or other current obligations.
In some cases the Fund may be required to maintain or limit exposure to a
specified percentage of its assets to a particular asset class. In such cases,
when the Fund uses a derivative instrument to increase or decrease exposure to
an asset class and is required by applicable SEC guidelines to set aside liquid
assets in a segregated account to secure its obligations under the derivative
instruments, the Advisor may, where reasonable in light of the circumstances,
measure compliance with the applicable percentage by reference to the nature of
the economic exposure created through the use of the derivative instrument and
not by reference to the nature of the exposure arising from the liquid assets
set aside in the segregated account (unless another interpretation is specified
by applicable regulatory requirements).
OPTIONS. The Fund may use options for any lawful purpose consistent with
the Fund's investment objective such as hedging or managing risk. An option is
a contract in which the "holder" (the buyer) pays a certain amount (the
"premium") to the "writer" (the seller) to obtain the right, but not the
obligation, to buy from the writer (in a "call") or sell to the writer (in a
"put") a specific asset at an agreed upon price (the "strike price" or
"exercise price") at or before a certain time (the "expiration
9
<PAGE> 33
date"). The holder pays the premium at inception and has no further financial
obligation. The holder of an option will benefit from favorable movements in
the price of the underlying asset but is not exposed to corresponding losses
due to adverse movements in the value of the underlying asset. The writer of
an option will receive fees or premiums but is exposed to losses due to changes
in the value of the underlying asset. The Fund may buy or write (sell) put and
call options on assets, such as securities, currencies, commodities, and
indices of debt and equity securities ("underlying assets") and enter into
closing transactions with respect to such options to terminate an existing
position. Options used by the Fund may include European, American, and Bermuda
style options. If an option is exercisable only at maturity, it is a
"European" option; if it is also exercisable prior to maturity, it is an
"American" option. If it is exercisable only at certain times, it is a
"Bermuda" option.
The Fund may purchase (buy) and write (sell) put and call options
underlying assets and enter into closing transactions with respect to such
options to terminate an existing position. The purchase of call options serves
as a long hedge, and the purchase of put options serves as a short hedge.
Writing put or call options can enable the Fund to enhance income by reason of
the premiums paid by the purchaser of such options. Writing call options
serves as a limited short hedge because declines in the value of the hedged
investment would be offset to the extent of the premium received for writing
the option. However, if the security appreciates to a price higher than the
exercise price of the call option, it can be expected that the option will be
exercised and the Fund will be obligated to sell the security at less than its
market value or will be obligated to purchase the security at a price greater
than that at which the security must be sold under the option. All or a
portion of any assets used as cover for OTC options written by the Fund would
be considered illiquid to the extent described under "Investment Policies and
Techniques -- Illiquid Securities." Writing put options serves as a limited
long hedge because increases in the value of the hedged investment would be
offset to the extent of the premium received for writing the option. However,
if the security depreciates to a price lower than the exercise price of the put
option, it can be expected that the put option will be exercised and the Fund
will be obligated to purchase the security at more than its market value.
The value of an option position will reflect, among other things, the
historical price volatility of the underlying investment, the current market
value of the underlying investment, the time remaining until expiration, the
relationship of the exercise price to the market price of the underlying
investment, and general market conditions.
The Fund may effectively terminate its right or obligation under an option
by entering into a closing transaction. For example, the Fund may terminate
its obligation under a call or put option that it had written by purchasing an
identical call or put option; this is known as a closing purchase transaction.
Conversely, the Fund may terminate a position in a put or call option it had
purchased by writing an identical put or call option; this is known as a
closing sale transaction. Closing transactions permit the Fund to realize the
profit or limit the loss on an option position prior to its exercise or
expiration.
The Fund may purchase or write both exchange-traded and OTC options.
Exchange-traded options are issued by a clearing organization affiliated with
the exchange on which the option is listed that, in effect, guarantees
completion of every exchange-traded option transaction. In contrast, OTC
options are contracts between the Fund and the other party to the transaction
("counter party") (usually a securities dealer or a bank) with no clearing
organization guarantee. Thus, when the Fund purchases or writes an OTC option,
it relies on the counter party to make or take delivery of the underlying
investment upon exercise of the option. Failure by the counter party to do so
would result in the loss of any premium paid by the Fund as well as the loss of
any expected benefit of the transaction.
The Fund's ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The Fund intends to
purchase or write only those exchange-traded options for which there appears to
be a liquid secondary market. However, there can be no assurance that such a
market will exist at any particular time. Closing transactions can be made for
OTC options only by negotiating directly with the counter party, or by a
transaction in the secondary market if any such market exists. Although the
Fund will enter into OTC options only with counter parties that are expected to
be capable of entering into closing transactions with the Fund, there is no
assurance that the Fund will in fact be able to close out an OTC option at a
favorable price prior to expiration. In the event of insolvency of the counter
party, the Fund might be unable to close out an OTC option position at any time
prior to its expiration. If the Fund were unable to effect a closing
transaction for an option it had purchased, it would have to exercise the
option to realize any profit.
The Fund may engage in options transactions on indices in much the same
manner as the options on securities discussed above, except the index options
may serve as a hedge against overall fluctuations in the securities market in
general.
10
<PAGE> 34
The writing and purchasing of options is a highly specialized activity
that involves investment techniques and risks different from those associated
with ordinary portfolio securities transactions. Imperfect correlation between
the options and securities markets may detract from the effectiveness of
attempted hedging.
SPREAD TRANSACTIONS. The Fund may use spread transactions for any lawful
purpose consistent with the Fund's investment objective such as hedging or
managing risk. The Fund may purchase covered spread options from securities
dealers. Such covered spread options are not presently exchange-listed or
exchange-traded. The purchase of a spread option gives the Fund the right to
put, or sell, a security that it owns at a fixed dollar spread or fixed yield
spread in relationship to another security that the Fund does not own, but
which is used as a benchmark. The risk to the Fund in purchasing covered
spread options is the cost of the premium paid for the spread option and any
transaction costs. In addition, there is no assurance that closing
transactions will be available. The purchase of spread options will be used to
protect the Fund against adverse changes in prevailing credit quality spreads,
i.e., the yield spread between high quality and lower quality securities. Such
protection is only provided during the life of the spread option.
FUTURES CONTRACTS. The Fund may use futures contracts for any lawful
purpose consistent with the Fund's investment objective such as hedging or
managing risk. The Fund may enter into futures contracts, including interest
rate, index, and currency futures. The Fund may also purchase put and call
options, and write covered put and call options, on futures in which it is
allowed to invest. The purchase of futures or call options thereon can serve
as a long hedge, and the sale of futures or the purchase of put options thereon
can serve as a short hedge. Writing covered call options on futures contracts
can serve as a limited short hedge, and writing covered put options on futures
contracts can serve as a limited long hedge, using a strategy similar to that
used for writing covered options in securities. The Fund's hedging may include
purchases of futures as an offset against the effect of expected increases in
currency exchange rates and securities prices and sales of futures as an offset
against the effect of expected declines in currency exchange rates and
securities prices. The Fund may also write put options on futures contracts
while at the same time purchasing call options on the same futures contracts in
order to create synthetically a long futures contract position. Such options
would have the same strike prices and expiration dates. The Fund will engage
in this strategy only when the Advisor believes it is more advantageous to the
Fund than is purchasing the futures contract.
To the extent required by regulatory authorities, the Fund only enters
into futures contracts that are traded on national futures exchanges and are
standardized as to maturity date and underlying financial instrument. Futures
exchanges and trading are regulated under the CEA by the CFTC. Although
techniques other than sales and purchases of futures contracts could be used to
reduce the Fund's exposure to market, currency, or interest rate fluctuations,
the Fund may be able to hedge its exposure more effectively and perhaps at a
lower cost through using futures contracts.
An interest rate futures contract provides for the future sale by one
party and purchase by another party of a specified amount of a specific
financial instrument (e.g., debt security) or currency for a specified price at
a designated date, time, and place. An index futures contract is an agreement
pursuant to which the parties agree to take or make delivery of an amount of
cash equal to the difference between the value of the index at the close of the
last trading day of the contract and the price at which the index futures
contract was originally written. Transaction costs are incurred when a futures
contract is bought or sold and margin deposits must be maintained. A futures
contract may be satisfied by delivery or purchase, as the case may be, of the
instrument, the currency or by payment of the change in the cash value of the
index. More commonly, futures contracts are closed out prior to delivery by
entering into an offsetting transaction in a matching futures contract.
Although the value of an index might be a function of the value of certain
specified securities, no physical delivery of those securities is made. If the
offsetting purchase price is less than the original sale price, the Fund
realizes a gain; if it is more, the Fund realizes a loss. Conversely, if the
offsetting sale price is more than the original purchase price, the Fund
realizes a gain; if it is less, the Fund realizes a loss. The transaction
costs must also be included in these calculations. There can be no assurance,
however, that the Fund will be able to enter into an offsetting transaction
with respect to a particular futures contract at a particular time. If the
Fund is not able to enter into an offsetting transaction, the Fund will
continue to be required to maintain the margin deposits on the futures
contract.
No price is paid by the Fund upon entering into a futures contract.
Instead, at the inception of a futures contract, the Fund is required to
deposit in a segregated account with its custodian, in the name of the futures
broker through whom the transaction was effected, "initial margin" consisting
of cash and/or other appropriate liquid assets in an amount generally equal to
10% or less of the contract value. Margin must also be deposited when writing
a call or put option on a futures contract, in accordance with applicable
exchange rules. Unlike margin in securities transactions, initial margin on
futures contracts does
11
<PAGE> 35
not represent a borrowing, but rather is in the nature of a performance bond or
good-faith deposit that is returned to the Fund at the termination of the
transaction if all contractual obligations have been satisfied. Under certain
circumstances, such as periods of high volatility, the Fund may be required by
an exchange to increase the level of its initial margin payment, and initial
margin requirements might be increased generally in the future by regulatory
action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of the Fund's obligations to or from a futures
broker. When the Fund purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast, when the Fund purchases
or sells a futures contract or writes a call or put option thereon, it is
subject to daily variation margin calls that could be substantial in the event
of adverse price movements. If the Fund has insufficient cash to meet daily
variation margin requirements, it might need to sell securities at a time when
such sales are disadvantageous. Purchasers and sellers of futures positions
and options on futures can enter into offsetting closing transactions by
selling or purchasing, respectively, an instrument identical to the instrument
held or written. Positions in futures and options on futures may be closed
only on an exchange or board of trade that provides a secondary market. The
Fund intends to enter into futures transactions only on exchanges or boards of
trade where there appears to be a liquid secondary market. However, there can
be no assurance that such a market will exist for a particular contract at a
particular time.
Under certain circumstances, futures exchanges may establish daily limits
on the amount that the price of a future or option on a futures contract can
vary from the previous day's settlement price; once that limit is reached, no
trades may be made that day at a price beyond the limit. Daily price limits do
not limit potential losses because prices could move to the daily limit for
several consecutive days with little or no trading, thereby preventing
liquidation of unfavorable positions.
If the Fund were unable to liquidate a futures or option on a futures
contract position due to the absence of a liquid secondary market or the
imposition of price limits, it could incur substantial losses. The Fund would
continue to be subject to market risk with respect to the position. In
addition, except in the case of purchased options, the Fund would continue to
be required to make daily variation margin payments and might be required to
maintain the position being hedged by the future or option or to maintain cash
or securities in a segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or options on futures contracts
might not correlate perfectly with movements in the prices of the investments
being hedged. For example, all participants in the futures and options on
futures contracts markets are subject to daily variation margin calls and might
be compelled to liquidate futures or options on futures contracts positions
whose prices are moving unfavorably to avoid being subject to further calls.
These liquidations could increase price volatility of the instruments and
distort the normal price relationship between the futures or options and the
investments being hedged. Also, because initial margin deposit requirements in
the futures markets are less onerous than margin requirements in the securities
markets, there might be increased participation by speculators in the future
markets. This participation also might cause temporary price distortions. In
addition, activities of large traders in both the futures and securities
markets involving arbitrage, "program trading" and other investment strategies
might result in temporary price distortions.
FOREIGN CURRENCIES. The Fund may purchase and sell foreign currency on a
spot basis, and may use currency-related derivatives instruments such as
options on foreign currencies, futures on foreign currencies, options on
futures on foreign currencies and forward currency contracts (i.e., an
obligation to purchase or sell a specific currency at a specified future date,
which may be any fixed number of days from the contract date agreed upon by the
parties, at a price set at the time the contract is entered into). The Fund
may use these instruments for hedging or any other lawful purpose consistent
with their respective investment objectives, including transaction hedging,
anticipatory hedging, cross hedging, proxy hedging, and position hedging. The
Fund's use of currency-related derivative instruments will be directly related
to the Fund's current or anticipated portfolio securities, and the Fund may
engage in transactions in currency-related derivative instruments as a means to
protect against some or all of the effects of adverse changes in foreign
currency exchange rates on their portfolio investments. In general, if the
currency in which a portfolio investment is denominated appreciates against the
U.S. dollar, the dollar value of the security will increase. Conversely, a
decline in the exchange rate of the currency would adversely affect the value
of the portfolio investment expressed in U.S. dollars.
12
<PAGE> 36
For example, the Fund might use currency-related derivative instruments to
"lock in" a U.S. dollar price for a portfolio investment, thereby enabling the
Fund to protect itself against a possible loss resulting from an adverse change
in the relationship between the U.S. dollar and the subject foreign currency
during the period between the date the security is purchased or sold and the
date on which payment is made or received. The Fund also might use
currency-related derivative instruments when the Advisor believes that one
currency may experience a substantial movement against another currency,
including the U.S. dollar, and it may use currency-related derivative
instruments to sell or buy the amount of the former foreign currency,
approximating the value of some or all of the Fund's portfolio securities
denominated in such foreign currency. Alternatively, where appropriate, the
Fund may use currency-related derivative instruments to hedge all or part of
its foreign currency exposure through the use of a basket of currencies or a
proxy currency where such currency or currencies act as an effective proxy for
other currencies. The use of this basket hedging technique may be more
efficient and economical than using separate currency-related derivative
instruments for each currency exposure held by the Fund. Furthermore,
currency-related derivative instruments may be used for short hedges - for
example, the Fund may sell a forward currency contract to lock in the U.S.
dollar equivalent of the proceeds from the anticipated sale of a security
denominated in a foreign currency.
In addition, the Fund may use a currency-related derivative instrument to
shift exposure to foreign currency fluctuations from one foreign country to
another foreign country where the Advisor believes that the foreign currency
exposure purchased will appreciate relative to the U.S. dollar and thus better
protect the Fund against the expected decline in the foreign currency exposure
sold. For example, if the Fund owns securities denominated in a foreign
currency and the Advisor believes that currency will decline, it might enter
into a forward contract to sell an appropriate amount of the first foreign
currency, with payment to be made in a second foreign currency that the Advisor
believes would better protect the Fund against the decline in the first
security than would a U.S. dollar exposure. Hedging transactions that use two
foreign currencies are sometimes referred to as "cross hedges." The effective
use of currency-related derivative instruments by the Fund in a cross hedge is
dependent upon a correlation between price movements of the two currency
instruments and the underlying security involved, and the use of two currencies
magnifies the risk that movements in the price of one instrument may not
correlate or may correlate unfavorably with the foreign currency being hedged.
Such a lack of correlation might occur due to factors unrelated to the value of
the currency instruments used or investments being hedged, such as speculative
or other pressures on the markets in which these instruments are traded.
The Fund also might seek to hedge against changes in the value of a
particular currency when no hedging instruments on that currency are available
or such hedging instruments are more expensive than certain other hedging
instruments. In such cases, the Fund may hedge against price movements in that
currency by entering into transactions using currency-related derivative
instruments on another foreign currency or a basket of currencies, the values
of which the Advisor believes will have a high degree of positive correlation
to the value of the currency being hedged. The risk that movements in the
price of the hedging instrument will not correlate perfectly with movements in
the price of the currency being hedged is magnified when this strategy is used.
The use of currency-related derivative instruments by the Fund involves a
number of risks. The value of currency-related derivative instruments depends
on the value of the underlying currency relative to the U.S. dollar. Because
foreign currency transactions occurring in the interbank market might involve
substantially larger amounts than those involved in the use of such derivative
instruments, the Fund could be disadvantaged by having to deal in the 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 (generally consisting of transactions of greater than $1 million).
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis.
Quotation information generally is representative of very large transactions in
the interbank market and thus might not reflect odd-lot transactions where
rates might be less favorable. The interbank market in foreign currencies is a
global, round-the-clock market. To the extent the U.S. options or futures
markets are closed while the markets for the underlying currencies remain open,
significant price and rate movements might take place in the underlying markets
that cannot be reflected in the markets for the derivative instruments until
they re-open.
Settlement of transactions in currency-related derivative instruments
might be required to take place within the country issuing the underlying
currency. Thus, the Fund might be required to accept or make delivery of the
underlying foreign currency in accordance with any U.S. or foreign regulations
regarding the maintenance of foreign banking
13
<PAGE> 37
arrangements by U.S. residents and might be required to pay any fees, taxes
and charges associated with such delivery assessed in the issuing country.
When the Fund engages in a transaction in a currency-related derivative
instrument, it relies on the counterparty to make or take delivery of the
underlying currency at the maturity of the contract or otherwise complete the
contract. In other words, the Fund will be subject to the risk that a loss may
be sustained by the Fund as a result of the failure of the counterparty to
comply with the terms of the transaction. The counterparty risk for
exchange-traded instruments is generally less than for privately-negotiated or
OTC currency instruments, since generally a clearing agency, which is the
issuer or counterparty to each instrument, provides a guarantee of performance.
For privately-negotiated instruments, there is no similar clearing agency
guarantee. In all transactions, the Fund will bear the risk that the
counterparty will default, and this could result in a loss of the expected
benefit of the transaction and possibly other losses to the Fund. The Fund
will enter into transactions in currency-related derivative instruments only
with counterparties that the Advisor reasonably believes are capable of
performing under the contract.
Purchasers and sellers of currency-related derivative instruments may
enter into offsetting closing transactions by selling or purchasing,
respectively, an instrument identical to the instrument purchased or sold.
Secondary markets generally do not exist for forward currency contracts, with
the result that closing transactions generally can be made for forward currency
contracts only by negotiating directly with the counterparty. Thus, there can
be no assurance that the Fund will in fact be able to close out a forward
currency contract (or any other currency-related derivative instrument) at a
time and price favorable to the Fund. In addition, in the event of insolvency
of the counterparty, the Fund might be unable to close out a forward currency
contract at any time prior to maturity. In the case of an exchange-traded
instrument, the Fund will be able to close the position out only on an exchange
which provides a market for the instruments. The ability to establish and
close out positions on an exchange is subject to the maintenance of a liquid
market, and there can be no assurance that a liquid market will exist for any
instrument at any specific time. In the case of a privately-negotiated
instrument, the Fund will be able to realize the value of the instrument only
by entering into a closing transaction with the issuer or finding a third party
buyer for the instrument. While the Fund will enter into privately-negotiated
transactions only with entities who are expected to be capable of entering into
a closing transaction, there can be no assurance that the Fund will in fact be
able to enter into such closing transactions.
The precise matching of currency-related derivative instrument amounts and
the value of the portfolio securities involved generally will not be possible
because the value of such securities, measured in the foreign currency, will
change after the currency-related derivative instrument position has been
established. Thus, the Fund might need to purchase or sell foreign currencies
in the spot (cash) market. The projection of short-term currency market
movements is extremely difficult, and the successful execution of a short-term
hedging strategy is highly uncertain.
Permissible foreign currency options will include options traded primarily
in the OTC market. Although options on foreign currencies are traded primarily
in the OTC market, the Fund will normally purchase or sell OTC options on
foreign currency only when the Advisor reasonably believes a liquid secondary
market will exist for a particular option at any specific time.
There will be a cost to the Fund of engaging in transactions in
currency-related derivative instruments that will vary with factors such as the
contract or currency involved, the length of the contract period and the market
conditions then prevailing. The Fund using these instruments may have to pay a
fee or commission or, in cases where the instruments are entered into on a
principal basis, foreign exchange dealers or other counterparties will realize
a profit based on the difference ("spread") between the prices at which they
are buying and selling various currencies. Thus, for example, a dealer may
offer to sell a foreign currency to the Fund at one rate, while offering a
lesser rate of exchange should the Fund desire to resell that currency to the
dealer.
When required by the SEC guidelines, the Fund will set aside permissible
liquid assets in segregated accounts or otherwise cover their respective
potential obligations under currency-related derivatives instruments. To the
extent the Fund's assets are so set aside, they cannot be sold while the
corresponding currency position is open, unless they are replaced with similar
assets. As a result, if a large portion of the Fund's assets are so set aside,
this could impede portfolio management or the Fund's ability to meet redemption
requests or other current obligations.
14
<PAGE> 38
The Advisor's decision to engage in a transaction in a particular
currency-related derivative instrument will reflect the Advisor's judgment that
the transaction will provide value to the Fund and its shareholders and is
consistent with the Fund's objectives and policies. In making such a judgment,
the Advisor will analyze the benefits and risks of the transaction and weigh
them in the context of the Fund's entire portfolio and objectives. The
effectiveness of any transaction in a currency-related derivative instrument is
dependent on a variety of factors, including the Advisor's skill in analyzing
and predicting currency values and upon a correlation between price movements
of the currency instrument and the underlying security. There might be
imperfect correlation, or even no correlation, between price movements of an
instrument and price movements of investments being hedged. Such a lack of
correlation might occur due to factors unrelated to the value of the
investments being hedged, such as speculative or other pressures on the markets
in which these instruments are traded. In addition, the Fund's use of
currency-related derivative instruments is always subject to the risk that the
currency in question could be devalued by the foreign government. In such a
case, any long currency positions would decline in value and could adversely
affect any hedging position maintained by the Fund.
The Fund's dealing in currency-related derivative instruments will
generally be limited to the transactions described above. However, the Fund
reserves the right to use currency-related derivatives instruments for
different purposes and under different circumstances. Of course, the Fund is
not required to use currency-related derivatives instruments and will not do so
unless deemed appropriate by the Advisor. It also should be realized that use
of these instruments does not eliminate, or protect against, price movements in
the Fund's securities that are attributable to other (i.e., non-currency
related) causes. Moreover, while the use of currency-related derivatives
instruments may reduce the risk of loss due to a decline in the value of a
hedged currency, at the same time the use of these instruments tends to limit
any potential gain which may result from an increase in the value of that
currency.
SWAP AGREEMENTS. The Fund may enter into interest rate, securities index,
commodity, or security and currency exchange rate swap agreements for any
lawful purpose consistent with the Fund's investment objective, such as for the
purpose of attempting to obtain or preserve a particular desired return or
spread at a lower cost to the Fund than if the Fund had invested directly in an
instrument that yielded that desired return or spread. The Fund also may enter
into swaps in order to protect against an increase in the price of, or the
currency exchange rate applicable to, securities that the Fund anticipates
purchasing at a later date. Swap agreements are two-party contracts entered
into primarily by institutional investors for periods ranging from a few weeks
to several years. In a standard "swap" transaction, two parties agree to
exchange the returns (or differentials in rates of return) earned or realized
on particular predetermined investments or instruments. The gross returns to
be exchanged or "swapped" between the parties are calculated with respect to a
"notional amount," i.e., the return on or increase in value of a particular
dollar amount invested at a particular interest rate, in a particular foreign
currency, or in a "basket" of securities representing a particular index. Swap
agreements may include interest rate caps, under which, in return for a
premium, one party agrees to make payments to the other to the extent that
interest rates exceed a specified rate, or "cap;" interest rate floors, under
which, in return for a premium, one party agrees to make payments to the other
to the extent that interest rates fall below a specified level, or "floor;" and
interest rate collars, under which a party sells a cap and purchases a floor,
or vice versa, in an attempt to protect itself against interest rate movements
exceeding given minimum or maximum levels.
The "notional amount" of the swap agreement is the agreed upon basis for
calculating the obligations that the parties to a swap agreement have agreed to
exchange. Under most swap agreements entered into by the Fund, the obligations
of the parties would be exchanged on a "net basis." Consequently, the Fund's
obligation (or rights) under a swap agreement will generally be equal only to
the net amount to be paid or received under the agreement based on the relative
values of the positions held by each party to the agreement (the "net amount").
The Fund's obligation under a swap agreement will be accrued daily (offset
against amounts owed to the Fund) and any accrued but unpaid net amounts owed
to a swap counterparty will be covered by the maintenance of a segregated
account consisting of cash, or liquid high grade debt obligations.
Whether the Fund's use of swap agreements will be successful in furthering
its investment objective will depend, in part, on the Advisor's ability to
predict correctly whether certain types of investments are likely to produce
greater returns than other investments. Swap agreements may be considered to
be illiquid. Moreover, the Fund bears the risk of loss of the amount expected
to be received under a swap agreement in the event of the default or bankruptcy
of a swap agreement counterparty. Certain restrictions imposed on the Fund by
the Internal Revenue Code may limit the Fund's ability to use swap agreements.
The swaps market is largely unregulated.
15
<PAGE> 39
The Fund will enter swap agreements only with counterparties that the
Advisor reasonably believes are capable of performing under the swap
agreements. If there is a default by the other party to such a transaction,
the Fund will have to rely on its contractual remedies (which may be limited by
bankruptcy, insolvency or similar laws) pursuant to the agreements related to
the transaction.
ADDITIONAL DERIVATIVE INSTRUMENTS AND STRATEGIES. In addition to the
derivative instruments and strategies described above and in the Fund's
Prospectus, the Advisor expects to discover additional derivative instruments
and other hedging or risk management techniques. The Advisor may utilize these
new derivative instruments and techniques to the extent that they are
consistent with the Fund's investment objective and permitted by the Fund's
investment limitations, operating policies, and applicable regulatory
authorities.
FOREIGN INVESTMENT COMPANIES
The Fund may invest, to a limited extent, in foreign investment
companies. Some of the countries in which the Fund invests may not permit
direct investment by outside investors. Investments in such countries may
only be permitted through foreign government-approved or -authorized
investment vehicles, which may include other investment companies. In
addition, it may be less expensive and more expedient for the Fund to invest
in a foreign investment company in a country which permits direct foreign
investment. Investing through such vehicles may involve frequent or layered
fees or expenses and may also be subject to limitation under the 1940 Act.
Under the 1940 Act, the Fund may invest up to 10% of its assets in shares of
other investment companies and up to 5% of its assets in any one investment
company as long as the investment does not represent more than 3% of the
voting stock of the acquired investment company. The Fund does not intend to
invest in such investment companies unless, in the judgment of the Advisor,
the potential benefits of such investments justify the payment of any
associated fees and expenses.
FOREIGN SECURITIES
Investing in foreign securities involves a series of risks not present in
investing in U.S. securities. Many of the foreign securities held by the Fund
will not be registered with the Securities and Exchange Commission (the "SEC"),
nor will the foreign issuers be subject to SEC reporting requirements.
Accordingly, there may be less publicly available information concerning
foreign issuers of securities held by the Fund than is available concerning
U.S. companies. Disclosure and regulatory standards in many respects are less
stringent in emerging market countries than in the U.S. and other major
markets. There also may be a lower level of monitoring and regulation of
emerging markets and the activities of investors in such markets, and
enforcement of existing regulations may be extremely limited. Foreign
companies, and in particular, companies in smaller and emerging capital markets
are not generally subject to uniform accounting, auditing and financial
reporting standards, or to other regulatory requirements comparable to those
applicable to U.S. companies. The Fund's net investment income and capital
gains from its foreign investment activities may be subject to non-U.S.
withholding taxes.
The costs attributable to foreign investing that the Fund must bear
frequently are higher than those attributable to domestic investing; this is
particularly true with respect to emerging capital markets. For example, the
cost of maintaining custody of foreign securities exceeds custodian costs for
domestic securities, and transaction and settlement costs of foreign investing
also frequently are higher than those attributable to domestic investing.
Costs associated with the exchange of currencies also make foreign investing
more expensive than domestic investing. Investment income on certain foreign
securities in which the Fund may invest may be subject to foreign withholding
or other government taxes that could reduce the return of these securities.
Tax treaties between the United States and foreign countries, however, may
reduce or eliminate the amount of foreign tax to which the Fund would be
subject.
Foreign markets also have different clearance and settlement procedures,
and in certain markets there have been times when settlements have failed to
keep pace with the volume of securities transactions, making it difficult to
conduct such transactions. Delays in settlement could result in temporary
periods when assets of the Fund are uninvested and no return is earned thereon.
The inability of the Fund to make intended security purchases due to
settlement problems could cause the Fund to miss investment opportunities.
Inability to dispose of a portfolio security due to settlement problems could
result either in losses to the Fund due to subsequent declines in the value of
such portfolio security or, if the Fund has entered into a contract to sell the
security, could result in possible liability to the purchaser.
16
<PAGE> 40
HIGH-YIELD (HIGH-RISK) SECURITIES
IN GENERAL. The Fund may invest up to 5% of its net assets in
non-investment grade debt obligations. Non-investment grade debt obligations
(hereinafter referred to as "lower-quality securities") include (i) bonds rated
as low as C by Moody's Investors Service, Inc. ("Moody's"), Standard & Poor's
Ratings Group ("S&P"), or Fitch Investors Service, Inc. ("Fitch"), or CCC by
Duff & Phelps, Inc. ("D&P"); (ii) commercial paper rated as low as C by S&P,
Not Prime by Moody's, or Fitch 4 by Fitch; and (iii) unrated debt obligations
of comparable quality. Lower-quality securities, while generally offering
higher yields than investment grade securities with similar maturities, involve
greater risks, including the possibility of default or bankruptcy. They are
regarded as predominantly speculative with respect to the issuer's capacity to
pay interest and repay principal. The special risk considerations in
connection with investments in these securities are discussed below. Refer to
the Appendix for a discussion of securities ratings.
EFFECT OF INTEREST RATES AND ECONOMIC CHANGES. The lower-quality and
comparable unrated security market is relatively new and its growth has
paralleled a long economic expansion. As a result, it is not clear how this
market may withstand a prolonged recession or economic downturn. Such
conditions could severely disrupt the market for and adversely affect the value
of such securities.
All interest-bearing securities typically experience appreciation when
interest rates decline and depreciation when interest rates rise. The market
values of lower-quality and comparable unrated securities tend to reflect
individual corporate developments to a greater extent than do higher rated
securities, which react primarily to fluctuations in the general level of
interest rates. Lower-quality and comparable unrated securities also tend to
be more sensitive to economic conditions than are higher-rated securities. As
a result, they generally involve more credit risks than securities in the
higher-rated categories. During an economic downturn or a sustained period of
rising interest rates, highly leveraged issuers of lower-quality and comparable
unrated securities may experience financial stress and may not have sufficient
revenues to meet their payment obligations. The issuer's ability to service
its debt obligations may also be adversely affected by specific corporate
developments, the issuer's inability to meet specific projected business
forecasts or the unavailability of additional financing. The risk of loss due
to default by an issuer of these securities is significantly greater than
issuers of higher-rated securities because such securities are generally
unsecured and are often subordinated to other creditors. Further, if the
issuer of a lower-quality or comparable unrated security defaulted, the Fund
might incur additional expenses to seek recovery. Periods of economic
uncertainty and changes would also generally result in increased volatility in
the market prices of these securities and thus in the Fund's net asset value.
As previously stated, the value of a lower-quality or comparable unrated
security will decrease in a rising interest rate market and accordingly, so
will the Fund's net asset value. If the Fund experiences unexpected net
redemptions in such a market, it may be forced to liquidate a portion of its
portfolio securities without regard to their investment merits. Due to the
limited liquidity of lower-quality and comparable unrated securities (discussed
below), the Fund may be forced to liquidate these securities at a substantial
discount. Any such liquidation would force the Fund to sell the more liquid
portion of its portfolio.
PAYMENT EXPECTATIONS. Lower-quality and comparable unrated securities
typically contain redemption, call or prepayment provisions which permit the
issuer of such securities containing such provisions to, at its discretion,
redeem the securities. During periods of falling interest rates, issuers of
these securities are likely to redeem or prepay the securities and refinance
them with debt securities with a lower interest rate. To the extent an issuer
is able to refinance the securities, or otherwise redeem them, the Fund may
have to replace the securities with a lower yielding security, which would
result in a lower return for the Fund.
CREDIT RATINGS. Credit ratings issued by credit rating agencies are
designed to evaluate the safety of principal and interest payments of rated
securities. They do not, however, evaluate the market value risk of
lower-quality securities and, therefore, may not fully reflect the true risks
of an investment. In addition, credit rating agencies may or may not make
timely changes in a rating to reflect changes in the economy or in the
condition of the issuer that affect the market value of the security.
Consequently, credit ratings are used only as a preliminary indicator of
investment quality. Investments in lower-quality and comparable unrated
obligations will be more dependent on the Advisor's credit analysis than would
be the case with
17
<PAGE> 41
investments in investment-grade debt obligations. The Advisor employs its own
credit research and analysis, which includes a study of existing debt, capital
structure, ability to service debt and to pay dividends, the issuer's
sensitivity to economic conditions, its operating history and the current trend
of earnings. The Advisor continually monitors the investments in the Fund's
portfolio and carefully evaluates whether to dispose of or to retain
lower-quality and comparable unrated securities whose credit ratings or credit
quality may have changed.
LIQUIDITY AND VALUATION. The Fund may have difficulty disposing of
certain lower-quality and comparable unrated securities because there may be a
thin trading market for such securities. Because not all dealers maintain
markets in all lower-quality and comparable unrated securities, there is no
established retail secondary market for many of these securities. The Fund
anticipates that such securities could be sold only to a limited number of
dealers or institutional investors. To the extent a secondary trading market
does exist, it is generally not as liquid as the secondary market for
higher-rated securities. The lack of a liquid secondary market may have an
adverse impact on the market price of the security. As a result, the Fund's
asset value and ability to dispose of particular securities, when necessary to
meet the Fund's liquidity needs or in response to a specific economic event,
may be impacted. The lack of a liquid secondary market for certain securities
may also make it more difficult for the Fund to obtain accurate market
quotations for purposes of valuing the Fund's portfolio. Market quotations are
generally available on many lower-quality and comparable unrated issues only
from a limited number of dealers and may not necessarily represent firm bids of
such dealers or prices for actual sales. During periods of thin trading, the
spread between bid and asked prices is likely to increase significantly. In
addition, adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of lower-quality
and comparable unrated securities, especially in a thinly traded market.
LEGISLATION. Legislation may be adopted, from time to time designed to
limit the use of certain lower-quality and comparable unrated securities by
certain issuers. It is anticipated that if additional legislation is enacted
or proposed, it could have a material affect on the value of these securities
and the existence of a secondary trading market for the securities.
ILLIQUID SECURITIES
The Fund may invest in illiquid securities (i.e., securities that are not
readily marketable). However, the Fund will not acquire illiquid securities
if, as a result, they would comprise more than 15% of the value of the Fund's
net assets (or such other amounts as may be permitted under the 1940 Act).
However, as a matter of internal policy, the Advisor intends to limit the
Fund's investments in illiquid securities to 10% of its net assets.
The Board of Directors of the Fund, or its delegate, has the ultimate
authority to determine, to the extent permissible under the federal securities
laws, which securities are illiquid for purposes of this limitation. Certain
securities exempt from registration or issued in transactions exempt from
registration under the Securities Act of 1933, as amended (the "Securities
Act"), such as securities that may be resold to institutional investors under
Rule 144A under the Securities Act and Section 4(2) commercial paper, may be
considered liquid under guidelines adopted by the Fund's Board of Directors.
The Board of Directors of the Fund has delegated the Advisor the
day-to-day determination of the liquidity of a security, although it has
retained oversight and ultimate responsibility for such determinations. The
Board of Directors has directed the Advisor to look to such factors as (i) the
frequency of trades or quotes for a security, (ii) the number of dealers
willing to purchase or sell the security and number of potential buyers, (iii)
the willingness of dealers to undertake to make a market in the security, (iv)
the nature of the security and nature of the marketplace trades, such as the
time needed to dispose of the security, the method of soliciting offers, and
the mechanics of transfer, (v) the likelihood that the security's marketability
will be maintained throughout the anticipated holding period, and (vi) any
other relevant factors. The Advisor may determine 4(2) commercial paper to be
liquid if (i) the 4(2) commercial paper is not traded flat or in default as to
principal and interest, (ii) the 4(2) commercial paper is rated in one of the
two highest rating categories by at least two nationally rated statistical
rating organizations ("NRSRO"), or if only one NRSRO rates the security, by
that NRSRO, or is determined by the Advisor to be of equivalent quality, and
(iii) the Advisor considers the trading market for the specific security taking
into account all relevant factors. With respect to the Fund's foreign
holdings, a foreign security may be considered liquid by the Advisor (despite
its restricted nature under the Securities Act) if the security can be freely
traded in a foreign securities market and all the facts and circumstances
support a finding of liquidity.
18
<PAGE> 42
Restricted securities may be sold only in privately negotiated
transactions or in a public offering with respect to which a registration
statement is in effect under the Securities Act. Where registration is
required, the Fund may be obligated to pay all or part of the registration
expenses and a considerable period may elapse between the time of the decision
to sell and the time the Fund may be permitted to sell a security under an
effective registration statement. If, during such a period, adverse market
conditions were to develop, the Fund might obtain a less favorable price than
prevailed when it decided to sell. Restricted securities will be priced at
fair value as determined in good faith by the Board of Directors of the Fund.
If through the appreciation of restricted securities or the depreciation of
unrestricted securities, the Fund should be in a position where more than 15%
of the value of its net assets are invested in illiquid securities, including
restricted securities which are not readily marketable (except for 144A
Securities and 4(2) commercial paper deemed to be liquid by the Advisor), the
Fund will take such steps as is deemed advisable, if any, to protect liquidity.
The Fund may sell over-the-counter ("OTC") options and, in connection
therewith, segregate assets or cover its obligations with respect to OTC
options written by the Fund. The assets used as cover for OTC options written
by the Fund will be considered illiquid unless the OTC options are sold to
qualified dealers who agree that the Fund may repurchase any OTC option it
writes at a maximum price to be calculated by a formula set forth in the option
agreement. The cover for an OTC option written subject to this procedure would
be considered illiquid only to the extent that the maximum repurchase price
under the formula exceeds the intrinsic value of the option.
LENDING OF PORTFOLIO SECURITIES
The Fund is authorized to lend up to 33-1/3% of the total value of its
portfolio securities to broker-dealers or institutional investors that the
Advisor deems qualified, but only when the borrower maintains with the Fund's
custodian bank collateral either in cash or money market instruments in an
amount at least equal to the market value of the securities loaned, plus
accrued interest and dividends, determined on a daily basis and adjusted
accordingly. Although the Fund is authorized to lend, the Fund does not
presently intend to engage in lending. In determining whether to lend
securities to a particular broker-dealer or institutional investor, the Advisor
will consider, and during the period of the loan will monitor, all relevant
facts and circumstances, including the creditworthiness of the borrower. The
Fund will retain authority to terminate any loans at any time. The Fund may
pay reasonable administrative and custodial fees in connection with a loan and
may pay a negotiated portion of the interest earned on the cash or money market
instruments held as collateral to the borrower or placing broker. The Fund
will receive reasonable interest on the loan or a flat fee from the borrower
and amounts equivalent to any dividends, interest or other distributions on the
securities loaned. The Fund will retain record ownership of loaned securities
to exercise beneficial rights, such as voting and subscription rights and
rights to dividends, interest or other distributions, when retaining such
rights is considered to be in the Fund's interest.
MORTGAGE- AND ASSET-BACKED SECURITIES
Mortgage-backed securities represent direct or indirect participations in,
or are secured by and payable from, mortgage loans secured by real property,
and include single- and multi-class pass-through securities and collateralized
mortgage obligations. Such securities may be issued or guaranteed by U.S.
government agencies or instrumentalities, such as the Government National
Mortgage Association and the Federal National Mortgage Association, or by
private issuers, generally originators and investors in mortgage loans,
including savings associations, mortgage bankers, commercial banks, investment
bankers, and special purpose entities (collectively, "private lenders").
Mortgage-backed securities issued by private lenders may be supported by pools
of mortgage loans or other mortgage-backed securities that are guaranteed,
directly or indirectly, by the U.S. government or one of its agencies or
instrumentalities, or they may be issued without any governmental guarantee of
the underlying mortgage assets but with some form of non-governmental credit
enhancement.
Asset-backed securities have structural characteristics similar to
mortgage-backed securities. Asset-backed debt obligations represent direct or
indirect participation in, or secured by and payable from, assets such as motor
vehicle installment sales contracts, other installment loan contracts, home
equity loans, leases of various types of property, and receivables from credit
card or other revolving credit arrangements. The credit quality of most
asset-backed securities depends primarily on the credit quality of the assets
underlying such securities, how well the entity issuing the security is
insulated from the credit risk of the originator or any other affiliated
entities, and the amount and quality of any credit enhancement of the
securities. Payments or distributions of principal and interest on
asset-backed debt obligations may be supported by non-governmental credit
enhancements including letters of credit, reserve funds, overcollateralization,
and guarantees by third parties. The market for
19
<PAGE> 43
privately issued asset-backed debt obligations is smaller and less liquid than
the market for government sponsored mortgage-backed securities.
The rate of principal payment on mortgage- and asset-backed securities
generally depends on the rate of principal payments received on the underlying
assets which in turn may be affected by a variety of economic and other
factors. As a result, the yield on any mortgage- and asset-backed security is
difficult to predict with precision and actual yield to maturity may be more or
less than the anticipated yield to maturity. The yield characteristics of
mortgage- and asset-backed securities differ from those of traditional debt
securities. Among the principal differences are that interest and principal
payments are made more frequently on mortgage-and asset-backed securities,
usually monthly, and that principal may be prepaid at any time because the
underlying mortgage loans or other assets generally may be prepaid at any time.
As a result, if the Fund purchases these securities at a premium, a prepayment
rate that is faster than expected will reduce yield to maturity, while a
prepayment rate that is slower than expected will have the opposite effect of
increasing the yield to maturity. Conversely, if the Fund purchases these
securities at a discount, a prepayment rate that is faster than expected will
increase yield to maturity, while a prepayment rate that is slower than
expected will reduce yield to maturity. Amounts available for reinvestment by
a Fund are likely to be greater during a period of declining interest rates
and, as a result, are likely to be reinvested at lower interest rates than
during a period of rising interest rates. Accelerated prepayments on
securities purchased by the Fund at a premium also impose a risk of loss of
principal because the premium may not have been fully amortized at the time the
principal is prepaid in full. The market for privately issued mortgage- and
asset-backed securities is smaller and less liquid than the market for
government-sponsored mortgage- backed securities.
While many mortgage- and asset-backed securities are issued with only one
class of security, many are issued in more than one class, each with different
payment terms. Multiple class mortgage- and asset-backed securities are issued
for two main reasons. First, multiple classes may be used as a method of
providing credit support. This is accomplished typically through creation of
one or more classes whose right to payments on the security is made subordinate
to the right to such payments of the remaining class or classes. Second,
multiple classes may permit the issuance of securities with payment terms,
interest rates, or other characteristics differing both from those of each
other and from those of the underlying assets. Examples include so-called
"strips" (mortgage- and asset-backed securities entitling the holder to
disproportionate interests with respect to the allocation of interest and
principal of the assets backing the security), and securities with class or
classes having characteristics which mimic the characteristics of non-mortgage-
or asset-backed securities, such as floating interest rates (i.e., interest
rates which adjust as a specified benchmark changes) or scheduled amortization
of principal.
The Fund may invest in stripped mortgage- or asset-backed securities,
which receive differing proportions of the interest and principal payments from
the underlying assets. The market value of such securities generally is more
sensitive to changes in prepayment and interest rates than is the case with
traditional mortgage- and asset-backed securities, and in some cases such
market value may be extremely volatile. With respect to certain stripped
securities, such as interest only and principal only classes, a rate of
prepayment that is faster or slower than anticipated may result in the Fund
failing to recover all or a portion of its investment, even though the
securities are rated investment grade.
Mortgage- and asset-backed securities backed by assets, other than as
described above, or in which the payment streams on the underlying assets are
allocated in a manner different than those described above may be issued in the
future. The Fund may invest in such securities if such investment is otherwise
consistent with its investment objectives and policies and with the investment
restrictions of the Fund.
MORTGAGE DOLLAR ROLLS AND REVERSE REPURCHASE AGREEMENTS
The Fund may engage in reverse repurchase agreements to facilitate
portfolio liquidity, a practice common in the mutual fund industry, or for
arbitrage transactions discussed below. In a reverse repurchase agreement, the
Fund would sell a security and enter into an agreement to repurchase the
security at a specified future date and price. The Fund generally retains the
right to interest and principal payments on the security. Since the Fund
receives cash upon entering into a reverse repurchase agreement, it may be
considered a borrowing. (See "Borrowing".) When required by guidelines of the
SEC, the Fund will set aside permissible liquid assets in a segregated account
to secure its obligations to repurchase the security.
20
<PAGE> 44
The Fund may also enter into mortgage dollar rolls, in which the Fund
would sell mortgage-backed securities for delivery in the current month and
simultaneously contract to purchase substantially similar securities on a
specified future date. While the Fund would forego principal and interest paid
on the mortgage-backed securities during the roll period, the Fund would be
compensated by the difference between the current sales price and the lower
price for the future purchase as well as by any interest earned on the proceeds
of the initial sale. The Fund also could be compensated through the receipt of
fee income equivalent to a lower forward price. At the time the Fund would
enter into a mortgage dollar roll, it would set aside permissible liquid assets
in a segregated account to secure its obligation for the forward commitment to
buy mortgage-backed securities. Mortgage dollar roll transactions may be
considered a borrowing by the Fund. (See "Borrowing".)
The mortgage dollar rolls and reverse repurchase agreements entered into
by the Fund may be used as arbitrage transactions in which the Fund will
maintain an offsetting position in investment grade debt obligations or
repurchase agreements that mature on or before the settlement date on the
related mortgage dollar roll or reverse repurchase agreements. Since the Fund
will receive interest on the securities or repurchase agreements in which it
invests the transaction proceeds, such transactions may involve leverage.
However, since such securities or repurchase agreements will be high quality
and will mature on or before the settlement date of the mortgage dollar roll or
reverse repurchase agreement, the Advisor believes that such arbitrage
transactions do not present the risks to the Fund that are associated with
other types of leverage.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with certain banks or
non-bank dealers. In a repurchase agreement, the Fund buys a security at one
price, and at the time of sale, the seller agrees to repurchase the obligation
at a mutually agreed upon time and price (usually within seven days). The
repurchase agreement, thereby, determines the yield during the purchaser's
holding period, while the seller's obligation to repurchase is secured by the
value of the underlying security. The Advisor will monitor, on an ongoing
basis, the value of the underlying securities to ensure that the value always
equals or exceeds the repurchase price plus accrued interest. Repurchase
agreements could involve certain risks in the event of a default or insolvency
of the other party to the agreement, including possible delays or restrictions
upon the Fund's ability to dispose of the underlying securities. Although no
definitive creditworthiness criteria are used, the Advisor reviews the
creditworthiness of the banks and non-bank dealers with which the Fund enters
into repurchase agreements to evaluate those risks. The Fund may, under
certain circumstances, deem repurchase agreements collateralized by U.S.
government securities to be investments in U.S. government securities.
SHORT SALES AGAINST THE BOX
The Fund may sell securities short against the box to hedge unrealized
gains on portfolio securities. Selling securities short against the box
involves selling a security that the Fund owns or has the right to acquire, for
delivery at a specified date in the future. If the Fund sells securities short
against the box, it may protect unrealized gains, but will lose the opportunity
to profit on such securities if the price rises.
SMALL AND MEDIUM COMPANIES
The Fund may invest a substantial portion of its assets in small and
medium companies. While small and medium companies generally have the
potential for rapid growth, investments in small and medium companies often
involve greater risks than investments in larger, more established companies
because small and medium companies may lack the management experience,
financial resources, product diversification, and competitive strengths of
larger companies. In addition, in many instances the securities of small and
medium companies are traded only over-the-counter or on a regional securities
exchange, and the frequency and volume of their trading is substantially less
than is typical of larger companies. Therefore, the securities of small and
medium companies may be subject to greater and more abrupt price fluctuations.
When making large sales, the Fund may have to sell portfolio holdings at
discounts from quoted prices or may have to make a series of small sales over
an extended period of time due to the trading volume of small and medium
company securities. Investors should be aware that, based on the foregoing
factors, an investment in the Fund may be subject to greater price
fluctuations than an investment in a fund that invests primarily in larger,
more established companies. The
21
<PAGE> 45
Advisor's research efforts may also play a greater role in selecting securities
for the Fund than in a fund that invests in larger, more established companies.
TEMPORARY DEFENSIVE POSITION
When the Advisor determines that market conditions warrant a temporary
defensive position, the Fund may invest without limitation in cash and
short-term fixed income securities, including U.S. government securities,
commercial paper, banker's acceptances, certificates of deposit, and time
deposits.
WARRANTS
The Fund may acquire warrants. Warrants are securities giving the holder
the right, but not the obligation, to buy the stock of an issuer at a given
price (generally higher than the value of the stock at the time of issuance)
during a specified period or perpetually. Warrants may be acquired separately
or in connection with the acquisition of securities. Warrants do not carry
with them the right to dividends or voting rights with respect to the
securities that they entitle their holder to purchase, and they do not
represent any rights in the assets of the issuer. As a result, warrants may be
considered to have more speculative characteristics than certain other types of
investments. In addition, the value of a warrant does not necessarily change
with the value of the underlying securities, and a warrant ceases to have value
if it is not exercised prior to its expiration date.
WHEN-ISSUED SECURITIES
The Fund may purchase securities on a "when-issued" basis. The price of
debt obligations purchased on a when-issued basis, which may be expressed in
yield terms, generally is fixed at the time the commitment to purchase is made,
but delivery and payment for the securities take place at a later date.
Normally, the settlement date occurs within 45 days of the purchase although in
some cases settlement may take longer. During the period between the purchase
and settlement, no payment is made by the Fund to the issuer and no interest on
the debt obligations accrues to the Fund. Forward commitments 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 value of
the Fund's other assets. While when-issued securities may be sold prior to the
settlement date, the Fund intends to purchase such securities with the purpose
of actually acquiring them unless a sale appears desirable for investment
reasons. At the time the Fund makes the commitment to purchase a security on a
when-issued basis, it will record the transaction and reflect the value of the
security in determining its net asset value. The Fund does not believe that
its net asset value will be adversely affected by purchases of securities on a
when-issued basis.
To the extent required by the SEC, the Fund will maintain cash and
marketable securities equal in value to commitments for when-issued securities.
Such segregated securities either will mature or, if necessary, be sold on or
before the settlement date. When the time comes to pay for when-issued
securities, the Fund will meet its obligations from then-available cash flow,
sale of the securities held in the separate account, described above, sale of
other securities or, although it would not normally expect to do so, from the
sale of the when-issued securities themselves (which may have a market value
greater or less than the Fund's payment obligation).
ZERO-COUPON, STEP-COUPON AND PAY-IN-KIND SECURITIES
The Fund may invest in zero-coupon, step-coupon, and pay-in-kind
securities. These securities are debt securities that do not make regular cash
interest payments. Zero-coupon and step-coupon securities are sold at a deep
discount to their face value. Pay-in-kind securities pay interest through the
issuance of additional securities. Because such securities do not pay current
cash income, the price of these securities can be volatile when interest rates
fluctuate. While these securities do not pay current cash income, federal
income tax law requires the holders of zero-coupon, step-coupon, and
pay-in-kind securities to include in income each year the portion of the
original issue discount (or deemed discount) and other non-cash income on such
securities accruing that year. In order to continue to qualify as a "regulated
investment company" under the Internal Revenue Code and avoid a certain excise
tax, the Fund may be required to distribute a portion of such discount and
income and may be required to dispose of other portfolio securities, which may
occur in periods of adverse market prices, in order to generate cash to meet
these distribution requirements.
22
<PAGE> 46
DIRECTORS AND OFFICERS OF THE CORPORATION
Directors and officers of the Corporation, together with information as to
their principal business occupations during the last five years, and other
information are shown below. Each director who is deemed an "interested
person," as defined in the 1940 Act, is indicated by an asterisk (*). Each
officer and director holds the same position with the 25 registered open-end
management investment companies consisting of 38 mutual funds, which are
managed by the Advisor (the "Strong Funds"). The Strong Funds, in the
aggregate, pays each Director who is not a director, officer, or employee of
the Advisor, or any affiliated company (a "disinterested director") an annual
fee of $50,000, plus $100 per Board meeting for each Strong Fund. In addition,
each disinterested director is reimbursed by the Strong Funds for travel and
other expenses incurred in connection with attendance at such meetings. Other
officers and directors of the Strong Funds receive no compensation or expense
reimbursement from the Strong Funds.
*RICHARD S. STRONG (DOB 5/12/42), Chairman of the Board and Director of the
Corporation.
Prior to August 1985, Mr. Strong was Chief Executive Officer of the
Advisor, which he founded in 1974. Since August 1985, Mr. Strong has been a
Security Analyst and Portfolio Manager of the Advisor. In October 1991, Mr.
Strong also became the Chairman of the Advisor. Mr. Strong is a director of
the Advisor. Mr. Strong has been in the investment management business since
1967. Mr. Strong has served the Corporation as a director since December 1990
and as Chairman of the Board since January 1992.
MARVIN E. NEVINS (DOB 7/9/18), Director of the Corporation.
Private Investor. From 1945 to 1980, Mr. Nevins was Chairman of Wisconsin
Centrifugal Inc.; a foundry. From July 1983 to December 1986, he was Chairman
of General Casting Corp., Waukesha, Wisconsin, a foundry. Mr. Nevins is a
former Chairman of the Wisconsin Association of Manufacturers & Commerce. He
was also a regent of the Milwaukee School of Engineering and a member of the
Board of Trustees of the Medical College of Wisconsin. Mr. Nevins has served
the Corporation as a director since December 1990.
WILLIE D. DAVIS (DOB 7/24/34), Director of the Corporation.
Mr. Davis has been director of Alliance Bank Since 1980, Sara Lee
Corporation (a food/consumer products company) since 1983, KMart Corporation (a
discount consumer products company) since 1985, YMCA Metropolitan - Los Angeles
since 1985, Dow Chemical Company since 1988, MGM Grand, Inc. (an
entertainment/hotel company) since 1990, WICOR, Inc. (a utility company) since
1990, Johnson Controls, Inc. (an industrial company) since 1992, L.A. Gear (a
footwear/sportswear company) since 1992, and Rally's Hamburger, Inc. since
1994. Mr. Davis has been a trustee of the University of Chicago since 1980,
Marquette University since 1988, and Occidental College since 1990. Since
1977, Mr. Davis has been President and Chief Executive Officer of All Pro
Broadcasting, Inc. Mr. Davis was a director of the Fireman's Fund (an
insurance company) from 1975 until 1990. Mr. Davis has served the Corporation
as a director since July 1994.
*JOHN DRAGISIC (DOB 11/26/40), President and Director of the Corporation.
Mr. Dragisic has been President of the Advisor since October 1995, and a
director of the Advisor since July 1994. Mr. Dragisic served as Vice Chairman
of the Advisor from July 1994 until October 1995. Mr. Dragisic was the
President and Chief Executive Officer of Grunau Company, Inc. (a mechanical
contracting and engineering firm), Milwaukee, Wisconsin from 1987 until July
1994. From 1981 to 1987, he was an Executive Vice President with Grunau
Company, Inc. From 1969 until 1973, Mr. Dragisic worked for the InterAmerican
Development Bank. Mr. Dragisic received his Ph.D. in Economics in 1971 from
the University of Wisconsin - Madison and his B.A. degree in Economics in 1962
from Lake Forest College. Mr. Dragisic has served the Corporation as Vice
Chairman from July 1994 until October 1995; as President since October 1995;
and as a director from July 1991 until July 1994, and since April 1995.
23
<PAGE> 47
STANLEY KRITZIK (DOB 1/9/30), Director of the Corporation.
Mr. Kritzik has been a Partner of Metropolitan Associates since 1962, a
Director of Aurora Health Care since 1987, and Health Network Ventures, Inc.
since 1992. Mr. Kritzik has served the Corporation as a director since April
1995.
WILLIAM F. VOGT (DOB 7/19/47), Director of Corporation.
Mr. Vogt has been the President of Vogt Management Consulting, Inc. since
1990. From 1982 until 1990, he served as Executive Director of University
Physicians of the University of Colorado. Mr. Vogt is the Past President of
the Medical Group Management Association and a Fellow of the American College
of Medical Practice Executives. Mr. Vogt has served the Corporation as a
director since April 1995.
LAWRENCE A. TOTSKY (DOB 5/6/59), C.P.A., Vice President of the Corporation.
Mr. Totsky has been Senior Vice President of the Advisor since December
1994. Mr. Totsky acted as the Advisor's Manager of Shareholder Accounting and
Compliance from June 1987 to June 1991 when he was named Director of Mutual
Fund Administration. Mr. Totsky has served the Corporation as a Vice President
since May 1993.
THOMAS P. LEMKE (DOB 7/30/54), Vice President of the Corporation.
Mr. Lemke has been Senior Vice President, Secretary, and General Counsel
of the Advisor since September 1994. For two years prior to joining the
Advisor, Mr. Lemke acted as Resident Counsel for Funds Management at J.P.
Morgan & Co., Inc. From February 1989 until April 1992, Mr. Lemke acted as
Associate General Counsel to Sanford C. Bernstein Co., Inc. For two years
prior to that, Mr. Lemke was Of Counsel at the Washington, D.C. law firm of Tew
Jorden & Schulte, a successor of Finley, Kumble & Wagner. From August 1979
until December 1986, Mr. Lemke worked at the Securities and Exchange
Commission, most notably as the Chief Counsel to the Division of Investment
Management (November 1984 - December 1986), and as Special Counsel to the
Office of Insurance Products, Division of Investment Management (April 1982 -
October 1984). Mr. Lemke has served the Corporation as a Vice President since
October 1994.
STEPHEN J. SHENKENBERG (DOB 6/14/58), Vice President and Secretary of the
Corporation.
Mr. Shenkenberg has been Deputy General Counsel to the Advisor since
November 1996. From December 1992 until November 1996 Mr. Shenkenberg acted as
Associate Counsel to the Advisor. From June 1987 until December 1992, Mr.
Shenkenberg was an attorney for Godfrey & Kahn, S.C., a Milwaukee law firm.
Mr. Shenkenberg has served the Corporation as a Vice President since April 1996
and as Secretary since October 1996.
JOHN S. WEITZER (DOB 10/31/67), Vice President of the Corporation.
Mr. Weitzer has been an Associate Counsel of the Advisor since July 1993.
Mr. Weitzer has served the Corporation as a Vice President since January 1996.
Except for Messrs. Nevins, Davis, Kritzik and Vogt, the address of all of
the above persons is P.O. Box 2936, Milwaukee, Wisconsin 53201. Mr. Nevins'
address is 6075 Pelican Bay Boulevard, Naples, Florida 34108. Mr. Davis'
address is 161 North La Brea, Inglewood, California 90301. Mr. Kritzik's
address is 1123 North Astor Street, P.O. Box 92547, Milwaukee, Wisconsin
53202-0547. Mr. Vogt's address is 2830 East Third Avenue, Denver, Colorado
80206.
In addition to the positions listed above, the following individuals also
hold the following positions with Strong Holdings, Inc. ("Holdings"), a
Wisconsin corporation and subsidiary of the Advisor; Strong Funds Distributors,
Inc., the Fund's underwriter ("Distributors"), Heritage Reserve Development
Corporation ("Heritage"), and Strong Service Corporation ("SSC"), each of which
is a Wisconsin corporation and subsidiary of Holdings; Fussville Real Estate
Holdings
24
<PAGE> 48
L.L.C. ("Real Estate Holdings") and Sherwood Development L.L.C. ("Sherwood"),
each of which is a Wisconsin Limited Liability Company and subsidiary of the
Advisor and Heritage; and Fussville Development L.L.C. ("Fussville
Development"), a Wisconsin Limited Liability Company and subsidiary of the
Advisor and Real Estate Holdings:
RICHARD S. STRONG:
CHAIRMAN AND A DIRECTOR - Holdings and Distributors (since October 1993);
Heritage (since January 1994); and SSC (since November 1995).
CHAIRMAN AND A MEMBER OF THE MANAGING BOARD - Real Estate Holdings and
Fussville Development (since December 1995 and February 1994,
respectively); and Sherwood (since October 1994).
JOHN DRAGISIC:
PRESIDENT AND A DIRECTOR - Holdings (since December 1995 and July 1994,
respectively); Distributors (since September 1996 and July 1994,
respectively); Heritage (since May 1994 and August 1994, respectively);
and SSC (since November 1995).
VICE CHAIRMAN AND A MEMBER OF THE MANAGING BOARD - Real Estate and
Fussville Development (since December 1995 and August 1994,
respectively); and Sherwood (since October 1994).
THOMAS P. LEMKE:
VICE PRESIDENT - Holdings, Heritage, Real Estate Holdings, and Fussville
Development (since December 1995); Distributors (since October 1996);
Sherwood (since October 1994); and SSC (since November 1995).
STEPHEN J. SHENKENBERG:
VICE PRESIDENT AND SECRETARY - Distributors (since December 1995).
SECRETARY - Holdings, Heritage, Fussville Development, Real Estate
Holdings, and Sherwood (since December 1995); and SSC (since November
1995).
As of March 31, 1997, the officers and directors of the Fund in the
aggregate beneficially owned less than 1% of the Fund's then outstanding
shares.
PRINCIPAL SHAREHOLDERS
Except for the organizational shares of the Fund, the Fund's shares are
held of record by an insurance company separate account. As of March 31, 1997,
the following persons owned of record or is known by the Fund to own of record
or beneficially more than 5% of the Fund's outstanding shares:
<TABLE>
<CAPTION>
Name and Address Shares Percent of Class
---------------- ------ ----------------
<S> <C> <C>
Nationwide Insurance 17,788,358 96.09%
P.O. Box 182029
Columbus, OH 43218
</TABLE>
A shareholder owning more than 25% of the Fund's shares may be considered
a "controlling person" of the Fund. Accordingly, its vote could have a more
significant effect on matters presented to shareholders for approval than the
vote of other Fund shareholders.
25
<PAGE> 49
INVESTMENT ADVISOR AND DISTRIBUTOR
The Advisor to the Fund is Strong Capital Management, Inc. Mr. Richard S.
Strong controls the Advisor. Mr. Strong is the Chairman and a director of the
Advisor, Mr. Dragisic is the President and a director of the Advisor, Mr.
Totsky is a Senior Vice President of the Advisor, Mr. Lemke is a Senior Vice
President, Secretary, and General Counsel of the Advisor, Mr. Shenkenberg is
Vice President, Assistant Secretary, and Deputy General Counsel of the Advisor,
and Mr. Weitzer is an Associate Counsel of the Advisor. A brief description of
the Fund's investment advisory agreement ("Advisory Agreement") is set forth in
the Prospectus under "Management."
The Fund's Advisory Agreement, dated May 1, 1995, was last approved by
shareholders at the annual meeting of shareholders held on April 13, 1995. The
Advisory Agreement was approved by the Fund's initial shareholder on its first
day of operations. The Advisory Agreement is required to be approved annually
by the Board of Directors of the Corporation or by vote of a majority of the
Fund's outstanding voting securities (as defined in the 1940 Act). In either
case, each annual renewal must also be approved by the vote of a majority of
the Corporation's directors who are not parties to the Advisory Agreement or
interested persons of any such party, cast in person at a meeting called for
the purpose of voting on such approval. The Advisory Agreement is terminable,
without penalty, on 60 days' written notice by the Board of Directors of the
Corporation, by vote of a majority of the Fund's outstanding voting securities,
or by the Advisor. In addition, the Advisory Agreement will terminate
automatically in the event of its assignment.
Under the terms of the Advisory Agreement, the Advisor manages the Fund's
investments subject to the supervision of the Corporation's Board of Directors.
The Advisor is responsible for investment decisions and supplies investment
research and portfolio management. At its expense, the Advisor provides office
space and all necessary office facilities, equipment, and personnel for
servicing the investments of the Fund. The Advisor places all orders for the
purchase and sale of the Fund's securities at its expense.
Except for expenses assumed by the Advisor, as set forth above, or by the
Distributor, as described below with respect to the distribution of the Fund's
shares, the Fund is responsible for all its other expenses, including, without
limitation, interest charges, taxes, brokerage commissions, and similar
expenses; organizational expenses; expenses of issue, sale, repurchase or
redemption of shares; expenses of registering or qualifying shares for sale
with the states and the SEC; expenses for printing and distributing
Prospectuses and quarterly financial statements to existing shareholders;
charges of custodians, transfer agent fees (including the printing and mailing
of reports and notices to shareholders), registrars, auditing and legal
services, clerical services related to recordkeeping and shareholder relations,
and printing of stock certificates; and fees for directors who are not
"interested persons" of the Advisor; and its allocable share of the
Corporation's expenses.
As compensation for its services, the Fund pays to the Advisor a monthly
management fee at the annual rate of 1.00% of the Fund's average daily net
asset value. (See "Additional Information - Calculation of Net Asset Value" in
the Prospectus.) From time to time, the Advisor may voluntarily waive all or a
portion of its management fee for the Fund. The organizational expenses of the
Fund which were $22,238, were advanced by the Advisor and will be reimbursed by
the Fund over a period of not more than 60 months from the Fund's date of
inception. In 1994, 1995, and 1996 the Fund paid the Advisor $920,374,
$1,676,828, and $2,296,381, respectively, in management fees.
The Advisory Agreement requires the Advisor to reimburse the Fund in the
event that the expenses and charges payable by the Fund in any fiscal year,
including the management fee but excluding taxes, interest, brokerage
commissions, and similar fees and to the extent permitted extraordinary
expenses, exceed two percent (2%) of the average net asset value of the Fund
for such year, as determined by valuations made as of the close of each
business day of the year. Reimbursement of expenses in excess of the
applicable limitation will be made on a monthly basis and will be paid to the
Fund by reduction of the Advisor's fee, subject to later adjustment month by
month for the remainder of the Fund's fiscal year. The Advisor may from time
to time absorb expenses for the Fund in addition to the reimbursement of
expenses in excess of applicable limitations.
On July 12, 1994, the Securities and Exchange Commission (the "SEC") filed
an administrative action (the "Order") against the Advisor, Mr. Strong, and
another employee of the Advisor in connection with conduct that occurred
between 1987 and early 1990. In re Strong/Corneliuson Capital Management,
Inc.; et al. Admin. Proc. File No. 3-8411. The proceeding was
26
<PAGE> 50
settled by consent without admitting or denying the allegations in the Order.
The Order found that the Advisor and Mr. Strong aided and abetted violations of
Section 17(a) of the 1940 Act by effecting trades between mutual funds, and
between mutual funds and Harbour Investments Ltd. ("Harbour"), without
complying with the exemptive provisions of SEC Rule 17a-7 or otherwise
obtaining an exemption. It further found that the Advisor violated, and Mr.
Strong aided and abetted violations of, the disclosure provisions of the 1940
Act and the Investment Advisers Act of 1940 by misrepresenting the Advisor's
policy on personal trading and by failing to disclose trading by Harbour, an
entity in which principals of the Advisor owned between 18 and 25 percent of
the voting stock. As part of the settlement, the respondents agreed to a
censure and a cease and desist order and the Advisor agreed to various
undertakings, including adoption of certain procedures and a limitation for six
months on accepting certain types of new advisory clients.
On June 6, 1996, the Department of Labor (the "DOL") filed an action
against the Advisor for equitable relief alleging violations of the Employee
Retirement Income Security Act of 1974 ("ERISA") in connection with cross
trades that occurred between 1987 and late 1989 involving certain pension
accounts managed by the Advisor. Contemporaneous with this filing, the
Advisor, without admitting or denying the DOL's allegations, agreed to the
entry of a consent judgment resolving all matters relating to the allegations.
Reich V. Strong Capital Management, Inc., (U.S.D.C.E.D. WI)(the "Consent
Judgment"). Under the terms of the Consent Judgment, the Advisor agreed to
reimburse the affected accounts a total of $5.9 million. The settlement did
not have any material impact on the Advisor's financial position or operations.
The Fund and the Advisor have adopted a Code of Ethics (the "Code") which
governs the personal trading activities of all "Access Persons" of the Advisor.
Access Persons include every director and officer of the Advisor and the
investment companies managed by the Advisor, including the Fund, as well as
certain employees of the Advisor who have access to information relating to the
purchase or sale of securities by the Advisor on behalf of accounts managed by
it. The Code is based upon the principal that such Access Persons have a
fiduciary duty to place the interests of the Fund and the Advisor's other
clients ahead of their own.
The Code requires Access Persons (other than Access Persons who are
independent directors of the investment companies managed by the Advisor,
including the Fund) to, among other things, preclear their securities
transactions (with limited exceptions, such as transactions in shares of mutual
funds, direct obligations of the U.S. government, and certain options on
broad-based securities market indexes) and to execute such transactions through
the Advisor's trading department. The Code, which applies to all Access Persons
(other than Access Persons who are independent directors of the investment
companies managed by the Advisor, including the Fund), includes a ban on
acquiring any securities in an initial public offering, other than a new
offering of a registered open-end investment company, and a prohibition from
profiting on short-term trading in securities. In addition, no Access Person
may purchase or sell any security which is contemporaneously being purchased or
sold, or to the knowledge of the Access Person, is being considered for
purchase or sale, by the Advisor on behalf of any mutual fund or other account
managed by it. Finally, the Code provides for trading "black out" periods of
seven calendar days during which time Access Persons who are portfolio managers
may not trade in securities which have been purchased or sold by any mutual
fund or other account managed by the portfolio manager.
From time to time the Advisor votes the shares owned by the Funds
according to its Statement of General Proxy Voting Policy ("Proxy Voting
Policy"). The general principal of the Proxy Voting Policy is to vote any
beneficial interest in an equity security prudently and solely in the best
long-term economic interest of the Fund and its beneficiaries considering all
relevant factors and without undue influence from individuals or groups who may
have an economic interest in the outcome of a proxy vote. Shareholders may
obtain a copy of the Proxy Voting Policy upon request from the Advisor.
The Advisor provides investment advisory services for multiple clients and
may give advice and take action, with respect to any client, that may differ
from the advice given, or the timing or nature of action taken, with respect to
any one account. However, the Advisor will allocate over a period of time, to
the extent practical, investment opportunities to each account on a fair and
equitable basis relative to other similarly-situated client accounts. The
Advisor, its principals and associates (to the extent not prohibited by the
Code), and other clients of the Advisor may have, acquire, increase, decrease,
or dispose of securities or interests therein at or about the same time that
the Advisor is purchasing or selling securities or interests therein for an
account that are or may be deemed to be inconsistent with the actions taken by
such persons.
Under a Distribution Agreement dated December 1, 1993 with the Corporation
(the "Distribution Agreement"), Strong Funds Distributors, Inc.
("Distributor"), a subsidiary of the Advisor, acts as underwriter of the Fund's
shares. The
27
<PAGE> 51
Distribution Agreement provides that the Distributor will use its best efforts
to distribute the Fund's shares. Shares are only offered and sold to the
separate accounts of certain insurance companies. Since the Fund is a
"no-load" fund, no sales commissions are charged on the purchase of Fund
shares. Certain sales charges may apply to the variable annuity or life
insurance contract, which should be described in the prospectus of the
insurance company's separate account. The Distribution Agreement further
provides that the Distributor will bear the additional costs of printing
prospectuses and shareholder reports which are used for selling purposes, as
well as advertising and other costs attributable to the distribution of the
Fund's shares. The Distributor is an indirect subsidiary of the Advisor and
controlled by the Advisor and Richard S. Strong. Prior to December 1, 1993,
the Advisor acted as underwriter for the Fund. On December 1, 1993, the
Distributor succeeded to the broker-dealer registration of the Advisor and, in
connection therewith, a Distribution Agreement was executed on substantially
identical terms as the former distribution agreement with the Advisor as
distributor. The Distribution Agreement is subject to the same termination and
renewal provisions as are described above with respect to the Advisory
Agreement.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Advisor is responsible for decisions to buy and sell securities for
the Fund and for the placement of the Fund's investment business and the
negotiation of the commissions to be paid on such transactions. It is the
policy of the Advisor to seek the best execution at the best security price
available with respect to each transaction, in light of the overall quality of
brokerage and research services provided to the Advisor or the Fund. In
over-the-counter transactions, orders are placed directly with a principal
market maker unless it is believed that a better price and execution can be
obtained using a broker. The best price to the Fund means the best net price
without regard to the mix between purchase or sale price and commission, if
any. In selecting broker-dealers and in negotiating commissions, the Advisor
considers a variety of factors, including best price and execution, the full
range of brokerage services provided by the broker, as well as its capital
strength and stability, and the quality of the research and research services
provided by the broker. Brokerage will not be allocated based on the sale of
any shares of the Strong Funds.
The Advisor has adopted procedures that provide generally for the Advisor
to seek to bunch orders for the purchase or sale of the same security for the
Fund, other mutual funds managed by the Advisor, and other advisory clients
(collectively, the "client accounts"). The Advisor will bunch orders when it
deems it to be appropriate and in the best interest of the client accounts.
When a bunched order is filled in its entirety, each participating client
account will participate at the average share price for the bunched order on
the same business day, and transaction costs shall be shared pro rata based on
each client's participation in the bunched order. When a bunched order is only
partially filled, the securities purchased will be allocated on a pro rata
basis to each client account participating in the bunched order based upon the
initial amount requested for the account, subject to certain exceptions, and
each participating account will participate at the average share price for the
bunched order on the same business day.
Section 28(e) of the Securities Exchange Act of 1934 ("Section 28(e)")
permits an investment advisor, under certain circumstances, to cause an account
to pay a broker or dealer a commission for effecting a transaction in excess of
the amount of commission another broker or dealer would have charged for
effecting the transaction in recognition of the value of the brokerage and
research services provided by the broker or dealer. Brokerage and research
services include (a) furnishing advice as to the value of securities, the
advisability of investing in, purchasing or selling securities, and the
availability of securities or purchasers or sellers of securities; (b)
furnishing analyses and reports concerning issuers, industries, securities,
economic factors and trends, portfolio strategy, and the performance of
accounts; and (c) effecting securities transactions and performing functions
incidental thereto (such as clearance, settlement, and custody).
In carrying out the provisions of the Advisory Agreement, the Advisor may
cause the Fund to pay a broker, which provides brokerage and research services
to the Advisor, a commission for effecting a securities transaction in excess
of the amount another broker would have charged for effecting the transaction.
The Advisor believes it is important to its investment decision-making process
to have access to independent research. The Advisory Agreement provides that
such higher commissions will not be paid by the Fund unless (a) the Advisor
determines in good faith that the amount is reasonable in relation to the
services in terms of the particular transaction or in terms of the Advisor's
overall responsibilities with respect to the accounts as to which it exercises
investment discretion; (b) such payment is made in compliance with the
provisions of Section 28(e), other applicable state and federal laws, and the
Advisory Agreement; and (c) in the opinion of the Advisor, the total
commissions paid by the Fund will be reasonable in relation to the benefits to
the Fund over the long term. The investment
28
<PAGE> 52
management fee paid by the Fund under the Advisory Agreement is not reduced as
a result of the Advisor's receipt of research services.
Generally, research services provided by brokers may include information
on the economy, industries, groups of securities, individual companies,
statistical information, accounting and tax law interpretations, political
developments, legal developments affecting portfolio securities, technical
market action, pricing and appraisal services, credit analysis, risk
measurement analysis, performance analysis, and analysis of corporate
responsibility issues. Such research services are received primarily in the
form of written reports, telephone contacts, and personal meetings with
security analysts. In addition, such research services may be provided in the
form of access to various computer-generated data, computer hardware and
software, and meetings arranged with corporate and industry spokespersons,
economists, academicians, and government representatives. In some cases,
research services are generated by third parties but are provided to the
Advisor by or through brokers. Such brokers may pay for all or a portion of
computer hardware and software costs relating to the pricing of securities.
Where the Advisor itself receives both administrative benefits and
research and brokerage services from the services provided by brokers, it makes
a good faith allocation between the administrative benefits and the research
and brokerage services, and will pay for any administrative benefits with cash.
In making good faith allocations of costs between administrative benefits and
research and brokerage services, a conflict of interest may exist by reason of
the Advisor's allocation of the costs of such benefits and services between
those that primarily benefit the Advisor and those that primarily benefit the
Fund and other advisory clients.
From time to time, the Advisor may purchase new issues of securities for
the Fund in a fixed price offering. In these situations, the seller may be a
member of the selling group that will, in addition to selling the securities to
the Fund and other advisory clients, provide the Advisor with research. The
National Association of Securities Dealers has adopted rules expressly
permitting these types of arrangements under certain circumstances. Generally,
the seller will provide research "credits" in these situations at a rate that
is higher than that which is available for typical secondary market
transactions. These arrangements may not fall within the safe harbor of Section
28(e).
Each year, the Advisor considers the amount and nature of research and
research services provided by brokers, as well as the extent to which such
services are relied upon, and attempts to allocate a portion of the brokerage
business of the Fund and other advisory clients on the basis of that
consideration. In addition, brokers may suggest a level of business they would
like to receive in order to continue to provide such services. The actual
brokerage business received by a broker may be more or less than the suggested
allocations, depending upon the Advisor's evaluation of all applicable
considerations.
The Advisor has informal arrangements with various brokers whereby, in
consideration for providing research services and subject to Section 28(e), the
Advisor allocates brokerage to those firms, provided that their brokerage and
research services are satisfactory to the Advisor and their execution
capabilities were compatible with the Advisor's policy of seeking best
execution at the best security price available, as discussed above. In no case
will the Advisor make binding commitments as to the level of brokerage
commissions it will allocate to a broker, nor will it commit to pay cash if any
informal targets are not met. The Advisor anticipates it will continue to
enter into such brokerage arrangements.
The Advisor may direct the purchase of securities on behalf of the Fund
and other advisory clients in secondary market transactions, in public
offerings directly from an underwriter, or in privately negotiated transactions
with an issuer. When the Advisor believes the circumstances so warrant,
securities purchased in public offerings may be resold shortly after
acquisition in the immediate aftermarket for the security in order to take
advantage of price appreciation from the public offering price or for other
reasons. Short-term trading of securities acquired in public offerings, or
otherwise, may result in higher portfolio turnover and associated brokerage
expenses.
The Advisor places portfolio transactions for other advisory accounts,
including other mutual funds managed by the Advisor. Research services
furnished by firms through which the Fund effects its securities transactions
may be used by the Advisor in servicing all of its accounts; not all of such
services may be used by the Advisor in connection with the Fund. In the
opinion of the Advisor, it is not possible to measure separately the benefits
from research services to each of the accounts (including the Fund) managed by
the Advisor. Because the volume and nature of the trading activities of the
accounts are not uniform, the amount of commissions in excess of those charged
by another broker paid by each account for brokerage and
29
<PAGE> 53
research services will vary. However, in the opinion of the Advisor, such
costs to the Fund will not be disproportionate to the benefits received by the
Fund on a continuing basis.
The Advisor seeks to allocate portfolio transactions equitably whenever
concurrent decisions are made to purchase or sell securities by the Fund and
another advisory account. In some cases, this procedure could have an adverse
effect on the price or the amount of securities available to the Fund. In
making such allocations between the Fund and other advisory accounts, the main
factors considered by the Advisor are the respective investment objectives, the
relative size of portfolio holdings of the same or comparable securities, the
availability of cash for investment, the size of investment commitments
generally held, and the opinions of the persons responsible for recommending
the investment.
Where consistent with a client's investment objectives, investment
restrictions, and risk tolerance, the Advisor may purchase securities sold in
underwritten public offerings for client accounts, commonly referred to as
"deal" securities. The Advisor has adopted deal allocation procedures (the
"procedures"), summarized below, that reflect the Advisor's overriding policy
that deal securities must be allocated among participating client accounts in a
fair and equitable manner and that deal securities may not be allocated in a
manner that unfairly discriminates in favor of certain clients or types of
clients.
The procedures provide that, in determining which client accounts a
portfolio manager team will seek to have purchase deal securities, the team
will consider all relevant factors including, but not limited to, the nature,
size, and expected allocation to the Advisor of deal securities; the size of
the account(s); the accounts' investment objectives and restrictions; the risk
tolerance of the client; the client's tolerance for possibly higher portfolio
turnover; the amount of commissions generated by the account during the past
year; and the number of other deals the client has participated in during the
past year.
Where more than one of the Advisor's portfolio manager team seeks to have
client accounts participate in a deal and the amount of deal securities
allocated to the Advisor by the underwriting syndicate is less than the
aggregate amount ordered by the Advisor (a "reduced allocation"), the deal
securities will be allocated among the portfolio manager teams based on all
relevant factors. The primary factor shall be assets under management,
although other factors that may be considered in the allocation decision
include, but are not limited to, the nature, size, and expected allocation of
the deal; the amount of brokerage commissions or other amounts generated by the
respective participating portfolio manager teams; and which portfolio manager
team is primarily responsible for the Advisor receiving securities in the deal.
Based on the relevant factors, the Advisor has established general allocation
percentages for its portfolio manager teams, and these percentages are reviewed
on a regular basis to determine whether asset growth or other factors make it
appropriate to use different general allocation percentages for reduced
allocations.
When a portfolio manager team receives a reduced allocation of deal
securities, the portfolio manager team will allocate the reduced allocation
among client accounts in accordance with the allocation percentages set forth
in the team's initial allocation instructions for the deal securities, except
where this would result in a de minimis allocation to any client account. On a
regular basis, the Advisor reviews the allocation of deal securities to ensure
that they have been allocated in a fair and equitable manner that does not
unfairly discriminate in favor of certain clients or types of clients.
During 1994, 1995, and 1996 the Fund paid approximately $1,429,000,
$2,469,000, and $3,494,000 respectively, in brokerage commissions.
For the 1994, 1995, and 1996 fiscal periods ended December 31, the Fund's
portfolio turnover rates were 662%, 542%, and 970%, respectively. These
portfolio turnover rates for this Fund were higher than anticipated primarily
because the Fund employed a trading strategy to preserve the favorable tax
treatment available to it under the Internal Revenue Code of 1986 (the "Code"),
as amended.
CUSTODIAN
As custodian of the Fund's assets, Firstar Trust Company, P.O. Box 761,
Milwaukee, Wisconsin 53201, has custody of all securities and cash of the Fund,
delivers and receives payment for securities sold, receives and pays for
securities purchased, collects income from investments, and performs other
duties, all as directed by officers of the Corporation. The custodian is in no
way responsible for any of the investment policies or decisions of the Fund.
30
<PAGE> 54
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT
The Advisor acts as transfer agent and dividend-disbursing agent for the
Fund at no cost.
ADMINISTRATIVE SERVICES
From time to time the Fund and/or the Advisor may enter into arrangements
under which certain administrative services may be performed by the insurance
companies that purchase shares in the Fund. These administrative services may
include, among other things, responding to ministerial inquiries concerning the
Fund's investment objective, investment program, policies and performance,
transmitting, on behalf of the Fund, proxy statements, annual reports, updated
prospectuses, and other communications regarding the Fund, and providing only
related services as the Fund or its shareholders may reasonably request.
Depending on the arrangements, the Fund and/or Advisor may compensate such
insurance companies or their agents directly or indirectly for the
administrative services. To the extent the Fund compensates the insurance
company for these services, the Fund will pay the insurance company an annual
fee that will vary depending upon the number of contract holders that utilize
the Fund as the funding medium for their contracts. The insurance company may
impose other account or service charges. See the prospectus for the separate
account of the insurance company for additional information regarding such
charges.
TAXES
GENERAL
As indicated under "Additional Information - Distributions and Taxes" in
the Prospectus, the Fund intends to continue to qualify annually for treatment
as a regulated investment company ("RIC") under the Internal Revenue Code of
1986, as amended (the "Code"). This qualification does not involve government
supervision of the Fund's management practices or policies.
In order to qualify for treatment as a RIC under the Code, the Fund must
distribute to its shareholders for each taxable year at least 90% of its
investment company taxable income (consisting generally of net investment
income, net short-term capital gain, and net gains from certain foreign
currency transactions) ("Distribution Requirement") and must meet several
additional requirements. Among these requirements are the following: (1) the
Fund must derive at least 90% of its gross income each taxable year from
dividends, interest, payments with respect to securities loans, and gains from
the sale or other disposition of securities or foreign currencies, or other
income (including gains from options, futures, or forward contracts) derived
with respect to its business of investing in securities or those currencies
("Income Requirement"); (2) the Fund must derive less than 30% of its gross
income each taxable year from the sale or other disposition of securities, or
any of the following, that were held for less than three months - options or
futures (other than those on foreign currencies), or foreign currencies (or
options, futures, or forward contracts thereon) that are not directly related
to the Fund's principal business or investing in securities (or options and
futures with respect to securities) ("30% Limitation"); (3) at the close of
each quarter of the Fund's taxable year, at least 50% of the value of its total
assets must be represented by cash and cash items, U.S. government securities,
securities of other RICs, and other securities, with these other securities
limited, in respect of any one issuer, to an amount that does not exceed 5% of
the value of the Fund's total assets and that does not represent more than 10%
of the issuer's outstanding voting securities; and (4) at the close of each
quarter of the Fund's taxable year, not more than 25% of the value of its total
assets may be invested in securities (other than U.S. government securities or
the securities of other RICs) of any one issuer. From time to time the Advisor
may find it necessary to make certain types of investments for the purpose of
ensuring that the Fund continues to qualify for treatment as a RIC under the
Code.
If Fund shares are sold at a loss after being held for six months or less,
the loss will be treated as long-term, instead of short-term, capital loss to
the extent of any capital gain distributions received on those shares.
In addition, the Fund must satisfy the diversification requirements of
Section 817(h) of the Code. In general, for a Fund to meet these investment
diversification requirements, Treasury regulations require that no more than
55% of the total value of the assets of the Fund may be represented by any one
investment, no more than 70% by two investments, no more than 80% by three
investments and no more than 90% by four investments. Generally, for purposes
of the regulations, all
31
<PAGE> 55
securities of the same issuer are treated as a single investment. With respect
to the United States Government securities (including any security that is
issued, guaranteed or insured by the United States or an instrumentality of the
United States), each governmental agency or instrumentality is treated as a
separate issuer. Compliance with the regulations is tested on the last day of
each calendar year quarter. There is a 30-day period after the end of each
calendar year quarter in which to cure any non-compliance with these
requirements.
FOREIGN TRANSACTIONS
Interest and dividends received by the Fund may be subject to income,
withholding, or other taxes imposed by foreign countries and U.S. possessions
that would reduce the yield on its securities. Tax conventions between certain
countries and the United States may reduce or eliminate these foreign taxes,
however, and many foreign countries do not impose taxes on capital gains in
respect of investments by foreign investors.
The Fund maintains its accounts and calculates its income in U.S. dollars.
In general, gain or loss (1) from the disposition of foreign currencies and
forward currency contracts, (2) from the disposition of
foreign-currency-denominated debt securities that are attributable to
fluctuations in exchange rates between the date the securities are acquired and
their disposition date, and (3) attributable to fluctuations in exchange rates
between the time the Fund accrues interest or other receivables or expenses or
other liabilities denominated in a foreign currency and the time the Fund
actually collects those receivables or pays those liabilities, will be treated
as ordinary income or loss. A foreign-currency-denominated debt security
acquired by the Fund may bear interest at a high normal rate that takes into
account expected decreases in the value of the principal amount of the security
due to anticipated currency devaluations; in that case, the Fund would be
required to include the interest in income as it accrues but generally would
realize a currency loss with respect to the principal only when the principal
was received (through disposition or upon maturity).
The Fund may invest in the stock of "passive foreign investment companies"
("PFICs"). A PFIC is a foreign corporation that, in general, meets either of
the following tests: (1) at least 75% of its gross income is passive or (2) an
average of at least 50% of its assets produce, or are held for the production
of, passive income. Under certain circumstances, the Fund will be subject to
federal income tax on a portion of any "excess distribution" received on the
stock or of any gain on disposition of the stock (collectively, "PFIC income"),
plus interest thereon, even if the Fund distributes the PFIC income to its
shareholders. The balance of the PFIC income will be included in the Fund's
investment company taxable income and, accordingly, will not be taxable to it
to the extent that income is distributed to its shareholders. If the Fund
invests in a PFIC and elects to treat the PFIC as a "qualified electing fund,"
then in lieu of the foregoing tax and interest obligation, the Fund will be
required to include in income each year its pro rata share of the qualified
electing fund's annual ordinary earnings and net capital gain (the excess of
net long-term capital gain over net short-term capital loss) -- which probably
would have to be distributed to its shareholders to satisfy the Distribution
Requirement -- even if those earnings and gain were not received by the Fund.
In most instances it will be very difficult, if not impossible, to make this
election because of certain requirements thereof.
DERIVATIVE INSTRUMENTS
The use of derivatives strategies, such as purchasing and selling
(writing) options and futures and entering into forward currency contracts,
involves complex rules that will determine for income tax purposes the
character and timing of recognition of the gains and losses the Fund realizes
in connection therewith. Gains from the disposition of foreign currencies
(except certain gains therefrom that may be excluded by future regulations),
and income from transactions in options, futures, and forward currency
contracts derived by the Fund with respect to its business of investing in
securities or foreign currencies, will qualify as permissible income under the
Income Requirement. However, income from the disposition of options and
futures (other than those on foreign currencies) will be subject to the 30%
Limitation if they are held for less than three months. Income from the
disposition of foreign currencies, and options, futures, and forward contracts
on foreign currencies, that are not directly related to the Fund's principal
business of investing in securities (or options and futures with respect to
securities) also will be subject to the 30% Limitation if they are held for
less than three months.
If the Fund satisfies certain requirements, any increase in value of a
position that is part of a "designated hedge" will be offset by any decrease in
value (whether realized or not) of the offsetting hedging position during the
period of the hedge for purposes of determining whether the Fund satisfies the
30% Limitation. Thus, only the net gain (if any) from the designated hedge
will be included in gross income for purposes of that limitation. The Funds
intend that, when they engage in hedging
32
<PAGE> 56
strategies, the hedging transactions will qualify for this treatment, but at
the present time it is not clear whether this treatment will be available for
all of the Fund's hedging transactions. To the extent this treatment is not
available or is not elected by the Fund, it may be forced to defer the closing
out of certain options, futures, or forward currency contracts beyond the time
when it otherwise would be advantageous to do so, in order for the Fund to
continue to qualify as a RIC.
For federal income tax purposes, the Fund is required to recognize as
income for each taxable year its net unrealized gains and losses on options,
futures, and forward currency contracts that are subject to section 1256 of the
Code ("Section 1256 Contracts") and are held by the Fund as of the end of the
year, as well as gains and losses on Section 1256 Contracts actually realized
during the year. Except for Section 1256 Contracts that are part of a "mixed
straddle" and with respect to which the Fund makes a certain election, any gain
or loss recognized with respect to Section 1256 Contracts is considered to be
60% long-term capital gain or loss and 40% short-term capital gain or loss,
without regard to the holding period of the Section 1256 Contract. Unrealized
gains on Section 1256 Contracts that have been held by the Fund for less than
three months as of the end of its taxable year, and that are recognized for
federal income tax purposes as described above, will not be considered gains on
investments held for less than three months for purposes of the 30% Limitation.
ZERO-COUPON, STEP-COUPON, AND PAY-IN-KIND SECURITIES
The Fund may acquire zero-coupon, step-coupon, or other securities issued
with original issue discount. As a holder of those securities, the Fund must
include in its income the original issue discount that accrues on the
securities during the taxable year, even if the Fund receives no corresponding
payment on the securities during the year. Similarly, the Fund must include in
its income securities it receives as "interest" on pay-in-kind securities.
Because the Fund annually must distribute substantially all of its investment
company taxable income, including any original issue discount and other
non-cash income, to satisfy the Distribution Requirement, it may be required in
a particular year to distribute as a dividend an amount that is greater than
the total amount of cash it actually receives. Those distributions may be made
from the proceeds on sales of portfolio securities, if necessary. The Fund may
realize capital gains or losses from those sales, which would increase or
decrease its investment company taxable income or net capital gain, or both.
In addition, any such gains may be realized on the disposition of securities
held for less than three months. Because of the 30% Limitation, any such gains
would reduce the Fund's ability to sell other securities, or certain options,
futures, or forward currency contracts, held for less that three months that
it might wish to sell in the ordinary course of its portfolio management.
The foregoing federal tax discussion as well as the tax discussion
contained within the Prospectus under "Additional Information - Distributions
and Taxes" is intended to provide you with an overview of the impact of federal
income tax provisions on the Fund or its shareholders. These tax provisions
are subject to change by legislative or administrative action at the federal,
state, or local level, and any changes may be applied retroactively. Any such
action that limits or restricts the Fund's current ability to pass-through
earnings without taxation at the Fund level, or otherwise materially changes
the Fund's tax treatment, could adversely affect the value of a shareholder's
investment in the Fund. Because the Fund's taxes are a complex matter, you
should consult your tax adviser for more detailed information concerning the
taxation of the Fund and the federal, state, and local tax consequences to
shareholders of an investment in the Fund.
DETERMINATION OF NET ASSET VALUE
A more complete discussion of the Fund's determination of net asset value
is contained in the Prospectus. Generally, the net asset value of the Fund
will be determined as of the close of trading on each day the New York Stock
Exchange (the "NYSE") is open for trading. The NYSE is open for trading Monday
through Friday except New Year's Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
Additionally, if any of the aforementioned holidays falls on a Saturday, the
NYSE will not be open for trading on the preceding Friday, and when any such
holiday falls on a Sunday, the NYSE will not be open for trading on the
succeeding Monday, unless unusual business conditions exist, such as the ending
of a monthly or the yearly accounting period.
Debt securities are valued by a pricing service that utilizes electronic
data processing techniques to determine values for normal institutional-sized
trading units of debt securities without regard to sale or bid prices when
such values are believed to more accurately reflect the fair market value for
such securities. Otherwise, sale or bid prices are used. Any securities or
other assets for which market quotations are not readily available are valued
at fair value as determined in good faith by the
33
<PAGE> 57
Board of Directors of the Corporation. Debt securities having remaining
maturities of 60 days or less are valued by the amortized cost method when the
Corporation's Board of Directors determines that the fair value of such
securities is their amortized cost. Under this method of valuation, a security
is initially valued at its acquisition cost, and thereafter, amortization of
any discount or premium is assumed each day, regardless of the impact of the
fluctuating rates on the market value of the instrument.
ADDITIONAL SHAREHOLDER INFORMATION
The Fund has elected to be governed by Rule 18f-1 under the 1940 Act,
which obligates it to redeem shares in cash, with respect to any one
shareholder during any 90-day period, up to the lesser of $250,000 or 1% of the
assets of the Fund. If the Advisor determines that existing conditions make
cash payments undesirable, redemption payments may be made in whole or in part
in securities or other financial assets, valued for this purpose as they are
valued in computing the NAV for the Fund's shares (a "redemption-in-kind").
Shareholders receiving securities or other financial assets in a
redemption-in-kind may realize a gain or loss for tax purposes, and will incur
any costs of sale, as well as the associated inconveniences. If you expect to
make a redemption in excess of the lesser of $250,000 or 1% of the Fund's
assets during any 90-day period and would like to avoid any possibility of
being paid with securities in-kind, you may do so by providing Strong Funds
with an unconditional instruction to redeem at least 15 calendar days prior to
the date on which the redemption transaction is to occur, specifying the dollar
amount or number of shares to be redeemed and the date of the transaction
(please call 1-800-368-3863). This will provide the Fund with sufficient time
to raise the cash in an orderly manner to pay the redemption and thereby
minimize the effect of the redemption on the interests of the Fund's remaining
shareholders. Redemption checks in excess of the lesser of $250,000 or 1% of
the Fund's assets during any 90-day period may not be honored by the Fund if
the Advisor determines that existing conditions make cash payments undesirable.
FUND ORGANIZATION
The Fund is a series of Strong Variable Insurance Funds, Inc., a Wisconsin
corporation (the "Corporation"). The Corporation (formerly known as Strong
Discovery Fund II, Inc., formerly known as Strong D Fund, Inc.) was organized
on December 28, 1990 and is authorized to issue an indefinite number of shares
of common stock and series and classes of series of shares of common stock,
with a par value of $.00001 per share. The Corporation is authorized to issue
an indefinite number of shares of common stock of the Fund. Each share of the
Corporation has one vote, and all shares of a series participate equally in
dividends and other capital gains distributions and in the residual assets of
that Fund in the event of liquidation. Fractional shares have the same rights
proportionately as do full shares. Shares of the Corporation have no
preemptive, conversion, or subscription rights. The Corporation currently has
seven series of common stock outstanding. The assets belonging to each series
of shares is held separately by the custodian, and in effect each series is a
separate fund. All holders of shares of the Corporation would vote on each
matter presented to shareholders for action except with respect to any matter
which affects only one or more series or classes, in which case only the shares
of the affected series or class shall be entitled to vote. Because of current
federal securities law requirements the Corporation expects that its
shareholders will offer to owners of variable annuity and variable life
insurance contracts the opportunity to instruct them as to how shares allocable
to their contracts will be voted with respect to certain matters, such as
approval of changes to the investment advisory agreement.
PERFORMANCE INFORMATION
As described under "Additional Information - Performance Information" in
the Prospectus, the Fund's historical performance or return may be shown in the
form of "average annual total return," "total return," and "cumulative total
return." From time to time, the Advisor may voluntarily waive all or a portion
of its management fee and/or absorb certain expenses for the Fund. Total
returns contained in advertisements include the effect of deducting the Fund's
expenses, but may not include charges and expenses attributable to any
particular insurance product. Since shares may only be purchased by the
separate accounts of certain insurance companies, contracts owners should
carefully review the prospectus of the separate account for information on fees
and expenses. Excluding such fees and expenses from the Fund's total return
quotations has the effect of increasing the performance quoted.
34
<PAGE> 58
AVERAGE ANNUAL TOTAL RETURN
The Fund's average annual total return quotation is computed in accordance
with a standardized method prescribed by rules of the SEC. The average annual
total return for the Fund for a specific period is found by first taking a
hypothetical $10,000 investment ("initial investment") in the Fund's shares on
the first day of the period and computing the "redeemable value" of that
investment at the end of the period. The redeemable value is then divided by
the initial investment, and this quotient is taken to the Nth root (N
representing the number of years in the period) and one is subtracted from the
result, which is then expressed as a percentage. The calculation assumes that
all income and capital gains dividends paid by the Fund have been reinvested at
net asset value on the reinvestment dates during the period. Average annual
total return figures for various periods are set forth in the table below.
TOTAL RETURN
Calculation of the Fund's total return is not subject to a standardized
formula. Total return performance for a specific period is calculated by first
taking an investment (assumed below to be $10,000) ("initial investment") in
the Fund's shares on the first day of the period and computing the "ending
value" of that investment at the end of the period. The total return
percentage is then determined by subtracting the initial investment from the
ending value and dividing the remainder by the initial investment and
expressing the result as a percentage. The calculation assumes that all income
and capital gains dividends paid by the Fund have been reinvested at net asset
value on the reinvestment dates during the period. Total return may also be
shown as the increased dollar value of the hypothetical investment over the
period. Total return figures for various periods are set forth in the table
below.
CUMULATIVE TOTAL RETURN
Calculation of the Fund's cumulative total return is not subject to a
standardized formula and represents the simple change in value of an investment
over a stated period and may be quoted as a percentage or as a dollar amount.
Total returns and cumulative total returns may be broken down into their
components of income and capital (including capital gains and changes in share
price) in order to illustrate the relationship between these factors and their
contributions to total return.
The Fund's performance figures are based upon historical results and do
not represent future performance. The Fund's shares are sold at net asset
value per share. The Fund's returns and net asset value will fluctuate and
shares are redeemable at the then current net asset value of the Fund, which
may be more or less than original cost. Factors affecting the Fund's
performance include general market conditions, operating expenses, and
investment management. Any additional fees charged by an insurance company or
other financial services firm would reduce the returns described in this
section.
The table below shows performance information for various periods ended
December 31, 1996. Securities prices fluctuated during these periods.
DISCOVERY FUND II
<TABLE>
<CAPTION>
Average
Total Return Annual Total Return
------------ -------------------
Initial $10,000 Ending Value Percentage Percentage
Investment December 31, 1996 Increase Increase
=============================================================================
<S> <C> <C> <C> <C>
Life of Fund* $10,000 $17,138 71.38% 12.29%
One Year $10,000 $10,081 0.81% 0.81%
</TABLE>
______________________________________
* Commenced operations on May 8, 1992.
The Fund's total return for the three months ending March 31, 1997, was
- -10.00%.
35
<PAGE> 59
COMPARISONS
(1) U.S. TREASURY BILLS, NOTES, OR BONDS
Investors may also wish to compare the performance of the Fund to that of
United States Treasury bills, notes, or bonds, which are issued by the U.S.
government, because such instruments represent alternative income producing
products. Treasury obligations are issued in selected denominations. Rates of
Treasury obligations are fixed at the time of issuance and payment of principal
and interest is backed by the full faith and credit of the United States
Treasury. The market value of such instruments will generally fluctuate
inversely with interest rates prior to maturity and will equal par value at
maturity.
(2) CERTIFICATES OF DEPOSIT
Investors may wish to compare the Fund's performance to that of
certificates of deposit offered by banks and other depositary institutions.
Certificates of deposit represent an alternative income producing product.
Certificates of deposit may offer fixed or variable interest rates and
principal is guaranteed and may be insured. Withdrawal of the deposits prior to
maturity normally will be subject to a penalty. Rates offered by banks and
other depositary institutions are subject to change at any time specified by
the issuing institution.
(3) MONEY MARKET FUNDS
Investors may also want to compare performance of the Fund to that of
money market funds. Money market fund yields will fluctuate and an investment
in money market fund shares is neither insured nor guaranteed by the U.S.
government, but share values usually remain stable.
(4) LIPPER ANALYTICAL SERVICES, INC. ("LIPPER") AND OTHER INDEPENDENT RANKING
ORGANIZATIONS
From time to time, in marketing and other fund literature, the Fund's
performance may be compared to the performance of other mutual funds in general
or to the performance of particular types of mutual funds, with similar
investment goals, as tracked by independent organizations. Among these
organizations, Lipper, a widely used independent research firm which ranks
mutual funds by overall performance, investment objectives, and assets, may be
cited. Lipper performance figures are based on changes in net asset value,
with all income and capital gain dividends reinvested. Such calculations do
not include the effect of any sales charges imposed by other funds. The Fund
will be compared to Lipper's appropriate fund category, that is, by fund
objective and portfolio holdings.
(5) MORNINGSTAR, INC.
The Fund's performance may also be compared to the performance of other
mutual funds by Morningstar, Inc. which rates funds on the basis of historical
risk and total return. Morningstar's ratings range from five stars (highest)
to one star (lowest) and represent Morningstar's assessment of the historical
risk level and total return of the Fund as a weighted average for 3, 5, and 10
year periods. Ratings are not absolute and do not represent future results.
(6) VARDS REPORT
The Fund's performance may also be compared to the performance of other
variable annuity products in general or to the performance of particular types
of variable annuity products, with similar investment goals, as tracked by the
VARDS Report (Variable Annuity Research and Data Service Report) produced by
Financial Planning Resources, Inc. The VARDS Report is a monthly performance
analysis of the variable annuity industry.
(7) INDEPENDENT SOURCES
Evaluations of Fund performance made by independent sources may also be
used in advertisements concerning the Fund, including reprints of, or
selections from, editorials or articles about the Fund, especially those with
similar objectives. Sources for Fund performance information and articles
about the Fund may include publications such as Money, Forbes, Kiplinger's,
Smart Money, Morningstar, Inc., Financial World, Business Week, U.S. News and
World Report, The Wall Street Journal, Barron's, and a variety of investment
newsletters.
36
<PAGE> 60
(8) INDICES
The Fund may compare its performance to a wide variety of indices
including the following:
(a) Consumer Price Index
(b) Dow Jones Average of 30 Industrials
(c) NASDAQ Over-the-Counter Composite Index
(d) Standard & Poor's 500 Stock Index
(e) Standard & Poor's 400 Mid-Cap Stock Index
(f) Standard & Poor's 600 Small-Cap Index
(g) Russell 2000 Stock Index
(h) Russell 3000 Stock Index
(i) Russell MidCap Index
(j) Russell MidCap Growth Index
(k) Russell MidCap Value Index
(l) Morgan Stanley Capital International EAFE(R) Index (Net
Dividend, Gross Dividend, and Price-Only). In addition, the Fund may
compare its performance to certain other indices that measure stock
market performance in geographic areas in which the Fund may invest.
The market prices and yields of the stocks in these indexes will
fluctuate. The Fund may also compare its portfolio weighting to the
EAFE Index weighting, which represents the relative capitalization
of the major overseas markets on a dollar-adjusted basis
(9) HISTORICAL ASSET CLASS RETURNS
From time to time, marketing materials may portray the historical returns
of various asset classes. Such presentations will typically compare the
average annual rates of return of inflation, U.S. Treasury bills, bonds, common
stocks, and small stocks. There are important differences between each of these
investments that should be considered in viewing any such comparison. The
market value of stocks will fluctuate with market conditions, and small-stock
prices generally will fluctuate more than large-stock prices. Stocks are
generally more volatile than bonds. In return for this volatility, stocks have
generally performed better than bonds or cash over time. Bond prices generally
will fluctuate inversely with interest rates and other market conditions, and
the prices of bonds with longer maturities generally will fluctuate more than
those of shorter-maturity bonds. Interest rates for bonds may be fixed at the
time of issuance, and payment of principal and interest may be guaranteed by
the issuer and, in the case of U.S. Treasury obligations, backed by the full
faith and credit of the U.S. Treasury.
(10) STRONG VARIABLE INSURANCE FUNDS
The Strong Variable Insurance Funds offer a range of investment options.
All of the members of the Strong Variable Insurance Funds and their investment
objectives are listed below. The Funds are listed in ascending order of risk
and return, as determined by the Funds' Advisor.
FUND NAME INVESTMENT OBJECTIVE
- -------------------------------------------------------------------------------
Strong Advantage Fund II Current income with a very low degree of
share price fluctuation.
- -------------------------------------------------------------------------------
Strong Government Securities Fund II Total return by investing for a high
level of current income with a moderate
degree of share-price fluctuation
- -------------------------------------------------------------------------------
Strong Asset Allocation Fund II High total return consistent with
reasonable risk over the long term.
- -------------------------------------------------------------------------------
Strong Special Fund II Capital growth.
- -------------------------------------------------------------------------------
Strong Growth Fund II Capital growth.
- -------------------------------------------------------------------------------
Strong Discovery Fund II Capital growth.
- -------------------------------------------------------------------------------
Strong International Stock Fund II Capital growth.
- -------------------------------------------------------------------------------
Each Fund may from time to time be compared to the other Funds in the
Strong Variable Insurance Funds based on a risk/reward spectrum. In general,
the amount of risk associated with any investment product is commensurate with
that product's potential level of reward. The Strong Variable Insurance Funds'
risk/reward continuum or any Fund's position on the continuum may be described
or diagrammed in marketing materials. The Strong Variable Insurance Funds'
risk/reward continuum positions the risk and reward potential of the Fund
relative to the other Strong Variable Insurance Funds, but is not intended to
position any Fund relative to other mutual funds or investment products.
Marketing materials may also discuss the
37
<PAGE> 61
relationship between risk and reward as it relates to an individual investor's
portfolio. Financial goals vary from person to person. You may choose one or
more of the Strong Variable Insurance Funds to help you reach your financial
goals.
The Advisor also serves as advisor to the Strong Family of Funds, which is
a retail fund complex composed of 26 open-end management investment companies.
ADDITIONAL FUND INFORMATION
(1) PORTFOLIO CHARACTERISTICS
In order to present a more complete picture of a Fund's portfolio,
marketing materials may include various actual or estimated portfolio
characteristics, including but not limited to median market capitalizations,
earnings per share, alphas, betas, price/earnings ratios, returns on equity,
dividend yields, capitalization ranges, growth rates, price/book ratios, top
holdings, sector breakdowns, asset allocations, quality breakdowns, and
breakdowns by geographic region.
(2) MEASURES OF VOLATILITY AND RELATIVE PERFORMANCE
Occasionally statistics may be used to specify Fund volatility or risk.
The general premise is that greater volatility connotes greater risk undertaken
in achieving performance. Measures of volatility or risk are generally used to
compare the Fund's net asset value or performance relative to a market index.
One measure of volatility is beta. Beta is the volatility of a fund relative
to the total market as represented by the Standard & Poor's 500 Stock Index. A
beta of more than 1.00 indicates volatility greater than the market, and a beta
of less than 1.00 indicates volatility less than the market. Another measure
of volatility or risk is standard deviation. Standard deviation is a
statistical tool that measures the degree to which a fund's performance has
varied from its average performance during a particular time period.
Standard deviation is calculated using the following formula:
Standard deviation = the square root of E (x(i) - x(m))(2)
------------------
n-1
where E = "the sum of",
x(i) = each individual return during the time period,
x(m) = the average return over the time period, and
n = the number of individual returns during the time period.
Statistics may also be used to discuss a Fund's relative performance. One
such measure is alpha. Alpha measures the actual return of a fund compared to
the expected return of a fund given its risk (as measured by beta). The
expected return is based on how the market as a whole performed, and how the
particular fund has historically performed against the market. Specifically,
alpha is the actual return less the expected return. The expected return is
computed by multiplying the advance or decline in a market representation by
the fund's beta. A positive alpha quantifies the value that the fund manager
has added, and a negative alpha quantifies the value that the fund manager has
lost.
Other measures of volatility and relative performance may be used as
appropriate. However, all such measures will fluctuate and do not represent
future results.
GENERAL INFORMATION
BUSINESS PHILOSOPHY
The Advisor is an independent, Midwestern-based investment advisor, owned
by professionals active in its management. Recognizing that investors are the
focus of its business, the Advisor strives for excellence both in investment
management and in the service provided to investors. This commitment affects
many aspects of the business, including professional staffing, product
development, investment management, and service delivery.
38
<PAGE> 62
The increasing complexity of the capital markets requires specialized
skills and processes for each asset class and style. Therefore, the Advisor
believes that active management should produce greater returns than a passively
managed index. The Advisor has brought together a group of top-flight
investment professionals with diverse product expertise, and each concentrates
on their investment specialty. The Advisor believes that people are the firm's
most important asset. For this reason, continuity of professionals is critical
to the firm's long-term success.
INVESTMENT ENVIRONMENT
Discussions of economic, social, and political conditions and their impact
on the Fund may be used in advertisements and sales materials. Such factors
that may impact the Fund include, but are not limited to, changes in interest
rates, political developments, the competitive environment, consumer behavior,
industry trends, technological advances, macroeconomic trends, and the supply
and demand of various financial instruments. In addition, marketing materials
may cite the portfolio management's views or interpretations of such factors.
EIGHT BASIC PRINCIPLES FOR SUCCESSFUL MUTUAL FUND INVESTING
These common sense rules are followed by many successful investors. They
make sense for beginners, too. If you have a question on these principles, or
would like to discuss them with us, please contact us at 1-800-368-3863.
1. Have a plan - even a simple plan can help you take control of your
financial future. Review your plan once a year, or if your circumstances
change.
2. Start investing as soon as possible. Make time a valuable ally. Let it
put the power of compounding to work for you, while helping to reduce your
potential investment risk.
3. Diversify your portfolio. By investing in different asset classes -
stocks, bonds, and cash - you help protect against poor performance in one
type of investment while including investments most likely to help you
achieve your important goals.
4. Invest regularly. Investing is a process, not a one-time event. By
investing regularly over the long term, you reduce the impact of
short-term market gyrations, and you attend to your long-term plan before
you're tempted to spend those assets on short-term needs.
5. Maintain a long-term perspective. For most individuals, the best
discipline is staying invested as market conditions change. Reactive,
emotional investment decisions are all too often a source of regret - and
principal loss.
6. Consider stocks to help achieve major long-term goals. Over time, stocks
have provided the more powerful returns needed to help the value of your
investments stay well ahead of inflation.
7. Keep a comfortable amount of cash in your portfolio. To meet current
needs, including emergencies, use a money market fund or a bank account -
not your long-term investment assets.
8. Know what you're buying. Make sure you understand the potential risks and
rewards associated with each of your investments. Ask questions...request
information...make up your own mind. And choose a fund company that helps
you make informed investment decisions.
PORTFOLIO MANAGEMENT
The portfolio manager works with a team of analysts, traders, and
administrative personnel. From time to time, marketing materials may discuss
various members of the team, including their education, investment experience,
and other credentials.
While the Fund has the ability to take advantage of favorable trends in
stock prices, it also retains the flexibility to invest up to 100% of its
assets in conservative, short-term, money market securities. The need for this
flexibility is based on a
39
<PAGE> 63
fundamental belief by the Advisor that economic and financial conditions create
favorable and unfavorable investment periods (or seasons) and that these
different seasons require different investment approaches. Through its
understanding and willingness to change with these investment cycles, the
Advisor seeks to achieve the Fund's objectives throughout the seasons of
investment. The Fund is managed to capitalize on change, which can include
technological, regulatory, political, social, economic, market, management and
demographic change.
The Advisor's investment philosophy is that (i) the maximum capital growth
should be aggressively pursued in a favorable market environment; (ii) capital
preservation is critical under unfavorable market conditions; and (iii) broad
use of asset classes and investment vehicles provides flexibility in achieving
capital growth and risk control. The Advisor also believes that (i) the
purpose of investment capital is to finance corporate growth, (ii) companies
that are growing rapidly often provide excellent opportunities for capital
appreciation, (iii) assessing the management behind a company is as important
as "crunching the numbers", and (iv) American and foreign economies are
increasingly intertwined, creating growth opportunities for both American and
foreign companies.
The Advisors investment process includes (i) independent, fundamental
analysis; (ii) top-down economic and secular research to determine the current
position of the economic cycle, identify unique secular trends and themes, and
allocate asset classes; (iii) bottom-up security analysis and selection process
with particular emphasis on the following: free cash flow, revenue and earnings
growth, balance sheet strength, share repurchase programs, competitive
position, discounted cash flow value, private market value, relative price
earnings ratio, and assessment of management, including on-site visits; (iv)
reducing equity exposure in bear markets; and (v) aggressively pursuing unique
investment opportunities.
The Advisor considers selling a stock when there is a change in market
conditions, a change in company fundamentals, or when the stock is excessively
overvalued. The Advisor attempts to reduce risk by diversifying broadly across
industries and by generally limiting position sizes up to 5% or less.
INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P., 411 East Wisconsin Avenue, Milwaukee, Wisconsin
53202, have been selected as the independent accountants for the Fund,
providing audit services and assistance and consultation with respect to the
preparation of filings with the SEC.
LEGAL COUNSEL
Godfrey & Kahn, S.C., 780 North Water Street, Milwaukee, Wisconsin 53202,
acts as outside legal counsel for the Fund.
FINANCIAL STATEMENTS
The Annual Report for the year ended December 31, 1996 that is attached
hereto contains the following financial information for the Fund:
(a) Schedule of Investments in Securities.
(b) Statement of Operations.
(c) Statement of Assets and Liabilities.
(d) Statement of Changes in Net Assets.
(e) Notes to Financial Statements.
(f) Financial Highlights.
(g) Report of Independent Accountants.
40
<PAGE> 64
APPENDIX
BOND RATINGS
STANDARD & POOR'S DEBT RATINGS
A Standard & Poor's corporate or municipal debt rating is a current
assessment of the creditworthiness of an obligor with respect to a specific
obligation. This assessment may take into consideration obligors such as
guarantors, insurers, or lessees.
The debt rating is not a recommendation to purchase, sell, or hold a
security, inasmuch as it does not comment as to market price or suitability for
a particular investor.
The ratings are based on current information furnished by the issuer or
obtained by S&P from other sources it considers reliable. S&P does not perform
an audit in connection with any rating and may, on occasion, rely on unaudited
financial information. The ratings may be changed, suspended, or withdrawn as
a result of changes in, or unavailability of, such information, or based on
other circumstances.
The ratings are based, in varying degrees, on the following
considerations:
1. Likelihood of default capacity and willingness of
the obligor as to the timely payment of interest and repayment
of principal in accordance with the terms of the obligation.
2. Nature of and provisions of the obligation.
3. Protection afforded by, and relative position of,
the obligation in the event of bankruptcy, reorganization, or
other arrangement under the laws of bankruptcy and other laws
affecting creditors' rights.
INVESTMENT GRADE
AAA Debt rated 'AAA' has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA Debt rated 'AA' has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree.
A Debt rated 'A' has a strong capacity to pay interest and repay
principal, although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher-rated
categories.
BBB Debt rated 'BBB' is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
SPECULATIVE GRADE
Debt rated 'BB', 'B', 'CCC', 'CC' and 'C' is regarded as having
predominantly speculative characteristics with respect to capacity to pay
interest and repay principal. 'BB' indicates the least degree of speculation
and 'C' the highest. While such debt will likely have some quality and
protective characteristics, these are outweighed by large uncertainties or
major exposures to adverse conditions.
BB Debt rated 'BB' has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The 'BB'
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied 'BBB-' rating.
A-1
<PAGE> 65
B Debt rated 'B' has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial, or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The 'B' rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied 'BB' or 'BB-' rating.
CCC Debt rated 'CCC' has a currently identifiable vulnerability to
default, and is dependent upon favorable business, financial, and economic
conditions to meet timely payment of interest and repayment of principal. In
the event of adverse business, financial, or economic conditions, it is not
likely to have the capacity to pay interest and repay principal. The 'CCC'
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied 'B' or 'B-' rating.
CC Debt rated 'CC' typically is applied to debt subordinated to senior
debt that is assigned an actual or implied 'CCC' rating.
C Debt rated 'C' typically is applied to debt subordinated to senior debt
which is assigned an actual or implied 'CCC-' rating. The 'C' rating may be
used to cover a situation where a bankruptcy petition has been filed, but debt
service payments are continued.
CI The rating 'CI' is reserved for income bonds on which no interest is
being paid.
D Debt rated 'D' is in payment default. The 'D' rating category is used
when interest payments or principal payments are not made on the date due, even
if the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grade period. The 'D' rating also will be
used upon the filing of a bankruptcy petition if debt service payments are
jeopardized.
MOODY'S LONG-TERM DEBT RATINGS
Aaa - Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edged". Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa - Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risk appear somewhat larger than in Aaa
securities.
A - Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper-medium grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may be
present which suggest a susceptibility to impairment some time in the future.
Baa - Bonds which are rated Baa are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest
payments and principal security appear adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable over
any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba - Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate, and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
maintenance of other terms of the contract over any long period of time may be
small.
A-2
<PAGE> 66
Caa - Bonds which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to principal
or interest.
Ca - Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other marked
shortcomings.
C - Bonds which are rated C are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
FITCH INVESTORS SERVICE, INC. BOND RATINGS
Fitch investment grade bond and preferred stock ratings provide a guide to
investors in determining the credit risk associated with a particular security.
The ratings represent Fitch's assessment of the issuer's ability to meet the
obligations of a specific debt or preferred issue in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the
issuer's future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided
by insurance policies or financial guaranties unless otherwise indicated.
Bonds and preferred stock carrying the same rating are of similar but not
necessarily identical credit quality since the rating categories do not fully
reflect small differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for other reasons.
AAA Bonds and preferred stock considered to be investment grade
and of the highest credit quality. The obligor has an exceptionally
strong ability to pay interest and/or dividends and repay principal,
which is unlikely to be affected by reasonably foreseeable events.
AA Bonds and preferred stock considered to be investment grade
and of very high credit quality. The obligor's ability to pay
interest and/or dividends and repay principal is very strong,
although not quite as strong as bonds rated 'AAA'. Because bonds
and preferred stock rated in the 'AAA' and 'AA' categories are not
significantly vulnerable to foreseeable future developments,
short-term debt of the issuers is generally rated 'F-1+'.
A Bonds and preferred stock considered to be investment grade
and of high credit quality. The obligor's ability to pay interest
and/or dividends and repay principal is considered to be strong,
but may be more vulnerable to adverse changes in economic
conditions and circumstances than debt or preferred securities with
higher ratings.
BBB Bonds and preferred stock considered to be investment grade
and of satisfactory credit quality. The obligor's ability to pay
interest or dividends and repay principal is considered to be
adequate. Adverse changes in economic conditions and circumstances,
however, are more likely to have adverse impact on these securities
and, therefore, impair timely payment. The likelihood that the
ratings of these bonds or preferred will fall below investment grade
is higher than for securities with higher ratings.
A-3
<PAGE> 67
Fitch speculative grade bond or preferred stock ratings provide a guide to
investors in determining the credit risk associated with a particular security.
The ratings ('BB' to 'C') represent Fitch's assessment of the likelihood of
timely payment of principal and interest or dividends in accordance with the
terms of obligation for issues not in default. For defaulted bonds or
preferred stock, the rating ('DDD' to 'D') is an assessment of the ultimate
recovery value through reorganization or liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer or possible recovery value in
bankruptcy, the current and prospective financial condition and operating
performance of the issuer and any guarantor, as well as the economic and
political environment that might affect the issuer's future financial strength.
Bonds or preferred stock that have the same rating are of similar but not
necessarily identical credit quality since the rating categories cannot fully
reflect the differences in the degrees of credit risk.
BB Bonds or preferred stock are considered speculative. The
obligor's ability to pay interest or dividends and repay principal
may be affected over time by adverse economic changes. However,
business and financial alternatives can be identified, which could
assist the obligor in satisfying its debt service requirements.
B Bonds or preferred stock are considered highly speculative.
While bonds in this class are currently meeting debt service
requirements or paying dividends, the probability of continued
timely payment of principal and interest reflects the obligor's
limited margin of safety and the need for reasonable business and
economic activity throughout the life of the issue.
CCC Bonds or preferred stock have certain identifiable
characteristics that, if not remedied, may lead to default. The
ability to meet obligations requires an advantageous business and
economic environment.
CC Bonds or preferred stock are minimally protected. Default
in payment of interest and/or principal seems probable over time.
C Bonds are in imminent default in payment of interest or
principal or suspension of preferred stock dividends is imminent.
DDD, DD,
and D Bonds are in default on interest and/or principal payments
or preferred stock dividends are suspended. Such securities are
extremely speculative and should be valued on the basis of their
ultimate recovery value in liquidation or reorganization of the
obligor. 'DDD' represents the highest potential for recovery of
these securities, and 'D' represents the lowest potential for
recovery.
DUFF & PHELPS, INC. LONG-TERM DEBT RATINGS
These ratings represent a summary opinion of the issuer's long-term
fundamental quality. Rating determination is based on qualitative and
quantitative factors which may vary according to the basic economic and
financial characteristics of each industry and each issuer. Important
considerations are vulnerability to economic cycles as well as risks related to
such factors as competition, government action, regulation, technological
obsolescence, demand shifts, cost structure, and management depth and
expertise. The projected viability of the obligor at the trough of the cycle
is a critical determination.
Each rating also takes into account the legal form of the security, (e.g.,
first mortgage bonds, subordinated debt, preferred stock, etc.). The extent of
rating dispersion among the various classes of securities is determined by
several factors including relative weightings of the different security classes
in the capital structure, the overall credit strength of the issuer, and the
nature of covenant protection. Review of indenture restrictions is important
to the analysis of a company's operating and financial constraints. From time
to time, Duff & Phelps Credit Rating Co. places issuers or security classes on
Rating Watch. The Rating Watch Status results from a need to notify investors
and the issuer that there are conditions present leading us to re-evaluate the
current rating(s). A listing on Rating Watch, however, does not mean a rating
change is inevitable. The Rating Watch Status can either be resolved quickly
or over a longer period of time, depending on the reasons surrounding the
A-4
<PAGE> 68
placement on Rating Watch. The "up" designation means a rating may be
upgraded; the "down" designation means a rating may be downgraded, and the
uncertain designation means a rating may be raised or lowered.
The Credit Rating Committee formally reviews all ratings once per quarter
(more frequently, if necessary). Ratings of 'BBB-' and higher fall within the
definition of investment grade securities, as defined by bank and insurance
supervisory authorities. Structured finance issues, including real estate,
asset-backed and mortgage-backed financings, use this same rating scale with
minor modification in the definitions. Thus, an investor can compare the
credit quality of investment alternatives across industries and structural
types. A "Cash Flow Rating" (as noted for specific ratings) addresses the
likelihood that aggregate principal and interest will equal or exceed the rated
amount under appropriate stress conditions.
<TABLE>
<CAPTION>
RATING SCALE DEFINITION
<S> <C>
AAA Highest credit quality. The risk factors are negligible, being only slightly more
than for risk-free U.S. Treasury debt.
AA+ High credit quality. Protection factors are strong. Risk is modest, but may
AA vary slightly from time to time because of economic conditions.
AA-
A+ Protection factors are average but adequate. However, risk factors are more
A variable and greater in periods of economic stress.
A-
BBB+ Below-average protection factors but still considered sufficient for prudent
BBB investment. Considerable variability in risk during economic cycles.
BBB-
BB+ Below investment grade but deemed likely to meet obligations when due.
BB Present or prospective financial protection factors fluctuate according to
BB- industry conditions or company fortunes. Overall quality may move up or
down frequently within this category.
B+ Below investment grade and possessing risk that obligations will not be met
B when due. Financial protection factors will fluctuate widely according to
B- economic cycles, industry conditions and/or company fortunes. Potential
exists for frequent changes in the rating within this category or into a higher
or lower rating grade.
CCC Well below investment grade securities. Considerable uncertainty exists as to
timely payment of principal, interest or preferred dividends.
Protection factors are narrow and risk can be substantial with unfavorable
economic/industry conditions, and/or with unfavorable company developments.
DD Defaulted debt obligations. Issuer failed to meet scheduled principal and/or
interest payments.
DP Preferred stock with dividend arrearages.
</TABLE>
A-5
<PAGE> 69
IBCA LONG-TERM DEBT RATINGS
AAA - Obligations for which there is the lowest expectation of investment
risk. Capacity for timely repayment of principal and interest is substantial,
such that adverse changes in business, economic or financial conditions are
unlikely to increase investment risk substantially.
AA - Obligations for which there is a very low expectation of investment
risk. Capacity for timely repayment of principal and interest is substantial.
Adverse changes in business, economic or financial conditions may increase
investment risk, albeit not very significantly.
A - Obligations for which there is a low expectation of investment risk.
Capacity for timely repayment of principal and interest is strong, although
adverse changes in business, economic or financial conditions may lead to
increased investment risk.
BBB - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial
conditions are more likely to lead to increased investment risk than for
obligations in other categories.
BB - Obligations for which there is a possibility of investment risk
developing. Capacity for timely repayment of principal and interest exists,
but is susceptible over time to adverse changes in business, economic or
financial conditions.
B - Obligations for which investment risk exists. Timely repayment of
principal and interest is not sufficiently protected against adverse changes in
business, economic or financial conditions.
CCC - Obligations for which there is a current perceived possibility of
default. Timely repayment of principal and interest is dependent on favorable
business, economic or financial conditions.
CC - Obligations which are highly speculative or which have a high risk of
default.
C - Obligations which are currently in default.
NOTES: "+" or "-" may be appended to a rating below AAA to denote relative
status within major rating categories. Ratings of BB and below are assigned
where it is considered that speculative characteristics are present.
THOMSON BANKWATCH LONG-TERM DEBT RATINGS
Long-Term Debt Ratings assigned by Thomson BankWatch also weigh heavily
government ownership and support. The quality of both the company's management
and franchise are of even greater importance in the Long-Term Debt Rating
decisions. Long-Term Debt Ratings look out over a cycle and are not adjusted
frequently for what we believe are short-term performance aberrations.
Long-Term Debt Ratings can be restricted to local currency debt - ratings
will be identified by the designation LC. In addition, Long-Term Debt Ratings
may include a plus (+) or minus (-) to indicate where within the category the
issue is placed. BankWatch Long-Term Debt Ratings are based on the following
scale:
Investment Grade
AAA (LC-AAA) - Indicates that the ability to repay principal and interest
on a timely basis is extremely high.
AA (LC-AA) - Indicates a very strong ability to repay principal and
interest on a timely basis, with limited incremental risk compared to issues
rated in the highest category.
A (LC-A) - Indicates the ability to repay principal and interest is
strong. Issues rated A could be more vulnerable to adverse developments (both
internal and external) than obligations with higher ratings.
A-6
<PAGE> 70
BBB (LC-BBB) - The lowest investment-grade category; indicates an
acceptable capacity to repay principal and interest. BBB issues are more
vulnerable to adverse developments (both internal and external) than
obligations with higher ratings.
Non-Investment Grade - may be speculative in the likelihood of timely repayment
of principal and interest
BB (LC-BB) - While not investment grade, the BB rating suggests that the
likelihood of default is considerably less than for lower-rated issues.
However, there are significant uncertainties that could affect the ability to
adequately service debt obligations.
B (LC-B) - Issues rated B show higher degree of uncertainty and therefore
greater likelihood of default than higher-rated issues. Adverse developments
could negatively affect the payment of interest and principal on a timely
basis.
CCC (LC-CCC) - Issues rated CCC clearly have a high likelihood of default,
with little capacity to address further adverse changes in financial
circumstances.
CC (LC-CC) - CC is applied to issues that are subordinate to other
obligations rated CCC and are afforded less protection in the event of
bankruptcy or reorganization.
D (LC-D) - Default.
SHORT-TERM RATINGS
STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt considered short-term in the relevant
market.
Ratings are graded into several categories, ranging from 'A-1' for the
highest quality obligations to 'D' for the lowest. These categories are as
follows:
A-1 This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus sign (+) designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated 'A-1'.
A-3 Issues carrying this designation have adequate capacity for timely
payment. They are, however, more vulnerable to the adverse effects of changes
in circumstances than obligations carrying the higher designations.
B Issues rated 'B' are regarded as having only speculative capacity for
timely payment.
C This rating is assigned to short-term debt obligations with doubtful
capacity for payment.
D Debt rated 'D' is in payment default. The 'D' rating category is used
when interest payments or principal payments are not made on the date due, even
if the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grace period.
STANDARD & POOR'S NOTE RATINGS
An S&P note rating reflects the liquidity factors and market-access risks
unique to notes. Notes maturing in three years or less will likely receive a
note rating. Notes maturing beyond three years will most likely receive a
long-term debt rating.
A-7
<PAGE> 71
The following criteria will be used in making the assessment:
- Amortization schedule - the larger the final maturity
relative to other maturities, the more likely the issue is to be
treated as a note.
- Source of payment - the more the issue depends on the market
for its refinancing, the more likely it is to be treated as a note.
Note rating symbols and definitions are as follows:
SP-1 Strong capacity to pay principal and interest. Issues determined to
possess very strong characteristics are given a plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term of the
notes.
SP-3 Speculative capacity to pay principal and interest.
MOODY'S SHORT-TERM RATINGS
Moody's short-term debt ratings are opinions of the ability of issuers to
repay punctually senior debt obligations. These obligations have an original
maturity not exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment ability of rated issuers:
Issuers rated Prime-1 (or supporting institutions) have a superior ability
for repayment of senior short-term debt obligations. Prime-1 repayment ability
will often be evidenced by many of the following characteristics: (i) leading
market positions in well-established industries, (ii) high rates of return on
funds employed, (iii) conservative capitalization structure with moderate
reliance on debt and ample asset protection, (iv) broad margins in earnings
coverage of fixed financial charges and high internal cash generation, and (v)
well established access to a range of financial markets and assured sources of
alternate liquidity.
Issuers rated Prime-2 (or supporting institutions) have a strong ability
for repayment of senior short-term debt obligations. This will normally be
evidenced by many of the characteristics cited above, but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be
more affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The effect of industry
characteristics and market compositions may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt
protection measurements and may require relatively high financial leverage.
Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
FITCH INVESTORS SERVICE, INC. SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes.
A-8
<PAGE> 72
The short-term rating places greater emphasis than a long-term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
F-1+ Exceptionally Strong Credit Quality. Issues assigned this
rating are regarded as having the strongest degree of assurance for
timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating
reflect an assurance of timely payment only slightly less in degree
than issues rated 'F-1+'.
F-2 Good Credit Quality. Issues assigned this rating have a
satisfactory degree of assurance for timely payment but the margin
of safety is not as great as for issues assigned 'F-1+' and 'F-1'
ratings.
F-3 Fair Credit Quality. Issues assigned this rating have
characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause
these securities to be rated below investment grade.
F-S Weak Credit Quality. Issues assigned this rating have
characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial
and economic conditions.
D Default. Issues assigned this rating are in actual or
imminent payment default.
LOC The symbol LOC indicates that the rating is based on a letter
of credit issued by a commercial bank.
DUFF & PHELPS, INC. SHORT-TERM DEBT RATINGS
Duff & Phelps' short-term ratings are consistent with the rating criteria
used by money market participants. The ratings apply to all obligations with
maturities of under one year, including commercial paper, the uninsured portion
of certificates of deposit, unsecured bank loans, master notes, bankers
acceptances, irrevocable letters of credit, and current maturities of long-term
debt. Asset-backed commercial paper is also rated according to this scale.
Emphasis is placed on liquidity which is defined as not only cash from
operations, but also access to alternative sources of funds including trade
credit, bank lines, and the capital markets. An important consideration is the
level of an obligor's reliance on short-term funds on an ongoing basis.
The distinguishing feature of Duff & Phelps' short-term ratings is the
refinement of the traditional '1' category. The majority of short-term debt
issuers carry the highest rating, yet quality differences exist within that
tier. As a consequence, Duff & Phelps has incorporated gradations of '1+' (one
plus) and '1-' (one minus) to assist investors in recognizing those
differences.
From time to time, Duff & Phelps places issuers or security classes on
Rating Watch. The Rating Watch status results from a need to notify investors
and the issuer that there are conditions present leading us to re-evaluate the
current rating(s). A listing on Rating Watch, however, does not mean a rating
change is inevitable.
The Rating Watch status can either be resolved quickly or over a longer
period of time, depending on the reasons surrounding the placement on Rating
Watch. The "up" designation means a rating may be upgraded; the "down"
designation means a rating may be downgraded, and the "uncertain" designation
means a rating may be raised or lowered.
<TABLE>
<S> <C>
Rating Scale: Definition
------------- ----------
High Grade
----------
</TABLE>
A-9
<PAGE> 73
D-1+ Highest certainty of timely payment. Short-Term liquidity,
including internal operating factors and/or access to alternative
sources of funds, is outstanding, and safety is just below risk-free
U.S. Treasury short-term obligations.
D-1 Very high certainty of timely payment. Liquidity factors are
excellent and supported by good fundamental protection factors.
Risk factors are minor.
D-1- High certainty of timely payment. Liquidity factors are
strong and supported by good fundamental protection factors. Risk
factors are very small.
Good Grade
D-2 Good certainty of timely payment. Liquidity factors and
company fundamentals are sound. Although ongoing funding needs may
enlarge total financing requirements, access to capital markets is
good. Risk factors are small.
Satisfactory Grade
D-3 Satisfactory liquidity and other protection factors qualify
issues as to investment grade. Risk factors are larger and subject
to more variation. Nevertheless, timely payment is expected.
Non-Investment Grade
D-4 Speculative investment characteristics. Liquidity is not
sufficient to insure against disruption in debt service. Operating
factors and market access may be subject to a high degree of
variation.
Default
D-5 Issuer failed to meet scheduled principal and/or interest payments.
THOMSON BANKWATCH (TBW) SHORT-TERM RATINGS
The TBW Short-Term Ratings apply, unless otherwise noted, to specific debt
instruments of the rated entities with a maturity of one year or less. TBW
Short-Term Ratings are intended to assess the likelihood of an untimely or
incomplete payments of principal or interest.
TBW-1 The highest category; indicates a very high likelihood that
principal and interest will be paid on a timely basis.
TBW-2 The second highest category; while the degree of safety regarding
timely repayment of principal and interest is strong, the relative degree of
safety is not as high as for issues rated "TBW-1".
TBW-3 The lowest investment-grade category; indicates that while the
obligation is more susceptible to adverse developments (both internal and
external) than those with higher ratings, the capacity to service principal and
interest in a timely fashion is considered adequate.
TBW-4 The lowest rating category; this rating is regarded as
non-investment grade and therefore speculative.
IBCA SHORT-TERM RATINGS
IBCA Short-Term Ratings assess the borrowing characteristics of banks and
corporations, and the capacity for timely repayment of debt obligations. The
Short-Term Ratings relate to debt which has a maturity of less than one year.
A-10
<PAGE> 74
A1 Obligations supported by the highest capacity for timely repayment.
Where issues possess a particularly strong credit feature, a rating of
A1+ is assigned.
A2 Obligations supported by a good capacity for timely repayment.
A3 Obligations supported by a satisfactory capacity for timely repayment.
B Obligations for which there is an uncertainty as to the capacity to
ensure timely repayment.
C Obligations for which there is a high risk of default or which are
currently in default.
A-11
<PAGE> 75
STRONG ASSET ALLOCATION FUND II
Strong Asset Allocation Fund II (the "Fund") is a diversified series of the
Strong Variable Insurance Funds, Inc. (the "Corporation"), an open-end
management investment company, commonly called a mutual fund. The Fund seeks
high total return consistent with reasonable risk over the long term. The Fund
allocates its assets globally among a diversified portfolio of equity
securities, bonds, and cash.
Shares of the Fund are only offered and sold to the separate accounts of
certain insurance companies for the purpose of funding variable annuity and
variable life insurance contracts. This Prospectus should be read together with
the prospectus of the separate account of the specific insurance product which
preceded or accompanies this Prospectus.
This Prospectus contains information that you should consider before you
invest. Please read it carefully and keep it for future reference. A Statement
of Additional Information for the Fund, dated May 1, 1997, which contains
further information, is incorporated by reference into this Prospectus, and has
been filed with the Securities and Exchange Commission ("SEC"). This Statement,
which may be revised from time to time, is available upon request and without
charge by writing to the Fund at P.O. Box 2936, Milwaukee, Wisconsin 53201 or by
calling 1-800-368-1683.
============================================================================
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
- ----------------------------------------------------------------------------
May 1, 1997
-------------------
PROSPECTUS PAGE 1
<PAGE> 76
TABLE OF CONTENTS
<TABLE>
<S> <C>
THE FUND................................. 2
FINANCIAL HIGHLIGHTS..................... 3
INVESTMENT OBJECTIVE AND POLICIES........ 4
IMPLEMENTATION OF POLICIES AND RISKS..... 5
SPECIAL CONSIDERATIONS................... 15
MANAGEMENT............................... 17
ADDITIONAL INFORMATION................... 20
APPENDIX................................. A-1
</TABLE>
No person has been authorized to give any information or to make any
representations other than those contained in this Prospectus and the Statement
of Additional Information and, if given or made, such information or
representations may not be relied upon as having been authorized by the Fund.
This Prospectus does not constitute an offer to sell securities to any person in
any state or jurisdiction in which such offering may not lawfully be made.
THE FUND
The Fund is a diversified series of the Corporation, which is an open-end
management investment company. The Fund offers and sells its shares only to
separate accounts of insurance companies for the purpose of funding variable
annuity and variable life insurance contracts. The Fund does not impose any
sales or redemption charges. Strong Capital Management, Inc. (the "Advisor") is
the investment advisor for the Fund.
-----------------
PROSPECTUS PAGE 2
<PAGE> 77
FINANCIAL HIGHLIGHTS
The following annual Financial Highlights for the Fund have been audited by
Coopers & Lybrand L.L.P., independent certified public accountants. Their report
for the fiscal year ended December 31, 1996 is included in the Fund's Annual
Report that is contained in the Fund's Statement of Additional Information. The
Financial Highlights should be read in conjunction with the Financial Statements
and related notes included in the Fund's Annual Report. Additional information
about the performance of the Fund is contained in the Fund's Annual Report,
which may be obtained without charge by calling or writing Strong Funds. Please
note that the total return shown in the Financial Highlights does not reflect
expenses that apply to the separate account or the related insurance policies.
Inclusion of these charges would reduce the total return for the periods shown.
The following presents information relating to a share of common stock
outstanding for the entire period ended as indicated.
<TABLE>
<CAPTION>
12-31-96 12-31-95(1)
-------- -----------
<S> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $ 9.98 $10.00
INCOME FROM INVESTMENT OPERATIONS
Net Investment Income 0.31 0.04
Net Realized and Unrealized Gains (Losses)
on Investments 0.97 (0.02)
------ ------
Total from Investment Operations 1.28 0.02
LESS DISTRIBUTIONS:
From Net Investment Income (0.31) (0.04)
From Net Realized Gains (0.64) --
------ ------
Total Distributions (0.95) (0.04)
------ ------
NET ASSET VALUE, END OF PERIOD $10.31 $ 9.98
====== ======
TOTAL RETURN +12.9% +0.2%
RATIOS AND SUPPLEMENTAL DATA
Net Assets, End of Period (In Thousands) $ 566 $ 499
Ratio of Expenses to Average Net Assets 2.0% 1.6%*
Ratio of Net Investment Income to Average
Net Assets 3.1% 4.3%*
Portfolio Turnover Rate 0.0% 0.0%
</TABLE>
* Calculated on an annualized basis.
(1)Inception date is November 30, 1995. Total return and portfolio turnover rate
are not annualized.
-------------------
PROSPECTUS PAGE 3
<PAGE> 78
INVESTMENT OBJECTIVE AND POLICIES
The Fund has adopted certain fundamental investment restrictions that are set
forth in the Fund's Statement of Additional Information ("SAI"). Those
restrictions, the Fund's investment objective and any other investment policies
identified as "fundamental" cannot be changed without shareholder approval. To
further guide investment activities, the Fund has also instituted a number of
non-fundamental operating policies, which are described throughout this
Prospectus and in the SAI. Although these additional policies may be changed by
the Corporation's Board of Directors without shareholder approval, the Fund will
promptly notify shareholders of any material change in operating policies.
The Fund seeks high total return consistent with reasonable risk over the
long term. The Fund allocates its assets globally among a diversified portfolio
of equity securities, bonds, and cash.
Under normal market conditions, the Fund's net assets will be allocated
according to a benchmark of 60% equities, 35% bonds, and 5% cash. The Advisor
intends to actively manage the Fund's assets, maintaining a balance over time
between investment opportunities and their associated potential risks. In
response to changing market and economic conditions, the Advisor may reallocate
the Fund's net assets among these asset categories. Those allocations normally
will be within the ranges indicated below. However, in pursuit of total return,
the Advisor may under-allocate or over-allocate the Fund's net assets in a
particular category.
ASSET-ALLOCATION CATEGORIES
<TABLE>
<CAPTION>
Percentage of Fund Net Assets
------------------------------
Category of Investment Benchmark Range
- ---------------------------------------------------------------------
<S> <C> <C>
Equities 60% 30-70%
Bonds 35% 20-70%
Cash 5% 0-50%
- ---------------------------------------------------------------------
</TABLE>
Equity securities in which the Fund may invest include common stocks,
preferred stocks, and securities that are convertible into common stocks, such
as warrants and convertible bonds. Bonds purchased by the Fund will be primarily
investment-grade debt obligations, although the Fund may invest up to 35% of its
net assets in non-investment-grade debt obligations. (See "Implementation of
Policies and Risks - Debt Obligations.") The cash portion of the Fund may
include, but is not limited to, debt securities issued or guaranteed by the U.S.
government or its agencies or instrumentalities, commercial paper, banker's
acceptances, certificates of deposit, and time deposits. The Fund may
-----------------
PROSPECTUS PAGE 4
<PAGE> 79
invest in obligations of domestic and foreign banks and their subsidiaries and
branches.
The Fund also has the flexibility to take advantage of investment
opportunities around the world by investing in foreign securities. The Fund may
invest up to 25% of its net assets in foreign securities, including both direct
investments and investments made through depositary receipts. Foreign
investments involve risks not normally found when investing in securities of
U.S. issuers. (See "Implementation of Policies and Risks - Foreign Securities
and Currencies.")
Within the asset-allocation categories described above, the Advisor will
allocate the Fund's investments among countries (including developing
countries), geographic regions, and currencies in response to changing market
and economic trends. In making geographical allocations of investments, the
Advisor will consider such factors as the historical and prospective
relationships among currencies and governmental policies that influence
currency-exchange rates, current and anticipated interest rates, inflation
levels, and business conditions within various countries, as well as other
macroeconomic, social, and political factors.
IMPLEMENTATION OF POLICIES AND RISKS
In addition to the Fund's investment policies described above (and subject to
certain restrictions described herein), the Fund may invest in some or all of
the following securities and employ some or all of the following investment
techniques, some of which may present special risks as described below. The Fund
may also engage in reverse repurchase agreements and mortgage dollar roll
transactions. A more complete discussion of these securities and investment
techniques and their associated risks is contained in the Fund's SAI.
DEBT OBLIGATIONS
IN GENERAL. The market value of all debt obligations is affected by changes
in the prevailing interest rates. The market value of such instruments generally
reacts inversely to interest rate changes. If the prevailing interest rates
decline, the market value of debt obligations generally increases. If the
prevailing interest rates increase, the market value of debt obligations
generally decreases. In general, the longer the maturity of a debt obligation,
the greater its sensitivity to changes in interest rates.
TYPES OF OBLIGATIONS. Debt obligations include (i) corporate debt securities,
including bonds, debentures, and notes; (ii) bank obligations, such as
certificates of deposit, banker's acceptances, and time deposits of domestic
and foreign banks and their subsidiaries and branches, and domestic savings and
loan associations (in amounts in excess of the insurance
-------------------
PROSPECTUS PAGE 5
<PAGE> 80
coverage (currently $100,000 per account) provided by the Federal Deposit
Insurance Corporation); (iii) commercial paper (including variable-amount master
demand notes); (iv) repurchase agreements; (v) loan interests; (vi) foreign debt
obligations issued by foreign issuers traded either in foreign markets or in
domestic markets through depositary receipts; (vii) convertible securities -
debt obligations of corporations convertible into or exchangeable for equity
securities or debt obligations that carry with them the right to acquire equity
securities, as evidenced by warrants attached to such securities, or acquired as
part of units of the securities; (viii) preferred stocks - securities that
represent an ownership interest in a corporation and that give the owner a prior
claim over common stock on the company's earnings or assets; (ix) trust
preferred securities-certain obligations which have characteristics of both debt
and preferred stock; (x) U.S. government securities; (xi) mortgage-backed
securities, collateralized mortgage obligations, and similar securities; and
(xii) municipal obligations.
RATINGS. Investment-grade debt obligations include:
- - U.S. government securities (as defined below);
- - bonds or bank obligations rated in one of the four highest rating categories
(e.g., BBB or higher by Standard & Poor's Ratings Group or "S&P");
- - short-term notes rated in one of the two highest rating categories (e.g., SP-2
or higher by S&P);
- - short-term bank obligations rated in one of the three highest rating
categories (e.g., A-3 or higher by S&P), with respect to obligations maturing
in one year or less;
- - commercial paper rated in one of the three highest rating categories (e.g.,
A-3 or higher by S&P);
- - unrated debt obligations determined by the Advisor to be of comparable
quality; and
- - repurchase agreements involving investment-grade debt obligations.
Investment-grade debt obligations are generally believed to have relatively
low degrees of credit risk. All ratings are determined at the time of
investment. Any subsequent rating downgrade of a debt obligation will be
monitored by the Advisor to consider what action, if any, the Fund should take
consistent with its investment objective. For purposes of determining whether a
security is investment grade, the Advisor may use the highest rating assigned to
that security by any nationally recognized statistical rating organization
("NRSRO"). Securities rated in the fourth-highest category (e.g., BBB by S&P),
although considered investment grade, have speculative characteristics and may
be subject to greater fluctuations in value than higher-rated securities.
Non-investment-grade debt obligations include:
- - securities rated as low as C by S&P or their equivalents;
- - commercial paper rated as low as C by S&P or its equivalent; and
- - unrated debt securities judged to be of comparable quality by the Advisor.
-------------------
PROSPECTUS PAGE 6
<PAGE> 81
HIGH-YIELD (HIGH-RISK) SECURITIES
High-yield (high-risk) securities, also referred to as "junk bonds," are
those securities that are rated lower than investment-grade and unrated
securities of comparable quality. Although these securities generally offer
higher yields than investment-grade securities with similar maturities,
lower-quality securities involve greater risks, including the possibility of
default or bankruptcy. In general, they are regarded to be predominantly
speculative with respect to the issuer's capacity to pay interest and repay
principal. Other potential risks associated with investing in high-yield
securities include:
- - substantial market-price volatility resulting from changes in interest rates,
changes in or uncertainty about economic conditions, and changes in the actual
or perceived ability of the issuer to meet its obligations;
- - greater sensitivity of highly-leveraged issuers to adverse economic changes
and individual-issuer developments;
- - subordination to the prior claims of other creditors;
- - additional Congressional attempts to restrict the use or limit the tax and
other advantages of these securities; and
- - adverse publicity and changing investor perceptions about these securities.
As with any other asset in the Fund's portfolio, any reduction in the value
of such securities as a result of the factors listed above would be reflected in
the net asset value of the Fund. In addition, a fund that invests in
lower-quality securities may incur additional expenses to the extent it is
required to seek recovery upon a default in the payment of principal and
interest on its holdings. As a result of the associated risks, successful
investments in high-yield (high-risk) securities will be more dependent on the
Advisor's credit analysis than generally would be the case with investments in
investment-grade securities.
It is uncertain how the high-yield market will perform during a prolonged
period of rising interest rates. A prolonged economic downturn or a prolonged
period of rising interest rates could adversely affect the market for these
securities, increase their volatility, and reduce their value and liquidity. In
addition, lower-quality securities tend to be less liquid than higher-quality
debt securities because the market for them is not as broad or active. If market
quotations are not available, these securities will be valued in accordance with
procedures established by the Corporation's Board of Directors. Judgment may,
therefore, play a greater role in valuing these securities. The lack of a liquid
secondary market may have an adverse effect on market price and the Fund's
ability to sell particular securities.
See the Appendix for information concerning the credit quality of the Fund's
investments for the fiscal year ended December 31, 1996.
-------------------
PROSPECTUS PAGE 7
<PAGE> 82
GOVERNMENT SECURITIES
U.S. government securities are issued or guaranteed by the U.S. government or
its agencies or instrumentalities. Securities issued by the government include
U.S. Treasury obligations, such as Treasury bills, notes, and bonds. Securities
issued by government agencies or instrumentalities include, for example,
obligations of the following:
- - the Federal Housing Administration, Farmers Home Administration, Export-Import
Bank of the United States, Small Business Administration, and the Government
National Mortgage Association, including GNMA pass-through certificates, whose
securities are supported by the full faith and credit of the United States;
- - the Federal Home Loan Banks, Federal Intermediate Credit Banks, and the
Tennessee Valley Authority, whose securities are supported by the right of the
agency to borrow from the U.S. Treasury;
- - the Federal National Mortgage Association, whose securities are supported by
the discretionary authority of the U.S. government to purchase certain
obligations of the agency or instrumentality; and
- - the Student Loan Marketing Association, the Interamerican Development Bank,
and International Bank for Reconstruction and Development, whose securities
are supported only by the credit of such agencies.
Although the U.S. government provides financial support to such U.S.
government-sponsored agencies or instrumentalities, no assurance can be given
that it will always do so. The U.S. government and its agencies and
instrumentalities do not guarantee the market value of their securities;
consequently, the value of such securities will fluctuate.
ZERO-COUPON, STEP-COUPON, AND PAY-IN-KIND SECURITIES
The Fund may invest in zero-coupon, step-coupon, and pay-in-kind securities.
These securities are debt securities that do not make regular cash interest
payments. Zero-coupon and step-coupon securities are sold at a deep discount to
their face value. Pay-in-kind securities pay interest through the issuance of
additional securities. Because such securities do not pay current cash income,
the price of these securities can be volatile when interest rates fluctuate.
While these securities do not pay current cash income, federal income tax law
requires the holders of zero-coupon, step-coupon, and pay-in-kind securities to
include in income each year the portion of the original issue discount (or
deemed discount) and other non-cash income on such securities accrued during
that year.
-------------------
PROSPECTUS PAGE 8
<PAGE> 83
WHEN-ISSUED SECURITIES
The Fund may invest without limitation in securities purchased on a when-
issued or delayed-delivery basis. Although the payment and interest terms of
these securities are established at the time the purchaser enters into the
commitment, these securities may be delivered and paid for at a future date,
generally within 45 days. Purchasing when-issued securities allows the Fund to
lock in a fixed price or yield on a security it intends to purchase. However,
when the Fund purchases a when-issued security, it immediately assumes the risk
of ownership, including the risk of price fluctuation.
The greater the Fund's outstanding commitments for these securities, the
greater the exposure to potential fluctuations in the net asset value of the
Fund. Purchasing when-issued securities may involve the additional risk that the
yield available in the market when the delivery occurs may be higher or the
market price lower than that obtained at the time of commitment. Although the
Fund may be able to sell these securities prior to the delivery date, it will
purchase when-issued securities for the purpose of actually acquiring the
securities, unless, after entering into the commitment, a sale appears desirable
for investment reasons. When required by SEC guidelines, the Fund will set aside
permissible liquid assets in a segregated account to secure its outstanding
commitments for when-issued securities.
FOREIGN SECURITIES AND CURRENCIES
The Fund may invest in foreign securities either directly or through the use
of depositary receipts. Depositary receipts are generally issued by banks or
trust companies and evidence ownership of underlying foreign securities. Foreign
investments involve special risks, including:
- - expropriation, confiscatory taxation, and withholding taxes on dividends and
interest;
- - less extensive regulation of foreign brokers, securities markets, and issuers;
- - less publicly available information and different accounting standards;
- - costs incurred in conversions between currencies, possible delays in
settlement in foreign securities markets, limitations on the use or transfer
of assets (including suspension of the ability to transfer currency from a
given country), and difficulty of enforcing obligations in other countries;
and
- - diplomatic developments and political or social instability.
Foreign economies may differ favorably or unfavorably from the U.S. economy
in various respects, including growth of gross domestic product, rates of
inflation, currency depreciation, capital reinvestment, resource
self-sufficiency, and balance-of-payments positions. Many foreign securities may
be less liquid and their prices more volatile than comparable U.S. securities.
Although the Fund generally invests only in securities that are regularly traded
on recognized exchanges or in over-the-counter markets, from time to time
foreign
-------------------
PROSPECTUS PAGE 9
<PAGE> 84
securities may be difficult to liquidate rapidly without adverse price effects.
Certain costs attributable to foreign investing, such as custody charges and
brokerage costs, may be higher than those attributable to domestic investing.
The Fund may invest a significant portion of its assets in the foreign
securities of issuers in developing countries. The risks of foreign investments
are generally intensified for investments in developing countries. Risks of
investing in such markets include:
- - less social, political, and economic stability;
- - smaller securities markets and the lower trading volume, which may result in a
lack of liquidity and greater price volatility;
- - certain national policies that may restrict the Fund's investment
opportunities, including restrictions on investments in issuers or industries
deemed sensitive to national interests, or expropriation or confiscation of
assets or property, which could result in the Fund's loss of its entire
investment in that market; and
- - less developed legal structures governing private or foreign investment or
allowing for judicial redress for injury to private property.
In addition, brokerage commissions, custodial services, withholding taxes,
and other costs relating to investment in emerging markets generally are more
expensive than in the U.S. and certain more established foreign markets.
Economies in emerging markets generally are heavily dependent upon international
trade and, accordingly, have been and may continue to be affected adversely by
trade barriers, exchange controls, managed adjustments in relative currency
values, and other protectionist measures negotiated or imposed by the countries
with which they trade.
The Fund may also invest a significant portion of its assets in debt
obligations issued or guaranteed by foreign governments or their agencies,
instrumentalities or political subdivisions, or by supranational issuers
(collectively, sovereign debt). Investment in sovereign debt involves special
risks. Certain foreign countries, particularly developing countries, have
experienced, and may continue to experience, high rates of inflation, high
interest rates, exchange rate fluctuations, large amounts of external debt,
balance of payments and trade difficulties, and extreme poverty and
unemployment. The issuer of the debt or the governmental authorities that
control the repayment of the debt may be unable or unwilling to repay principal
or interest when due in accordance with the terms of such debt, and the Fund may
have limited legal recourse in the event of default.
Because most foreign securities are denominated in non-U.S. currencies, the
investment performance of the Fund could be affected by changes in foreign
currency exchange rates to some extent. The value of the Fund's assets
denominated in foreign currencies will increase or decrease in response to
fluctuations in the value of those foreign currencies relative to the U.S.
dollar. Currency exchange rates can be volatile at times in response to supply
and demand in the currency exchange markets, international balances of
---------------------
PROSPECTUS PAGE 10
<PAGE> 85
payments, governmental intervention, speculation, and other political and
economic conditions.
The Fund may purchase and sell foreign currency on a spot basis and may
engage in forward currency contracts, currency options, and futures transactions
for hedging or any other lawful purpose. (See "Derivative Instruments.")
FOREIGN INVESTMENT COMPANIES
The Fund may invest, to a limited extent, in foreign investment companies.
Some of the countries in which the Fund invests may not permit direct investment
by outside investors. Investments in such countries may only be permitted
through foreign government-approved or -authorized investment vehicles, which
may include other investment companies. In addition, it may be less expensive
and more expedient for the Fund to invest in a foreign investment company in a
country which permits direct foreign investment. Investing through such vehicles
may involve frequent or layered fees or expenses and may also be subject to
limitation under the Investment Company Act of 1940 (the "1940 Act"). The Fund
does not intend to invest in such investment companies unless, in the judgment
of the Advisor, the potential benefits of such investments justify the payment
of any associated fees or expenses.
DERIVATIVE INSTRUMENTS
The Fund may use derivative instruments for any lawful purpose consistent
with the Fund's investment objective such as hedging or managing risk.
Derivative instruments are commonly defined to include securities or contracts
whose values depend on (or "derive" from) the value of one or more other assets,
such as securities, currencies, or commodities. These "other assets" are
commonly referred to as "underlying assets."
A derivative instrument generally consists of, is based upon, or exhibits
characteristics similar to options or forward contracts. Options and forward
contracts are considered to be the basic "building blocks" of derivatives. For
example, forward-based derivatives include forward contracts, swap contracts, as
well as exchange-traded futures. Option-based derivatives include privately
negotiated, over-the-counter (OTC) options (including caps, floors, collars, and
options on forward and swap contracts) and exchange-traded options on futures.
Diverse types of derivatives may be created by combining options or forward
contracts in different ways, and by applying these structures to a wide range of
underlying assets.
An option is a contract in which the "holder" (the buyer) pays a certain
amount (the "premium") to the "writer" (the seller) to obtain the right, but not
the obligation, to buy from the writer (in a "call") or sell to the writer (in a
"put") a specific asset at an agreed upon price at or before a certain time. The
holder pays the premium at inception and has no further financial obligation.
The holder of an option-based derivative generally will benefit from favorable
movements in the price of the underlying asset but is not exposed to
---------------------
PROSPECTUS PAGE 11
<PAGE> 86
corresponding losses due to adverse movements in the value of the underlying
asset. The writer of an option-based derivative generally will receive fees or
premiums but generally is exposed to losses due to changes in the value of the
underlying asset.
A forward is a sales contract between a buyer (holding the "long" position)
and a seller (holding the "short" position) for an asset with delivery deferred
until a future date. The buyer agrees to pay a fixed price at the agreed future
date and the seller agrees to deliver the asset. The seller hopes that the
market price on the delivery date is less than the agreed upon price, while the
buyer hopes for the contrary. The change in value of a forward-based derivative
generally is roughly proportional to the change in value of the underlying
asset.
Derivative instruments may include (i) options; (ii) futures; (iii) options
on futures; (iv) short sales against the box, in which the Fund sells a security
it owns for delivery at a future date; (v) swaps, in which two parties agree to
exchange a series of cash flows in the future, such as interest-rate payments;
(vi) interest-rate caps, under which, in return for a premium, one party agrees
to make payments to the other to the extent that interest rates exceed a
specified rate, or "cap"; (vii) interest-rate floors, under which, in return for
a premium, one party agrees to make payments to the other to the extent that
interest rates fall below a specified level, or "floor"; (viii) forward currency
contracts and foreign currency exchange-related securities; and (ix) structured
instruments which combine the foregoing in different ways.
Derivatives may be exchange-traded or traded in OTC transactions between
private parties. OTC transactions are subject to additional risks, such as the
credit risk of the counterparty to the instrument and are less liquid than
exchange-traded derivatives since they often can only be closed out with the
other party to the transaction. Derivative instruments may include elements of
leverage and, accordingly, the fluctuation of the value of the derivative
instrument in relation to the underlying asset may be magnified. When required
by SEC guidelines, the Fund will set aside permissible liquid assets in a
segregated account to secure its obligations under the derivative.
The successful use of derivatives by the Fund is dependent upon a variety of
factors, particularly the Advisor's ability to correctly anticipate trends in
the underlying asset. In a hedging transaction, if the Advisor incorrectly
anticipates trends in the underlying asset, the Fund may be in a worse position
than if no hedging had occurred. In addition, there may be imperfect correlation
between the Fund's derivative transactions and the instruments being hedged. To
the extent that the Fund is engaging in derivative transactions for risk
management, the Fund's successful use of such transactions is more dependent
upon the Advisor's ability to correctly anticipate such trends, since losses in
these transactions may not be offset in gains in the Fund's portfolio or in
lower purchase prices for assets it intends to acquire. The Advisor's prediction
of trends in underlying assets may prove to be inaccurate, which could result in
substantial losses to the Fund.
---------------------
PROSPECTUS PAGE 12
<PAGE> 87
In addition to the derivative instruments and strategies described above, the
Advisor expects to discover additional derivative instruments and other trading
techniques. The Advisor may utilize these new derivative instruments and
techniques to the extent that they are consistent with the Fund's investment
objective and permitted by the Fund's investment limitations, operating
policies, and applicable regulatory authorities.
MORTGAGE- AND ASSET-BACKED SECURITIES
Mortgage-backed securities represent direct or indirect participation in, or
are secured by and payable from, mortgage loans secured by real property, and
include single- and multi-class pass-through securities and collateralized
mortgage obligations. Such securities may be issued or guaranteed by U.S.
government agencies or instrumentalities or by private issuers, generally
originators and investors in mortgage loans, including savings associations,
mortgage bankers, commercial banks, investment bankers, and special purpose
entities (collectively, "private lenders"). Mortgage-backed securities issued by
private lenders may be supported by pools of mortgage loans or other
mortgage-backed securities that are guaranteed, directly or indirectly, by the
U.S. government or one of its agencies or instrumentalities, or they may be
issued without any governmental guarantee of the underlying mortgage assets but
with some form of non-governmental credit enhancement.
Asset-backed securities have structural characteristics similar to mortgage-
backed securities. However, the underlying assets are not first-lien mortgage
loans or interests therein; rather, they include assets such as motor vehicle
installment sales contracts, other installment loan contracts, home equity
loans, leases of various types of property, and receivables from credit card or
other revolving credit arrangements. Payments or distributions of principal and
interest on asset-backed securities may be supported by non-governmental credit
enhancements similar to those utilized in connection with mortgage-backed
securities.
The yield characteristics of mortgage- and asset-backed securities differ
from those of traditional debt securities. Among the principal differences are
that interest and principal payments are made more frequently on mortgage-and
asset-backed securities, usually monthly, and that principal may be prepaid at
any time because the underlying mortgage loans or other assets generally may be
prepaid at any time. As a result, if the Fund purchases these securities at a
premium, a prepayment rate that is faster than expected will reduce yield to
maturity, while a prepayment rate that is slower than expected will have the
opposite effect of increasing the yield to maturity. Conversely, if the Fund
purchases these securities at a discount, a prepayment rate that is faster than
expected will increase yield to maturity, while a prepayment rate that is slower
than expected will reduce yield to maturity. Accelerated prepayments on
securities purchased by the Fund at a premium also impose a risk of loss of
principal because the premium may not have been fully amortized at the time the
principal is prepaid in full. The market for privately issued mortgage- and
---------------------
PROSPECTUS PAGE 13
<PAGE> 88
asset-backed securities is smaller and less liquid than the market for
government-sponsored mortgage-backed securities.
The Fund may invest in stripped mortgage- or asset-backed securities, which
receive differing proportions of the interest and principal payments from the
underlying assets. The market value of such securities generally is more
sensitive to changes in prepayment and interest rates than is the case with
traditional mortgage- and asset-backed securities, and in some cases such market
value may be extremely volatile. With respect to certain stripped securities,
such as interest-only ("IO") and principal-only ("PO") classes, a rate of
prepayment that is faster or slower than anticipated may result in the Fund
failing to recover all or a portion of its investment, even though the
securities are rated investment grade.
SMALL AND MEDIUM COMPANIES
The Fund may invest a substantial portion of its assets in small and medium
companies. While small and medium companies generally have potential for rapid
growth, investments in small and medium companies often involve greater risks
than investments in larger, more established companies because small and medium
companies may lack the management experience, financial resources, product
diversification, and competitive strengths of larger companies. In addition, in
many instances the securities of small and medium companies are traded only
over-the-counter or on a regional securities exchange, and the frequency and
volume of their trading is substantially less than is typical of larger
companies. Therefore, the securities of small and medium companies may be
subject to greater and more abrupt price fluctuations. When making large sales,
the Fund may have to sell portfolio holdings at discounts from quoted prices or
may have to make a series of small sales over an extended period of time due to
the trading volume of small and medium company securities. Investors should be
aware that, based on the foregoing factors, an investment in the Fund may be
subject to greater price fluctuations than an investment in a fund that invests
primarily in larger, more established companies. The Advisor's research efforts
may also play a greater role in selecting securities for the Fund than in a fund
that invests in larger, more established companies.
ILLIQUID SECURITIES
The Fund may invest up to 15% of its net assets in illiquid securities.
Illiquid securities are those securities that are not readily marketable,
including restricted securities and repurchase obligations maturing in more than
seven days. Certain restricted securities that may be resold to institutional
investors under Rule 144A under the Securities Act and Section 4(2) commercial
paper may be determined to be liquid under guidelines adopted by the
Corporation's Board of Directors.
---------------------
PROSPECTUS PAGE 14
<PAGE> 89
CASH MANAGEMENT
The Fund may invest directly in cash and short-term fixed-income securities,
including, for this purpose, shares of one or more money market funds managed by
the Advisor (collectively, the "Strong Money Funds"). The Strong Money Funds
seek current income, a stable price of $1.00, and daily liquidity. All money
market instruments can change in value when interest rates or an issuer's
creditworthiness change dramatically. The Strong Money Funds cannot guarantee
that they will always be able to maintain a stable net asset value of $1.00 per
share.
PORTFOLIO TURNOVER
The Fund's historical portfolio turnover rate is listed under "Financial
Highlights." The annual portfolio turnover rate indicates changes in the Fund's
portfolio. The turnover rate may vary from year to year, as well as within a
year. It may also be affected by sales of portfolio securities necessary to meet
cash requirements for redemption of shares. High portfolio turnover in any year
will result in the payment by the Fund of above-average transaction costs. The
Fund has a wide investment scope and an active management investment policy. The
Fund's portfolio turnover rate may be as much as 400% or more. This rate should
not be considered as a limiting factor. The Fund may engage in substantial
short-term trading, which involves significant risk and may be deemed
speculative. Such trading will result in a higher portfolio turnover rate and
correspondingly higher brokerage costs.
SPECIAL CONSIDERATIONS
The Fund is designed as an investment vehicle for variable annuity and
variable life insurance contracts funded by separate accounts of certain
insurance companies. Section 817(h) of the Internal Revenue Code of 1986, as
amended (the "Code") and the regulations thereunder impose certain
diversification standards on the investments underlying variable annuity and
variable life insurance contracts in order for such contracts to be treated for
tax purposes as annuities or life insurance. Section 817(h) of the Code provides
that a variable annuity and variable life insurance contract based on a separate
account shall not be treated as an annuity or life insurance contract for any
period (and any subsequent period) for which the account's investments are not
adequately diversified. These diversification requirements are in addition to
the diversification requirements applicable to the Fund under Subchapter M of
the Code and the 1940 Act and may affect the composition of the Fund's
investments.
Since the shares of the Fund are currently sold to segregated asset accounts
underlying such variable annuity and variable life insurance contracts, the Fund
intends to comply with the diversification requirements as set forth
---------------------
PROSPECTUS PAGE 15
<PAGE> 90
in the regulations. The Secretary of the Treasury may in the future issue
additional regulations or revenue rulings that may prescribe the circumstances
in which a contract owner's control of the investments of a separate account may
cause the contract owner, rather than the insurance company, to be treated as
the owner of assets of the separate account. Failure to comply with Section
817(h) of the Code or any regulation thereunder, or with any future regulations
or revenue rulings on contract owner control, would cause earnings regarding a
contract owner's interest in an insurance company's separate account to be
includible in the contract owner's gross income in the year earned. Such
standards may apply only prospectively, although retroactive application is
possible. In the event that any such regulations or revenue rulings are adopted,
the Fund may not be able to continue to operate as currently described in this
prospectus, or maintain its investment program.
The Fund will be managed in such a manner as to comply with the requirements
of Subchapter L of the Code. It is possible that in order to comply with such
requirements, less desirable investment decisions may be made which would affect
the investment performance of the Fund.
The Fund may sell its shares to the separate accounts of various insurance
companies, which are not affiliated with each other, for the purpose of funding
variable annuity and variable life insurance contracts. The Fund currently does
not foresee any disadvantages to contract owners arising out of the fact that it
offers its shares to separate accounts of various insurance companies, which are
not affiliated with each other, to serve as an investment medium for their
variable products. However, it is theoretically possible that the interests of
owners of various contracts participating in the Fund through the separate
accounts might at some time be in conflict. The Board of Directors of the
Corporation, however, will monitor events in order to identify any material
irreconcilable conflicts which may possibly arise and to determine what action,
if any, should be taken in response to such conflicts. If such a conflict were
to occur, one or more insurance companies' separate accounts might be required
to withdraw its investments in the Fund, and shares of another Fund may be
substituted. This might force the Fund to sell securities at disadvantageous
prices. In addition, the Board of Directors may refuse to sell Fund shares to
any separate account or may suspend or terminate the offering of Fund shares if
such action is required by law or regulatory authority or is in the best
interest of the shareholders of the Fund.
Except for the organizational shares of the Fund, the Fund's shares may be
held of record only by insurance company separate accounts. As of March 31,
1997, Acacia National Life Insurance Company owned approximately 65% of the
Fund. Acacia National Life Insurance Company's ownership of greater than 25% of
the Fund's shares may result in it being deemed to be the controlling entity of
the Fund. It may continue to be deemed as such until other insurance companies,
if any, selling significant numbers of variable annuity and variable life
insurance contracts, have made substantial investments in the Fund's shares.
---------------------
PROSPECTUS PAGE 16
<PAGE> 91
MANAGEMENT
The Board of Directors of the Corporation is responsible for managing the
Fund's business and affairs. The Fund has entered into an investment advisory
agreement (an "Advisory Agreement") with the Advisor. Under the terms of the
Advisory Agreement, the Advisor manages the Fund's investments and business
affairs, subject to the supervision of the Board of Directors.
The Advisor began conducting business in 1974. Since then, its principal
business has been providing continuous investment supervision for individuals
and institutional accounts, such as pension funds and profit-sharing plans, as
well as mutual funds, several of which are funding vehicles for variable
insurance products. As of March 31, 1997, the Advisor had over $23 billion under
management. The Advisor's principal mailing address is P.O. Box 2936, Milwaukee,
Wisconsin 53201. Mr. Richard S. Strong, the Chairman of the Board of the
Corporation, is the controlling shareholder of the Advisor.
As compensation for its services, the Fund pays the Advisor a monthly
management fee. The annual fee is .85% of the Fund's average daily net assets up
to $35,000,000 and .80% of the Fund's average daily net assets in excess of
$35,000,000. Under the terms of the Advisory Agreement, the Advisor provides
office space and all necessary office facilities, equipment, and personnel for
servicing the investments of the Fund. From time to time, the Advisor may
voluntarily waive all or a portion of its management fee and/or absorb certain
expenses for the Fund without further notification of the commencement or
termination of any such waiver or absorption. Any such waiver or absorption will
have the effect of lowering the overall expense ratio of the Fund and increasing
the Fund's return to investors at the time such amounts were waived and/or
absorbed.
Except for expenses assumed by the Advisor or Strong Funds Distributors,
Inc., the Fund is responsible for all its other expenses, including, without
limitation, interest charges, taxes, brokerage commissions and similar expenses;
expenses of issue, sale, repurchase, or redemption of shares; expenses of
registering or qualifying shares for sale with the states and the SEC; expenses
of printing and distribution of prospectuses to existing shareholders; charges
of custodians (including fees as custodian for keeping books and similar
services for the Fund), transfer agents (including the printing and mailing of
reports and notices to shareholders), registrars, auditing and legal services,
and clerical services related to recordkeeping and shareholder relations;
printing of stock certificates; fees for directors who are not "interested
persons" of the Advisor; expenses of indemnification; extraordinary expenses;
and costs of shareholder and director meetings.
The Advisor permits portfolio managers and other persons who may have access
to information about the purchase or sale of securities in the Fund's portfolio
("access persons") to purchase and sell securities for their own accounts,
subject to the Advisor's policy governing personal investing. The policy
requires access persons to conduct their personal investment activities
---------------------
PROSPECTUS PAGE 17
<PAGE> 92
in a manner that the Advisor believes is not detrimental to the Fund or to the
Advisor's other advisory clients. Among other things, the policy requires access
persons to obtain preclearance before executing personal trades and prohibits
access persons from keeping profits derived from the purchase or sale of the
same security within 60 calendar days. See the SAI for more information.
PORTFOLIO MANAGERS. The following individuals serve as portfolio managers for
the Fund.
BRADLEY C. TANK. Mr. Tank leads the Fund's investment team and allocates the
Fund's assets among equities, bonds, and cash. In addition, Mr. Tank co-manages
the Fund's bond component. Before joining the Advisor in June 1990, he spent
eight years at Salomon Brothers, Inc., where he was a fixed income specialist
and, for the last six years, a vice president. Mr. Tank received his B.A. in
1980 from the University of Wisconsin-Eau Claire and his M.B.A. in 1982 from the
University of Wisconsin-Madison, where he also completed the Applied Securities
Analysis Program. Mr. Tank has co-managed the Fund since its inception in June
1995. Mr. Tank currently chairs the Advisor's Fixed Income Investment Committee.
Equity Component
ANTHONY L.T. CRAGG. Mr. Cragg co-manages the Fund. Mr. Cragg joined the
Advisor in April 1993 to develop the Advisor's international investment
activities. During the prior seven years, he helped establish Dillon, Read
International Asset Management, where he was in charge of Japanese, Asian, and
Australian investments. A graduate of Christ Church, Oxford University, Mr.
Cragg began his investment career as an international investment manager in 1980
at Gartmore, Ltd., where his tenure included assignments in London, Hong Kong,
and Tokyo. He has co-managed the Fund since its inception in June 1995.
RONALD C. OGNAR. Mr. Ognar co-manages the Fund. Mr. Ognar, a Chartered
Financial Analyst with more than 25 years of investment experience, joined the
Advisor in April 1993 after two years as a principal and portfolio manager with
RCM Capital Management. For approximately three years prior to that, he was a
portfolio manager at Kemper Financial Services in Chicago. Mr. Ognar began his
investment career in 1968 at LaSalle National Bank in Chicago after serving two
years in the U.S. Army. He received his bachelor's degree in Accounting from the
University of Illinois in 1968. Mr. Ognar has co-managed the Fund since its
inception in June 1995.
RICHARD S. STRONG. Mr. Strong co-manages the Fund. Mr. Strong founded the
Advisor in 1974. He began his investment career at Employers Insurance of Wausau
in 1966, after receiving his master's degree in Finance from the University of
Wisconsin-Madison that January. He received his undergraduate degree in 1963
from Baldwin-Wallace College. Mr. Strong has co-managed the
---------------------
PROSPECTUS PAGE 18
<PAGE> 93
Fund since its inception in June 1995. In addition to his role as co-portfolio
manager, he is currently the Chairman of the Board, Director, and Chief
Investment Officer of the Advisor.
RICHARD T. WEISS. Mr. Weiss co-manages the Fund. Mr. Weiss joined the Advisor
in 1991 from Chicago-based Stein Roe & Farnham, where he began his career as a
research analyst in 1975. He was named a portfolio manager in 1981. Mr. Weiss
attended Harvard Graduate School of Business Administration, where he was
awarded his M.B.A. in 1975, and the University of Southern California, where he
received his bachelor's degree in Business Administration in 1973. Mr. Weiss has
co-managed the Fund since its inception in June 1995. In addition, Mr. Weiss is
a director of the Advisor.
RIMAS M. MILAITIS. Mr. Milaitis co-manages the Fund. Mr. Milaitis joined the
Advisor in December of 1995. For the previous four years, he managed several
conservative equity portfolios at Aon Advisers, Inc. ("AAI") in Chicago,
Illinois. For two years prior to that, he served as an equity trader for AAI.
Prior to working at AAI, Mr. Milaitis served as an equity portfolio assistant
for three years to the Illinois State Board of Investment. He attended DePaul
University, where he was awarded his M.B.A. in 1991 and Illinois State
University where he received his B.S. degree in Economics in 1984.
Bond and Cash Component
JEFFREY A. KOCH. Mr. Koch co-manages the Fund. Mr. Koch joined the Advisor as
a portfolio manager and securities analyst in June 1989. For a brief period
prior to that, he was a market-maker clerk at Fossett Corporation, a clearing
firm. Mr. Koch earned his M.B.A. in Finance at Washington University in St.
Louis, Missouri in 1989. His undergraduate degree, awarded in 1987, is from the
University of Minnesota-Morris. Mr. Koch is also a Chartered Financial Analyst.
Mr. Koch has co-managed the Fund since its inception in June 1995.
SHIRISH T. MALEKAR. Mr. Malekar co-manages the Fund. Mr. Malekar joined the
Advisor in 1994. He was an international bond portfolio manager at Pacific
Investment Management Company in California for the previous three years. Prior
to that, he was a bond trader at Harris Bank in Chicago for one year and a bond
trader at PaineWebber Incorporated in New York and Tokyo for more than two
years. He has an M.S. in Management from the Massachusetts Institute of
Technology, an M.S. in Petroleum Engineering from the University of Pittsburgh,
and a B.S. in Chemical Engineering from the University of Bombay, India. Mr.
Malekar has co-managed the Fund since its inception in June 1995.
JAY N. MUELLER. Mr. Mueller co-manages the Fund. Mr. Mueller joined the
Advisor in September 1991 as a securities analyst and portfolio manager. For
four years prior to that, he was a securities analyst and portfolio manager with
R. Meeder & Associates of Dublin, Ohio. Mr. Mueller received his bachelor's
degree in Economics in 1982 from the University of Chicago. Mr. Mueller is
---------------------
PROSPECTUS PAGE 19
<PAGE> 94
also a Chartered Financial Analyst. Mr. Mueller has co-managed the Fund since
its inception in June 1995.
ADDITIONAL INFORMATION
HOW TO INVEST. Investments in the Fund may only be made by separate accounts
established and maintained by insurance companies for purposes of funding
variable annuity and variable life insurance contracts. For instructions on how
to direct a separate account to purchase shares in the Fund, please refer to the
prospectus of the insurance company's separate account. The Fund does not impose
any sales charge or 12b-1 fee. Certain sales charges may apply to the variable
annuity or variable life insurance contract, which should be described in the
prospectus of the insurance company's separate account. The Fund may decline to
accept a purchase order upon receipt when, in the judgment of the Advisor, it
would not be in the best interest of the existing shareholders to accept the
order. Shares of the Fund will be sold at the net asset value next determined
after receipt by the Fund of a purchase order in proper form placed by an
insurance company investing in the Fund. Certificates for shares in the Fund
will not be issued.
CALCULATION OF NET ASSET VALUE. The net asset value ("NAV") per share for the
Fund is determined as of the close of trading on the New York Stock Exchange
(the "Exchange"), currently 3:00 p.m. Central Time, on days the Exchange is open
for business. The NAV will not be determined for the Fund on days during which
the Fund receives no orders to purchase shares and no shares are tendered for
redemption. The Fund's NAV is calculated by taking the fair value of the Fund's
total assets, subtracting all its liabilities, and dividing by the total number
of shares outstanding. Expenses are accrued daily and applied when determining
the NAV.
The Fund's portfolio securities are valued based on market quotations or at
fair value as determined by the method selected by the Fund's Board of
Directors. Equity securities traded on a national securities exchange or NASDAQ
are valued at the last sales price on the national securities exchange or NASDAQ
on which such securities are primarily traded. Securities traded on NASDAQ for
which there were no transactions on a given day or securities not listed on an
exchange or NASDAQ are valued at the average of the most recent bid and asked
prices. Other exchange-traded securities (generally foreign securities) will be
valued based on market quotations.
Debt securities are valued by a pricing service that utilizes electronic data
processing techniques to determine values for normal institutional-sized trading
units of debt securities without regard to sale or bid prices when such values
are believed to more accurately reflect the fair market value for such
securities. Otherwise, sale or bid prices are used. Any securities or other
assets for which market quotations are not readily available are valued at fair
---------------------
PROSPECTUS PAGE 20
<PAGE> 95
value as determined in good faith by the Board of Directors. Debt securities
having remaining maturities of 60 days or less are valued by the amortized cost
method when the Board of Directors determines that the fair value of such
securities is their amortized cost.
Securities quoted in foreign currency are valued daily in U.S. dollars at the
foreign currency exchange rates that are prevailing at the time the daily NAV
per share is determined. Although the Fund values its foreign assets in U.S.
dollars on a daily basis, the Fund does not intend to convert its holdings of
foreign currencies into U.S. dollars on a daily basis. Foreign currency exchange
rates are generally determined prior to the close of trading on the Exchange.
Occasionally, events affecting the value of foreign investments and such
exchange rates occur between the time at which they are determined and the close
of trading on the Exchange. Such events would not normally be reflected in a
calculation of the Fund's NAV on that day. If events that materially affect the
value of the Fund's foreign investments or the foreign currency exchange rates
occur during such period, the investments will be valued at their fair value as
determined in good faith by or under the direction of the Board of Directors.
HOW TO REDEEM SHARES. Shares of the Fund may be redeemed on any business day.
The price received upon redemption will be the net asset value next determined
after the redemption request in proper form is received by the Fund. (See
"Calculation of Net Asset Value.") Contract owners should refer to the
withdrawal or surrender instructions in the prospectus of the separate account
for instructions on how to redeem shares. Once the redemption request is
received in proper form, the Fund will ordinarily forward payment to the
separate account no later than seven days after receipt.
The right of redemption may be suspended during any period in which: (i)
trading on the Exchange is restricted, as determined by the SEC, or the Exchange
is closed for other than weekends and holidays; (ii) the SEC has permitted such
suspension by order; or (iii) an emergency, as determined by the SEC, exists
which makes disposal of portfolio securities or valuation of net assets of the
Fund not reasonably practicable.
DISTRIBUTIONS AND TAXES. The policy of the Fund is to pay dividends to the
insurance company's separate accounts from net investment income quarterly and
to distribute substantially all net realized capital gains, after using any
available capital loss carryovers, annually. All dividends and capital gain
distributions paid to the insurance company's separate accounts will be
automatically reinvested in additional Fund shares.
The Fund intends to continue to qualify for treatment as a Regulated
Investment Company or "RIC" under Subchapter M of the Code and, if so qualified,
will not be liable for federal income tax on earnings and gains distributed to
its shareholders in a timely manner. If the Fund does not so qualify, however,
it would be treated for tax purposes as an ordinary corporation and would
---------------------
PROSPECTUS PAGE 21
<PAGE> 96
receive no tax deduction for distributions made to its shareholders. For more
information regarding tax implications for owners of variable annuity or
variable life insurance contracts investing in the Fund, please refer to the
prospectus of your insurance company's separate account. See "Special
Considerations" for a discussion of special tax considerations relating to the
Fund's compliance with Subchapter L of the Code, as an investment vehicle for
variable annuity and variable life insurance contracts of certain insurance
companies.
This section is not intended to be a full discussion of present or proposed
federal income tax law and its effect on the Fund and investors. (See the SAI
for a further discussion.) Investors are urged to consult their own tax adviser.
ORGANIZATION. The Fund is a series of common stock of the Corporation, which
is a Wisconsin corporation. The Corporation is authorized to issue an indefinite
number of shares of common stock and series and classes of series of shares of
common stock. All holders of shares of the Corporation would vote on each matter
presented to shareholders for action except with respect to any matter which
affects only one or more series or classes, in which case only the shares of the
affected series or class shall be entitled to vote.
All shares participate equally in dividends and other capital gains
distributions by the Fund and in the residual assets of the Fund in the event of
liquidation. Generally, the Corporation will not hold an annual meeting of
shareholders unless required by the 1940 Act.
The insurance company separate accounts, as the record shareholders in the
Fund, have the right to vote on matters submitted for a shareholder vote. Under
current interpretations of the 1940 Act, these insurance companies must solicit
voting instructions from contract owners and vote Fund shares in accordance with
the instructions received or, for Fund shares for which no voting instructions
were received, in the same proportion as those Fund shares for which
instructions were received. Contract owners should refer to the prospectus of
the insurance company's separate account for a complete description of their
voting rights.
TRANSFER AGENT, DIVIDEND-DISBURSING AGENT, AND DISTRIBUTOR. The Advisor, P.O.
Box 2936, Milwaukee, Wisconsin 53201, acts as transfer agent and
dividend-disbursing agent for the Fund. Strong Funds Distributors, Inc., P.O.
Box 2936, Milwaukee, Wisconsin 53201, an indirect subsidiary of the Advisor,
acts as distributor of the shares of the Fund.
---------------------
PROSPECTUS PAGE 22
<PAGE> 97
PERFORMANCE INFORMATION. The Fund may advertise a variety of types of
performance information, including "average annual total return," "total
return," and "cumulative total return." Each of these figures is based upon
historical results and does not represent the future performance of the Fund.
Average annual total return and total return figures measure both the net
investment income generated by, and the effect of any realized and unrealized
appreciation or depreciation of, the underlying investments in the Fund assuming
the reinvestment of all dividends and distributions. Total return figures are
not annualized and simply represent the aggregate change of the Fund's
investments over a specified period of time.
The Fund's shares are sold at the net asset value per share of the Fund.
Returns and net asset value will fluctuate. Shares of the Fund are redeemable by
the separate accounts of insurance companies at the then current net asset value
per share for the Fund, which may be more or less than the original cost. TOTAL
RETURNS CONTAINED IN ADVERTISEMENTS INCLUDE THE EFFECT OF DEDUCTING THE FUND'S
EXPENSES, BUT MAY NOT INCLUDE CHARGES AND EXPENSES ATTRIBUTABLE TO ANY
PARTICULAR INSURANCE PRODUCT. SINCE SHARES MAY ONLY BE PURCHASED BY THE SEPARATE
ACCOUNTS OF CERTAIN INSURANCE COMPANIES, CONTRACT OWNERS SHOULD CAREFULLY REVIEW
THE PROSPECTUS OF THE SEPARATE ACCOUNT FOR INFORMATION ON FEES AND EXPENSES.
Excluding such fees and expenses from the Fund's total return quotations has the
effect of increasing the performance quoted. The Fund will not use information
concerning its investment performance in advertisements or sales materials
unless appropriate information concerning the relevant separate account is also
included. Additional information concerning the Fund's performance appears in
the SAI.
---------------------
PROSPECTUS PAGE 23
<PAGE> 98
APPENDIX
RATINGS OF DEBT OBLIGATIONS
<TABLE>
<CAPTION>
Standard & Poor's Moody's Investor Fitch Investors Duff & Phelps Thomsons
Definition Ratings Group Services, Inc. Service, Inc. Rating Co. IBCA, Inc. BankWatch, Inc.
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Highest quality AAA Aaa AAA AAA AAA AAA
High quality AA Aa AA AA AA AA
Upper medium grade A A A A A A
Medium grade BBB Baa BBB BBB BBB BBB
Low grade BB Ba BB BB BB BB
Speculative B B B B B B
Submarginal CCC, CC, C Caa, Ca CCC, CC, C CCC CCC, CC CCC, CC
Probably in
default D C DDD, DD, D DD C D
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
----------------------
PROSPECTUS PAGE A-1
<PAGE> 99
ASSET COMPOSITION
For the fiscal year ended December 31, 1996, the following Fund's assets were
invested in the credit categories shown below. Percentages are computed on a
dollar-weighted basis and are an average of twelve monthly calculations.
<TABLE>
<CAPTION>
Asset Allocation Fund II
-------------------------------------------
Percentage of Advisor's Assessment of
Rating Investments* Unrated Securities
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
AAA 73.4 --
AA -- --
A -- --
BBB -- --
BB -- --
B -- --
CCC -- --
CC -- --
C -- --
D -- --
Unrated -- --
Total 73.4 --
- ---------------------------------------------------------------------------------------------
</TABLE>
* The indicated percentages are based on the highest rating received from any
one NRSRO. Each of the NRSROs utilizes rating categories that are
substantially similar to those used in this chart (see the preceding table for
the rating categories of the six NRSROs).
-------------------
PROSPECTUS PAGE A-2
<PAGE> 100
STATEMENT OF ADDITIONAL INFORMATION
STRONG ASSET ALLOCATION FUND II
P.O. Box 2936
Milwaukee, Wisconsin 53201
Toll-Free: (800) 368-1683
Strong Asset Allocation Fund II (the "Fund") is a diversified series of
the Strong Variable Insurance Funds, Inc. (the "Corporation"), an open-end
management investment company designed to provide an investment vehicle for
variable annuity and variable life insurance contracts of certain insurance
companies. Shares in the Fund are only offered and sold to the separate
accounts of such insurance companies. The Fund is described herein and in the
Prospectus for the Fund dated May 1, 1997.
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the Prospectus for the Fund dated May 1, 1997 and the
prospectus for the separate account of the specific insurance product.
Requests for copies of the Fund's Prospectus may be made by calling one of the
numbers listed above. The financial statements appearing in the Fund's Annual
Report, which accompanies this Statement of Additional Information, are
incorporated by reference.
This Statement of Additional Information is dated May 1, 1997.
<PAGE> 101
STRONG ASSET ALLOCATION FUND II
TABLE OF CONTENTS PAGE
INVESTMENT RESTRICTIONS.......................................................3
INVESTMENT POLICIES AND TECHNIQUES............................................4
Borrowing...................................................................5
Convertible Securities......................................................5
Debt Obligations............................................................5
Depositary Receipts.........................................................6
Derivative Instruments......................................................7
Foreign Investment Companies...............................................16
Foreign Securities.........................................................16
High-Yield (High-Risk) Securities..........................................16
Illiquid Securities........................................................18
Lending of Portfolio Securities............................................19
Mortgage- and Asset-Backed Securities......................................19
Mortgage Dollar Rolls and Reverse Repurchase Agreements....................20
Municipal Obligations......................................................21
Repurchase Agreements......................................................21
Short Sales Against the Box................................................21
Small and Medium Companies.................................................21
Sovereign Debt.............................................................22
Temporary Defensive Position...............................................24
Variable- or Floating-Rate Securities......................................24
Warrants...................................................................25
When-Issued Securities.....................................................25
Zero-Coupon, Step-Coupon and Pay-in-Kind Securities........................25
DIRECTORS AND OFFICERS OF THE CORPORATION....................................26
PRINCIPAL SHAREHOLDERS.......................................................28
INVESTMENT ADVISOR AND DISTRIBUTOR...........................................29
PORTFOLIO TRANSACTIONS AND BROKERAGE.........................................31
CUSTODIAN....................................................................33
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT.................................33
ADMINISTRATIVE SERVICES......................................................34
TAXES........................................................................34
DETERMINATION OF NET ASSET VALUE.............................................36
FUND ORGANIZATION............................................................36
PERFORMANCE INFORMATION......................................................37
GENERAL INFORMATION..........................................................41
PORTFOLIO MANAGEMENT.........................................................42
INDEPENDENT ACCOUNTANTS......................................................42
LEGAL COUNSEL................................................................42
FINANCIAL STATEMENTS.........................................................43
APPENDIX....................................................................A-1
______________________________
No person has been authorized to give any information or to make any
representations other than those contained in this Statement of Additional
Information and the Prospectus dated May 1, 1997 and, if given or made, such
information or representations may not be relied upon as having been authorized
by the Fund.
This Statement of Additional Information does not constitute an offer to sell
securities.
2
<PAGE> 102
INVESTMENT RESTRICTIONS
The investment objective of the Fund is to seek high total return
consistent with reasonable risk over the long term. The Fund's investment
objective and policies are described in detail in the Prospectus under the
caption "Investment Objective and Policies." The following are the Fund's
fundamental investment limitations which cannot be changed without shareholder
approval.
The Fund:
1. May not with respect to 75% of its total assets, purchase the securities
of any issuer (except securities issued or guaranteed by the U.S.
government or its agencies or instrumentalities) if, as a result, (i) more
than 5% of the Fund's total assets would be invested in the securities of
that issuer, or (ii) the Fund would hold more than 10% of the outstanding
voting securities of that issuer.
2. May (i) borrow money from banks and (ii) make other investments or engage
in other transactions permissible under the Investment Company Act of 1940
(the "1940 Act") which may involve a borrowing, provided that the
combination of (i) and (ii) shall not exceed 33 1/3% of the value of the
Fund's total assets (including the amount borrowed), less the Fund's
liabilities (other than borrowings), except that the Fund may borrow up to
an additional 5% of its total assets (not including the amount borrowed)
from a bank for temporary or emergency purposes (but not for leverage or
the purchase of investments). The Fund may also borrow money from the
other Strong Funds or other persons to the extent permitted by applicable
law.
3. May not issue senior securities, except as permitted under the 1940 Act.
4. May not act as an underwriter of another issuer's securities, except to
the extent that the Fund may be deemed to be an underwriter within the
meaning of the Securities Act of 1933 in connection with the purchase and
sale of portfolio securities.
5. May not purchase or sell physical commodities unless acquired as a result
of ownership of securities or other instruments (but this shall not
prevent the Fund from purchasing or selling options, futures contracts, or
other derivative instruments, or from investing in securities or other
instruments backed by physical commodities).
6. May not make loans if, as a result, more than 33 1/3% of the Fund's total
assets would be lent to other persons, except through (i) purchases of
debt securities or other debt instruments, or (ii) engaging in repurchase
agreements.
7. May not purchase the securities of any issuer if, as a result, more than
25% of the Fund's total assets would be invested in the securities of
issuers, the principal business activities of which are in the same
industry.
8. May not purchase or sell real estate unless acquired as a result of
ownership of securities or other instruments (but this shall not prohibit
the Fund from purchasing or selling securities or other instruments backed
by real estate or of issuers engaged in real estate activities).
9. May, notwithstanding any other fundamental investment policy or
restriction, invest all of its assets in the securities of a single
open-end management investment company with substantially the same
fundamental investment objective, policies, and restrictions as the Fund.
3
<PAGE> 103
The following are the Fund's non-fundamental operating policies which may
be changed by the Board of Directors of the Corporation without shareholder
approval.
The Fund may not:
1. Sell securities short, unless the Fund owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short, or
unless it covers such short sale as required by the current rules and
positions of the Securities and Exchange Commission or its staff, and
provided that transactions in options, futures contracts, options on
futures contracts, or other derivative instruments are not deemed to
constitute selling securities short.
2. Purchase securities on margin, except that the Fund may obtain such
short-term credits as are necessary for the clearance of transactions; and
provided that margin deposits in connection with futures contracts,
options on futures contracts, or other derivative instruments shall not
constitute purchasing securities on margin.
3. Invest in illiquid securities if, as a result of such investment, more
than 15% of its net assets would be invested in illiquid securities, or
such other amounts as may be permitted under the 1940 Act.
4. Purchase securities of other investment companies except in compliance
with the 1940 Act and applicable state law.
5. Invest all of its assets in the securities of a single open-end
investment management company with substantially the same fundamental
investment objective, restrictions and policies as the Fund.
6. Engage in futures or options on futures transactions which are
impermissible pursuant to Rule 4.5 under the Commodity Exchange Act and,
in accordance with Rule 4.5, will use futures or options on futures
transactions solely for bona fide hedging transactions (within the meaning
of the Commodity Exchange Act), provided, however, that the Fund may, in
addition to bona fide hedging transactions, use futures and options on
futures transactions if the aggregate initial margin and premiums required
to establish such positions, less the amount by which any such options
positions are in the money (within the meaning of the Commodity Exchange
Act), do not exceed 5% of the Fund's net assets.
7. Borrow money except (i) from banks or (ii) through reverse repurchase
agreements or mortgage dollar rolls, and will not purchase securities when
bank borrowings exceed 5% of its total assets.
8. Make any loans other than loans of portfolio securities, except through
(i) purchases of debt securities or other debt instruments, or (ii)
engaging in repurchase agreements.
Except for the fundamental investment limitations listed above and the
Fund's investment objective, the other investment policies described in the
Prospectus and this Statement of Additional Information are not fundamental and
may be changed with approval of the Corporation's Board of Directors. Unless
noted otherwise, if a percentage restriction is adhered to at the time of
investment, a later increase or decrease in percentage resulting from a change
in the Fund's assets (i.e., due to cash inflows or redemptions) or in market
value of the investment or the Fund's assets will not constitute a violation of
that restriction.
INVESTMENT POLICIES AND TECHNIQUES
The following information supplements the discussion of the Fund's
investment objective, policies, and techniques that are described in detail in
the Prospectus under the captions "Investment Objectives and Policies" and
"Implementation of Policies and Risks."
4
<PAGE> 104
BORROWING
The Fund may borrow money from banks and make other investments or engage
in other transactions permissible under the 1940 Act which may be considered a
borrowing (such as mortgage dollar rolls and reverse repurchase agreements) as
discussed under "Investment Restrictions." However, the Fund may not purchase
securities when bank borrowings exceed 5% of the Fund's total assets.
Presently, the Fund only intends to borrow from banks for temporary or
emergency purposes.
The Fund has established a line-of-credit (LOC) with certain banks by
which they may borrow funds for temporary or emergency purposes. A borrowing
is presumed to be for temporary or emergency purposes if it is repaid by the
Fund within sixty days and is not extended or renewed. The Fund intends to use
the LOC to meet large or unexpected redemptions that would otherwise force the
Fund to liquidate securities under circumstances which are unfavorable to the
Fund's remaining shareholders. The Fund pays a commitment fee to the banks for
the LOC.
CONVERTIBLE SECURITIES
The Fund may invest in convertible securities, which are bonds,
debentures, notes, preferred stocks, or other securities that may be converted
into or exchanged for a specified amount of common stock of the same or a
different issuer within a particular period of time at a specified price or
formula. A convertible security entitles the holder to receive interest
normally paid or accrued on debt or the dividend paid on preferred stock until
the convertible security matures or is redeemed, converted, or exchanged.
Convertible securities have unique investment characteristics in that they
generally (i) have higher yields than common stocks, but lower yields than
comparable non-convertible securities, (ii) are less subject to fluctuation in
value than the underlying stock since they have fixed income characteristics,
and (iii) provide the potential for capital appreciation if the market price of
the underlying common stock increases. Most convertible securities currently
are issued by U.S. companies, although a substantial Eurodollar convertible
securities market has developed, and the markets for convertible securities
denominated in local currencies are increasing.
The value of a convertible security is a function of its "investment
value" (determined by its yield in comparison with the yields of other
securities of comparable maturity and quality that do not have a conversion
privilege) and its "conversion value" (the security's worth, at market value,
if converted into the underlying common stock). The investment value of a
convertible security is influenced by changes in interest rates, with
investment value declining as interest rates increase and increasing as
interest rates decline. The credit standing of the issuer and other factors
also may have an effect on the convertible security's investment value. The
conversion value of a convertible security is determined by the market price of
the underlying common stock. If the conversion value is low relative to the
investment value, the price of the convertible security is governed principally
by its investment value. Generally, the conversion value decreases as the
convertible security approaches maturity. To the extent the market price of
the underlying common stock approaches or exceeds the conversion price, the
price of the convertible security will be increasingly influenced by its
conversion value. A convertible security generally will sell at a premium over
its conversion value by the extent to which investors place value on the right
to acquire the underlying common stock while holding a fixed income security.
A convertible security may be subject to redemption at the option of the
issuer at a price established in the convertible security's governing
instrument. If a convertible security held by the Fund is called for
redemption, the Fund will be required to permit the issuer to redeem the
security, convert it into the underlying common stock, or sell it to a third
party.
DEBT OBLIGATIONS
The Fund may invest a portion of its assets in debt obligations. Issuers
of debt obligations have a contractual obligation to pay interest at a
specified rate on specified dates and to repay principal on a specified
maturity date. Certain debt obligations (usually intermediate- and long-term
bonds) have provisions that allow the issuer to redeem or "call" a bond before
its maturity. Issuers are most likely to call such securities during periods
of falling interest rates and the Fund may have to replace such securities with
lower yielding securities, which could result in a lower return for the Fund.
5
<PAGE> 105
PRICE VOLATILITY. The market value of debt obligations is affected
primarily by changes in prevailing interest rates. The market value of a debt
obligation generally reacts inversely to interest-rate changes, meaning, when
prevailing interest rates decline, an obligation's price usually rises, and
when prevailing interest rates rise, an obligation's price usually declines.
MATURITY. In general, the longer the maturity of a debt obligation, the
higher its yield and the greater its sensitivity to changes in interest rates.
Conversely, the shorter the maturity, the lower the yield but the greater the
price stability. Commercial paper is generally considered the shortest form of
debt obligation.
CREDIT QUALITY. The values of debt obligations may also be affected by
changes in the credit rating or financial condition of their issuers.
Generally, the lower the quality rating of a security, the higher the degree of
risk as to the payment of interest and return of principal. To compensate
investors for taking on such increased risk, those issuers deemed to be less
creditworthy generally must offer their investors higher interest rates than do
issuers with better credit ratings.
In conducting its credit research and analysis, the Advisor considers both
qualitative and quantitative factors to evaluate the creditworthiness of
individual issuers. The Advisor also relies, in part, on credit ratings
compiled by a number of Nationally Recognized Statistical Rating Organizations
("NRSROs"). Refer to the Appendix for a discussion of securities ratings.
DEPOSITARY RECEIPTS
The Fund may invest in foreign securities by purchasing depositary
receipts, including American Depositary Receipts ("ADRs") and European
Depositary Receipts ("EDRs"), or other securities convertible into securities
of foreign issuers. These securities may not necessarily be denominated in the
same currency as the securities into which they may be converted. Generally,
ADRs, in registered form, are denominated in U.S. dollars and are designed for
use in the U.S. securities markets, while EDRs, in bearer form, may be
denominated in other currencies and are designed for use in the European
securities markets. ADRs are receipts typically issued by a U.S. bank or
trust company evidencing ownership of the underlying securities. EDRs are
European receipts evidencing a similar arrangement. For purposes of the Fund's
investment policies, ADRs and EDRs are deemed to have the same classification
as the underlying securities they represent, except that ADRs and EDRs shall be
treated as indirect foreign investments. Thus, an ADR or EDR representing
ownership of common stock will be treated as common stock. ADR and EDR
depositary receipts do not eliminate all of the risks associated with directly
investing in the securities of foreign issuers.
ADR facilities may be established as either "unsponsored" or "sponsored."
While ADRs issued under these two types of facilities are in some respects
similar, there are distinctions between them relating to the rights and
obligations of ADR holders and the practices of market participants.
A depositary may establish an unsponsored facility without participation
by (or even necessarily the acquiescence of) the issuer of the deposited
securities, although typically the depositary requests a letter of
non-objection from such issuer prior to the establishment of the facility.
Holders of unsponsored ADRs generally bear all the costs of such facilities.
The depositary usually charges fees upon the deposit and withdrawal of the
deposited securities, the conversion of dividends into U.S. dollars, the
disposition of non-cash distributions, and the performance of other services.
The depositary of an unsponsored facility frequently is under no obligation to
pass through voting rights to ADR holders in respect of the deposited
securities. In addition, an unsponsored facility is generally not obligated to
distribute communications received from the issuer of the deposited securities
or to disclose material information about such issuer in the U.S. and thus
there may not be a correlation between such information and the market value of
the depositary receipts.
Sponsored ADR facilities are created in generally the same manner as
unsponsored facilities, except that the issuer of the deposited securities
enters into a deposit agreement with the depositary. The deposit agreement
sets out the rights and responsibilities of the issuer, the depositary, and the
ADR holders. With sponsored facilities, the issuer of the deposited securities
generally will bear some of the costs relating to the facility (such as
dividend payment fees of the depositary), although ADR holders continue to bear
certain other costs (such as deposit and withdrawal fees). Under the terms of
most sponsored arrangements, depositories agree to distribute notices of
shareholder meetings and voting instructions, and to provide shareholder
communications and other information to the ADR holders at the request of the
issuer of the deposited securities.
6
<PAGE> 106
DERIVATIVE INSTRUMENTS
IN GENERAL. The Fund may use derivative instruments for any lawful
purpose consistent with the Fund's investment objective such as hedging or
managing risk. Derivative instruments are commonly defined to include
securities or contracts whose values depend on (or "derive" from) the value of
one or more other assets, such as securities, currencies, or commodities.
These "other assets" are commonly referred to as "underlying assets."
A derivative instrument generally consists of, is based upon, or exhibits
characteristics similar to options or forward contracts. Options and forward
contracts are considered to be the basic "building blocks" of derivatives. For
example, forward-based derivatives include forward contracts, swap contracts,
as well as exchange-traded futures. Option-based derivatives include privately
negotiated, over-the-counter (OTC) options (including caps, floors, collars,
and options on forward and swap contracts) and exchange-traded options on
futures. Diverse types of derivatives may be created by combining options or
forward contracts in different ways, and by applying these structures to a wide
range of underlying assets.
An option is a contract in which the "holder" (the buyer) pays a certain
amount (the "premium") to the "writer" (the seller) to obtain the right, but
not the obligation, to buy from the writer (in a "call") or sell to the writer
(in a "put") a specific asset at an agreed upon price at or before a certain
time. The holder pays the premium at inception and has no further financial
obligation. The holder of an option-based derivative generally will benefit
from favorable movements in the price of the underlying asset but is not
exposed to corresponding losses due to adverse movements in the value of the
underlying asset. The writer of an option-based derivative generally will
receive fees or premiums but generally is exposed to losses due to changes in
the value of the underlying asset.
A forward is a sales contract between a buyer (holding the "long"
position) and a seller (holding the "short" position) for an asset with
delivery deferred until a future date. The buyer agrees to pay a fixed price
at the agreed future date and the seller agrees to deliver the asset. The
seller hopes that the market price on the delivery date is less than the agreed
upon price, while the buyer hopes for the contrary. The change in value of a
forward-based derivative generally is roughly proportional to the change in
value of the underlying asset.
HEDGING. The Fund may use derivative instruments to protect against
possible adverse changes in the market value of securities held in, or are
anticipated to be held in, the Fund's portfolio. Derivatives may also be used
by the Fund to "lock-in" the Fund's realized but unrecognized gains in the
value of its portfolio securities. Hedging strategies, if successful, can
reduce the risk of loss by wholly or partially offsetting the negative effect
of unfavorable price movements in the investments being hedged. However,
hedging strategies can also reduce the opportunity for gain by offsetting the
positive effect of favorable price movements in the hedged investments.
MANAGING RISK. The Fund may also use derivative instruments to manage the
risks of the Fund's portfolio. Risk management strategies include, but are not
limited to, facilitating the sale of portfolio securities, managing the
effective maturity or duration of debt obligations in the Fund's portfolio,
establishing a position in the derivatives markets as a substitute for buying
or selling certain securities, or creating or altering exposure to certain
asset classes, such as equity, debt, and foreign securities. The use of
derivative instruments may provide a less expensive, more expedient or more
specifically focused way for the Fund to invest than "traditional" securities
(i.e., stocks or bonds) would.
EXCHANGE OR OTC DERIVATIVES. Derivative instruments may be
exchange-traded or traded in OTC transactions between private parties.
Exchange-traded derivatives are standardized options and futures contracts
traded in an auction on the floor of a regulated exchange. Exchange contracts
are generally very liquid. The exchange clearinghouse is the counterparty of
every contract. Thus, each holder of an exchange contract bears the credit
risk of the clearinghouse (and has the benefit of its financial strength)
rather than that of a particular counterparty. Over-the-counter transactions
are subject to additional risks, such as the credit risk of the counterparty to
the instrument and are less liquid than exchange-traded derivatives since they
often can only be closed out with the other party to the transaction.
7
<PAGE> 107
RISKS AND SPECIAL CONSIDERATIONS. The use of derivative instruments
involves risks and special considerations as described below. Risks pertaining
to particular derivative instruments are described in the sections that follow.
(1) MARKET RISK. The primary risk of derivatives is the same as the risk
of the underlying assets, namely that the value of the underlying asset may go
up or down. Adverse movements in the value of an underlying asset can expose
the Fund to losses. Derivative instruments may include elements of leverage
and, accordingly, the fluctuation of the value of the derivative instrument in
relation to the underlying asset may be magnified. The successful use of
derivative instruments depends upon a variety of factors, particularly Strong
Capital Management, Inc.'s (the "Advisor") ability to predict movements of the
securities, currencies, and commodity markets, which requires different skills
than predicting changes in the prices of individual securities. There can be
no assurance that any particular strategy adopted will succeed. The Advisor's
decision to engage in a derivative instrument will reflect the Advisor's
judgment that the derivative transaction will provide value to the Fund and its
shareholders and is consistent with the Fund's objectives, investment
limitations, and operating policies. In making such a judgment, the Advisor
will analyze the benefits and risks of the derivative transaction and weigh
them in the context of the Fund's entire portfolio and investment objective.
(2) CREDIT RISK. The Fund will be subject to the risk that a loss may be
sustained by the Fund as a result of the failure of a counterparty to comply
with the terms of a derivative instrument. The counterparty risk for
exchange-traded derivative instruments is generally less than for
privately-negotiated or OTC derivative instruments, since generally a clearing
agency, which is the issuer or counterparty to each exchange-traded instrument,
provides a guarantee of performance. For privately-negotiated instruments,
there is no similar clearing agency guarantee. In all transactions, the Fund
will bear the risk that the counterparty will default, and this could result in
a loss of the expected benefit of the derivative transaction and possibly other
losses to the Fund. The Fund will enter into transactions in derivative
instruments only with counterparties that the Advisor reasonably believes are
capable of performing under the contract.
(3) CORRELATION RISK. When a derivative transaction is used to completely
hedge another position, changes in the market value of the combined position
(the derivative instrument plus the position being hedged) result from an
imperfect correlation between the price movements of the two instruments. With
a perfect hedge, the value of the combined position remains unchanged for any
change in the price of the underlying asset. With an imperfect hedge, the
values of the derivative instrument and its hedge are not perfectly correlated.
Correlation risk is the risk that there might be imperfect correlation, or
even no correlation, between price movements of an instrument and price
movements of investments being hedged. For example, if the value of a
derivative instruments used in a short hedge (such as writing a call option,
buying a put option, or selling a futures contract) increased by less than the
decline in value of the hedged investments, the hedge would not be perfectly
correlated. Such a lack of correlation might occur due to factors unrelated to
the value of the investments being hedged, such as speculative or other
pressures on the markets in which these instruments are traded. The
effectiveness of hedges using instruments on indices will depend, in part, on
the degree of correlation between price movements in the index and price
movements in the investments being hedged.
(4) LIQUIDITY RISK. Derivatives are also subject to liquidity risk.
Liquidity risk is the risk that a derivative instrument cannot be sold, closed
out, or replaced quickly at or very close to its fundamental value. Generally,
exchange contracts are very liquid because the exchange clearinghouse is the
counterparty of every contract. OTC transactions are less liquid than
exchange-traded derivatives since they often can only be closed out with the
other party to the transaction. The Fund might be required by applicable
regulatory requirement to maintain assets as "cover," maintain segregated
accounts, and/or make margin payments when it takes positions in derivative
instruments involving obligations to third parties (i.e., instruments other
than purchased options). If the Fund was unable to close out its positions in
such instruments, it might be required to continue to maintain such assets or
accounts or make such payments until the position expired, matured, or was
closed out. The requirements might impair the Fund's ability to sell a
portfolio security or make an investment at a time when it would otherwise be
favorable to do so, or require that the Fund sell a portfolio security at a
disadvantageous time. The Fund's ability to sell or close out a position in an
instrument prior to expiration or maturity depends on the existence of a liquid
secondary market or, in the absence of such a market, the ability and
willingness of the counterparty to enter into a transaction closing out the
position. Therefore, there is no assurance that any derivatives position can
be sold or closed out at a time and price that is favorable to the Fund.
(5) LEGAL RISK. Legal risk is the risk of loss caused by the legal
unenforcibility of a party's obligations under the derivative. While a party
seeking price certainty agrees to surrender the potential upside in exchange
for downside
8
<PAGE> 108
protection, the party taking the risk is looking for a positive payoff.
Despite this voluntary assumption of risk, a counterparty that has lost money
in a derivative transaction may try to avoid payment by exploiting various
legal uncertainties about certain derivative products.
(6) SYSTEMIC OR "INTERCONNECTION" RISK. Interconnection risk is the risk
that a disruption in the financial markets will cause difficulties for all
market participants. In other words, a disruption in one market will spill
over into other markets, perhaps creating a chain reaction. Much of the OTC
derivatives market takes place among the OTC dealers themselves, thus creating
a large interconnected web of financial obligations. This interconnectedness
raises the possibility that a default by one large dealer could create losses
at other dealers and destabilize the entire market for OTC derivative
instruments.
GENERAL LIMITATIONS. The use of derivative instruments is subject to
applicable regulations of the Securities and Exchange Commission (the "SEC"),
the several options and futures exchanges upon which they may be traded, the
Commodity Futures Trading Commission ("CFTC"), and various state regulatory
authorities. In addition, the Fund's ability to use derivative instruments may
be limited by certain tax considerations. For a discussion of the federal
income tax treatment of the Fund's derivative instruments, see "Taxes -
Derivative Instruments."
The Fund has filed a notice of eligibility for exclusion from the
definition of the term "commodity pool operator" with the CFTC and the National
Futures Association, which regulate trading in the futures markets. In
accordance with Rule 4.5 of the regulations under the Commodity Exchange Act
(the "CEA"), the notice of eligibility for the Fund includes representations
that the Fund will use futures contracts and related options solely for bona
fide hedging purposes within the meaning of CFTC regulations, provided that the
Fund may hold other positions in futures contracts and related options that do
not qualify as a bona fide hedging position if the aggregate initial margin
deposits and premiums required to establish these positions, less the amount by
which any such futures contracts and related options positions are "in the
money," do not exceed 5% of the Fund's net assets. Adherence to these
guidelines does not limit the Fund's risk to 5% of the Fund's assets.
The SEC has identified certain trading practices involving derivative
instruments that involve the potential for leveraging the Fund's assets in a
manner that raises issues under the 1940 Act. In order to limit the potential
for the leveraging of the Fund's assets, as defined under the 1940 Act, the SEC
has stated that the Fund may use coverage or the segregation of the Fund's
assets. To the extent required by SEC guidelines, the Fund will not enter into
any such transactions unless it owns either: (i) an offsetting ("covered")
position in securities, options, futures, or derivative instruments; or (ii)
cash or liquid securities positions with a value sufficient at all times to
cover its potential obligations to the extent that the position is not
"covered". The Fund will also set aside cash and/or appropriate liquid assets
in a segregated custodial account if required to do so by the SEC and CFTC
regulations. Assets used as cover or held in a segregated account cannot be
sold while the derivative position is open, unless they are replaced with
similar assets. As a result, the commitment of a large portion of the Fund's
assets to segregated accounts could impede portfolio management or the Fund's
ability to meet redemption requests or other current obligations.
In some cases the Fund may be required to maintain or limit exposure to a
specified percentage of its assets to a particular asset class. In such cases,
when the Fund uses a derivative instrument to increase or decrease exposure to
an asset class and is required by applicable SEC guidelines to set aside liquid
assets in a segregated account to secure its obligations under the derivative
instruments, the Advisor may, where reasonable in light of the circumstances,
measure compliance with the applicable percentage by reference to the nature of
the economic exposure created through the use of the derivative instrument and
not by reference to the nature of the exposure arising from the liquid assets
set aside in the segregated account (unless another interpretation is specified
by applicable regulatory requirements).
OPTIONS. The Fund may use options for any lawful purpose consistent with
the Fund's investment objective such as hedging or managing risk. An option is
a contract in which the "holder" (the buyer) pays a certain amount (the
"premium") to the "writer" (the seller) to obtain the right, but not the
obligation, to buy from the writer (in a "call") or sell to the writer (in a
"put") a specific asset at an agreed upon price (the "strike price" or
"exercise price") at or before a certain time (the "expiration date"). The
holder pays the premium at inception and has no further financial obligation.
The holder of an option will benefit from favorable movements in the price of
the underlying asset but is not exposed to corresponding losses due to adverse
9
<PAGE> 109
movements in the value of the underlying asset. The writer of an option will
receive fees or premiums but is exposed to losses due to changes in the value
of the underlying asset. The Fund may buy or write (sell) put and call options
on assets, such as securities, currencies, commodities, and indices of debt and
equity securities ("underlying assets") and enter into closing transactions
with respect to such options to terminate an existing position. Options used
by the Fund may include European, American, and Bermuda style options. If an
option is exercisable only at maturity, it is a "European" option; if it is also
exercisable prior to maturity, it is an "American" option. If it is
exercisable only at certain times, it is a "Bermuda" option.
The Fund may purchase (buy) and write (sell) put and call options
underlying assets and enter into closing transactions with respect to such
options to terminate an existing position. The purchase of call options serves
as a long hedge, and the purchase of put options serves as a short hedge.
Writing put or call options can enable the Fund to enhance income by reason of
the premiums paid by the purchaser of such options. Writing call options
serves as a limited short hedge because declines in the value of the hedged
investment would be offset to the extent of the premium received for writing
the option. However, if the security appreciates to a price higher than the
exercise price of the call option, it can be expected that the option will be
exercised and the Fund will be obligated to sell the security at less than its
market value or will be obligated to purchase the security at a price greater
than that at which the security must be sold under the option. All or a
portion of any assets used as cover for OTC options written by the Fund would
be considered illiquid to the extent described under "Investment Policies and
Techniques -- Illiquid Securities." Writing put options serves as a limited
long hedge because increases in the value of the hedged investment would be
offset to the extent of the premium received for writing the option. However,
if the security depreciates to a price lower than the exercise price of the put
option, it can be expected that the put option will be exercised and the Fund
will be obligated to purchase the security at more than its market value.
The value of an option position will reflect, among other things, the
historical price volatility of the underlying investment, the current market
value of the underlying investment, the time remaining until expiration, the
relationship of the exercise price to the market price of the underlying
investment, and general market conditions.
The Fund may effectively terminate its right or obligation under an option
by entering into a closing transaction. For example, the Fund may terminate
its obligation under a call or put option that it had written by purchasing an
identical call or put option; this is known as a closing purchase transaction.
Conversely, the Fund may terminate a position in a put or call option it had
purchased by writing an identical put or call option; this is known as a
closing sale transaction. Closing transactions permit the Fund to realize the
profit or limit the loss on an option position prior to its exercise or
expiration.
The Fund may purchase or write both exchange-traded and OTC options.
Exchange-traded options are issued by a clearing organization affiliated with
the exchange on which the option is listed that, in effect, guarantees
completion of every exchange-traded option transaction. In contrast, OTC
options are contracts between the Fund and the other party to the transaction
("counter party") (usually a securities dealer or a bank) with no clearing
organization guarantee. Thus, when the Fund purchases or writes an OTC option,
it relies on the counter party to make or take delivery of the underlying
investment upon exercise of the option. Failure by the counter party to do so
would result in the loss of any premium paid by the Fund as well as the loss of
any expected benefit of the transaction.
The Fund's ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The Fund intends to
purchase or write only those exchange-traded options for which there appears to
be a liquid secondary market. However, there can be no assurance that such a
market will exist at any particular time. Closing transactions can be made for
OTC options only by negotiating directly with the counter party, or by a
transaction in the secondary market if any such market exists. Although the
Fund will enter into OTC options only with counter parties that are expected to
be capable of entering into closing transactions with the Fund, there is no
assurance that the Fund will in fact be able to close out an OTC option at a
favorable price prior to expiration. In the event of insolvency of the counter
party, the Fund might be unable to close out an OTC option position at any time
prior to its expiration. If the Fund were unable to effect a closing
transaction for an option it had purchased, it would have to exercise the
option to realize any profit.
The Fund may engage in options transactions on indices in much the same
manner as the options on securities discussed above, except the index options
may serve as a hedge against overall fluctuations in the securities market in
general.
10
<PAGE> 110
The writing and purchasing of options is a highly specialized activity
that involves investment techniques and risks different from those associated
with ordinary portfolio securities transactions. Imperfect correlation between
the options and securities markets may detract from the effectiveness of
attempted hedging.
SPREAD TRANSACTIONS. The Fund may use spread transactions for any lawful
purpose consistent with the Fund's investment objective such as hedging or
managing risk. The Fund may purchase covered spread options from securities
dealers. Such covered spread options are not presently exchange-listed or
exchange-traded. The purchase of a spread option gives the Fund the right to
put, or sell, a security that it owns at a fixed dollar spread or fixed yield
spread in relationship to another security that the Fund does not own, but
which is used as a benchmark. The risk to the Fund in purchasing covered
spread options is the cost of the premium paid for the spread option and any
transaction costs. In addition, there is no assurance that closing
transactions will be available. The purchase of spread options will be used to
protect the Fund against adverse changes in prevailing credit quality spreads,
i.e., the yield spread between high quality and lower quality securities. Such
protection is only provided during the life of the spread option.
FUTURES CONTRACTS. The Fund may use futures contracts for any lawful
purpose consistent with the Fund's investment objective such as hedging or
managing risk. The Fund may enter into futures contracts, including interest
rate, index, and currency futures. The Fund may also purchase put and call
options, and write covered put and call options, on futures in which it is
allowed to invest. The purchase of futures or call options thereon can serve
as a long hedge, and the sale of futures or the purchase of put options thereon
can serve as a short hedge. Writing covered call options on futures contracts
can serve as a limited short hedge, and writing covered put options on futures
contracts can serve as a limited long hedge, using a strategy similar to that
used for writing covered options in securities. The Fund's hedging may include
purchases of futures as an offset against the effect of expected increases in
currency exchange rates and securities prices and sales of futures as an offset
against the effect of expected declines in currency exchange rates and
securities prices. The Fund may also write put options on futures contracts
while at the same time purchasing call options on the same futures contracts in
order to create synthetically a long futures contract position. Such options
would have the same strike prices and expiration dates. The Fund will engage
in this strategy only when the Advisor believes it is more advantageous to the
Fund than is purchasing the futures contract.
To the extent required by regulatory authorities, the Fund only enters
into futures contracts that are traded on national futures exchanges and are
standardized as to maturity date and underlying financial instrument. Futures
exchanges and trading are regulated under the CEA by the CFTC. Although
techniques other than sales and purchases of futures contracts could be used to
reduce the Fund's exposure to market, currency, or interest rate fluctuations,
the Fund may be able to hedge its exposure more effectively and perhaps at a
lower cost through using futures contracts.
An interest rate futures contract provides for the future sale by one
party and purchase by another party of a specified amount of a specific
financial instrument (e.g., debt security) or currency for a specified price at
a designated date, time, and place. An index futures contract is an agreement
pursuant to which the parties agree to take or make delivery of an amount of
cash equal to the difference between the value of the index at the close of the
last trading day of the contract and the price at which the index futures
contract was originally written. Transaction costs are incurred when a futures
contract is bought or sold and margin deposits must be maintained. A futures
contract may be satisfied by delivery or purchase, as the case may be, of the
instrument, the currency or by payment of the change in the cash value of the
index. More commonly, futures contracts are closed out prior to delivery by
entering into an offsetting transaction in a matching futures contract.
Although the value of an index might be a function of the value of certain
specified securities, no physical delivery of those securities is made. If the
offsetting purchase price is less than the original sale price, the Fund
realizes a gain; if it is more, the Fund realizes a loss. Conversely, if the
offsetting sale price is more than the original purchase price, the Fund
realizes a gain; if it is less, the Fund realizes a loss. The transaction
costs must also be included in these calculations. There can be no assurance,
however, that the Fund will be able to enter into an offsetting transaction
with respect to a particular futures contract at a particular time. If the
Fund is not able to enter into an offsetting transaction, the Fund will
continue to be required to maintain the margin deposits on the futures
contract.
No price is paid by the Fund upon entering into a futures contract.
Instead, at the inception of a futures contract, the Fund is required to
deposit in a segregated account with its custodian, in the name of the futures
broker through whom the transaction was effected, "initial margin" consisting
of cash and/or other appropriate liquid assets in an amount generally equal to
10% or less of the contract value. Margin must also be deposited when writing
a call or put option on a futures contract, in accordance with applicable
exchange rules. Unlike margin in securities transactions, initial margin on
futures contracts does
11
<PAGE> 111
not represent a borrowing, but rather is in the nature of a performance bond or
good-faith deposit that is returned to the Fund at the termination of the
transaction if all contractual obligations have been satisfied. Under certain
circumstances, such as periods of high volatility, the Fund may be required by
an exchange to increase the level of its initial margin payment, and initial
margin requirements might be increased generally in the future by
regulatory action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of the Fund's obligations to or from a futures
broker. When the Fund purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast, when the Fund purchases
or sells a futures contract or writes a call or put option thereon, it is
subject to daily variation margin calls that could be substantial in the event
of adverse price movements. If the Fund has insufficient cash to meet daily
variation margin requirements, it might need to sell securities at a time when
such sales are disadvantageous. Purchasers and sellers of futures positions
and options on futures can enter into offsetting closing transactions by
selling or purchasing, respectively, an instrument identical to the instrument
held or written. Positions in futures and options on futures may be closed
only on an exchange or board of trade that provides a secondary market. The
Fund intends to enter into futures transactions only on exchanges or boards of
trade where there appears to be a liquid secondary market. However, there can
be no assurance that such a market will exist for a particular contract at a
particular time.
Under certain circumstances, futures exchanges may establish daily limits
on the amount that the price of a future or option on a futures contract can
vary from the previous day's settlement price; once that limit is reached, no
trades may be made that day at a price beyond the limit. Daily price limits do
not limit potential losses because prices could move to the daily limit for
several consecutive days with little or no trading, thereby preventing
liquidation of unfavorable positions.
If the Fund was unable to liquidate a futures or option on a futures
contract position due to the absence of a liquid secondary market or the
imposition of price limits, it could incur substantial losses. The Fund would
continue to be subject to market risk with respect to the position. In
addition, except in the case of purchased options, the Fund would continue to
be required to make daily variation margin payments and might be required to
maintain the position being hedged by the future or option or to maintain cash
or securities in a segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or options on futures contracts
might not correlate perfectly with movements in the prices of the investments
being hedged. For example, all participants in the futures and options on
futures contracts markets are subject to daily variation margin calls and might
be compelled to liquidate futures or options on futures contracts positions
whose prices are moving unfavorably to avoid being subject to further calls.
These liquidations could increase price volatility of the instruments and
distort the normal price relationship between the futures or options and the
investments being hedged. Also, because initial margin deposit requirements in
the futures markets are less onerous than margin requirements in the securities
markets, there might be increased participation by speculators in the future
markets. This participation also might cause temporary price distortions. In
addition, activities of large traders in both the futures and securities
markets involving arbitrage, "program trading" and other investment strategies
might result in temporary price distortions.
FOREIGN CURRENCIES. The Fund may purchase and sell foreign currency on a
spot basis, and may use currency-related derivatives instruments such as
options on foreign currencies, futures on foreign currencies, options on
futures on foreign currencies and forward currency contracts (i.e., an
obligation to purchase or sell a specific currency at a specified future date,
which may be any fixed number of days from the contract date agreed upon by the
parties, at a price set at the time the contract is entered into). The Fund
may use these instruments for hedging or any other lawful purpose consistent
with its investment objective, including transaction hedging, anticipatory
hedging, cross hedging, proxy hedging, and position hedging. The Fund's use of
currency-related derivative instruments will be directly related to the Fund's
current or anticipated portfolio securities, and the Fund may engage in
transactions in currency-related derivative instruments as a means to protect
against some or all of the effects of adverse changes in foreign currency
exchange rates on its portfolio investments. In general, if the currency in
which a portfolio investment is denominated appreciates against the U.S.
dollar, the dollar value of the security will increase. Conversely, a decline
in the exchange rate of the currency would adversely affect the value of the
portfolio investment expressed in U.S. dollars.
12
<PAGE> 112
For example, the Fund might use currency-related derivative instruments to
"lock in" a U.S. dollar price for a portfolio investment, thereby enabling the
Fund to protect itself against a possible loss resulting from an adverse change
in the relationship between the U.S. dollar and the subject foreign currency
during the period between the date the security is purchased or sold and the
date on which payment is made or received. The Fund also might use
currency-related derivative instruments when the Advisor believes that one
currency may experience a substantial movement against another currency,
including the U.S. dollar, and it may use currency-related derivative
instruments to sell or buy the amount of the former foreign currency,
approximating the value of some or all of the Fund's portfolio securities
denominated in such foreign currency. Alternatively, where appropriate, the
Fund may use currency-related derivative instruments to hedge all or part of
its foreign currency exposure through the use of a basket of currencies or a
proxy currency where such currency or currencies act as an effective proxy for
other currencies. The use of this basket hedging technique may be more
efficient and economical than using separate currency-related derivative
instruments for each currency exposure held by the Fund. Furthermore,
currency-related derivative instruments may be used for short hedges - for
example, the Fund may sell a forward currency contract to lock in the U.S.
dollar equivalent of the proceeds from the anticipated sale of a security
denominated in a foreign currency.
In addition, the Fund may use a currency-related derivative instrument to
shift exposure to foreign currency fluctuations from one foreign country to
another foreign country where the Advisor believes that the foreign currency
exposure purchased will appreciate relative to the U.S. dollar and thus better
protect the Fund against the expected decline in the foreign currency exposure
sold. For example, if the Fund owns securities denominated in a foreign
currency and the Advisor believes that currency will decline, it might enter
into a forward contract to sell an appropriate amount of the first foreign
currency, with payment to be made in a second foreign currency that the Advisor
believes would better protect the Fund against the decline in the first
security than would a U.S. dollar exposure. Hedging transactions that use two
foreign currencies are sometimes referred to as "cross hedges." The effective
use of currency-related derivative instruments by the Fund in a cross hedge is
dependent upon a correlation between price movements of the two currency
instruments and the underlying security involved, and the use of two currencies
magnifies the risk that movements in the price of one instrument may not
correlate or may correlate unfavorably with the foreign currency being hedged.
Such a lack of correlation might occur due to factors unrelated to the value of
the currency instruments used or investments being hedged, such as speculative
or other pressures on the markets in which these instruments are traded.
The Fund also might seek to hedge against changes in the value of a
particular currency when no hedging instruments on that currency are available
or such hedging instruments are more expensive than certain other hedging
instruments. In such cases, the Fund may hedge against price movements in that
currency by entering into transactions using currency-related derivative
instruments on another foreign currency or a basket of currencies, the values
of which the Advisor believes will have a high degree of positive correlation
to the value of the currency being hedged. The risk that movements in the
price of the hedging instrument will not correlate perfectly with movements in
the price of the currency being hedged is magnified when this strategy is used.
The use of currency-related derivative instruments by the Fund involves a
number of risks. The value of currency-related derivative instruments depends
on the value of the underlying currency relative to the U.S. dollar. Because
foreign currency transactions occurring in the interbank market might involve
substantially larger amounts than those involved in the use of such derivative
instruments, the Fund could be disadvantaged by having to deal in the 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 (generally consisting of transactions of greater than $1 million).
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis.
Quotation information generally is representative of very large transactions in
the interbank market and thus might not reflect odd-lot transactions where
rates might be less favorable. The interbank market in foreign currencies is a
global, round-the-clock market. To the extent the U.S. options or futures
markets are closed while the markets for the underlying currencies remain open,
significant price and rate movements might take place in the underlying markets
that cannot be reflected in the markets for the derivative instruments until
they re-open.
Settlement of transactions in currency-related derivative instruments
might be required to take place within the country issuing the underlying
currency. Thus, the Fund might be required to accept or make delivery of the
underlying foreign currency in accordance with any U.S. or foreign regulations
regarding the maintenance of foreign banking
13
<PAGE> 113
arrangements by U.S. residents and might be required to pay any fees, taxes and
charges associated with such delivery assessed in the issuing country.
When the Fund engages in a transaction in a currency-related derivative
instrument, it relies on the counterparty to make or take delivery of the
underlying currency at the maturity of the contract or otherwise complete the
contract. In other words, the Fund will be subject to the risk that a loss may
be sustained by the Fund as a result of the failure of the counterparty to
comply with the terms of the transaction. The counterparty risk for exchange-
traded instruments is generally less than for privately-negotiated or OTC
currency instruments, since generally a clearing agency, which is the issuer or
counterparty to each instrument, provides a guarantee of performance. For
privately-negotiated instruments, there is no similar clearing agency
guarantee. In all transactions, the Fund will bear the risk that the
counterparty will default, and this could result in a loss of the expected
benefit of the transaction and possibly other losses to the Fund. The Fund
will enter into transactions in currency-related derivative instruments only
with counterparties that the Advisor reasonably believes are capable of
performing under the contract.
Purchasers and sellers of currency-related derivative instruments may
enter into offsetting closing transactions by selling or purchasing,
respectively, an instrument identical to the instrument purchased or sold.
Secondary markets generally do not exist for forward currency contracts, with
the result that closing transactions generally can be made for forward currency
contracts only by negotiating directly with the counterparty. Thus, there can
be no assurance that the Fund will in fact be able to close out a forward
currency contract (or any other currency-related derivative instrument) at a
time and price favorable to the Fund. In addition, in the event of insolvency
of the counterparty, the Fund might be unable to close out a forward currency
contract at any time prior to maturity. In the case of an exchange-traded
instrument, the Fund will be able to close the position out only on an exchange
which provides a market for the instruments. The ability to establish and
close out positions on an exchange is subject to the maintenance of a liquid
market, and there can be no assurance that a liquid market will exist for any
instrument at any specific time. In the case of a privately-negotiated
instrument, the Fund will be able to realize the value of the instrument only
by entering into a closing transaction with the issuer or finding a third party
buyer for the instrument. While the Fund will enter into privately-negotiated
transactions only with entities who are expected to be capable of entering into
a closing transaction, there can be no assurance that the Fund will in fact be
able to enter into such closing transactions.
The precise matching of currency-related derivative instrument amounts and
the value of the portfolio securities involved generally will not be possible
because the value of such securities, measured in the foreign currency, will
change after the currency-related derivative instrument position has been
established. Thus, the Fund might need to purchase or sell foreign currencies
in the spot (cash) market. The projection of short-term currency market
movements is extremely difficult, and the successful execution of a short-term
hedging strategy is highly uncertain.
Permissible foreign currency options will include options traded primarily
in the OTC market. Although options on foreign currencies are traded primarily
in the OTC market, the Fund will normally purchase or sell OTC options on
foreign currency only when the Advisor reasonably believes a liquid secondary
market will exist for a particular option at any specific time.
There will be a cost to the Fund of engaging in transactions in
currency-related derivative instruments that will vary with factors such as the
contract or currency involved, the length of the contract period and the market
conditions then prevailing. The Fund using these instruments may have to pay a
fee or commission or, in cases where the instruments are entered into on a
principal basis, foreign exchange dealers or other counterparties will realize
a profit based on the difference ("spread") between the prices at which they
are buying and selling various currencies. Thus, for example, a dealer may
offer to sell a foreign currency to the Fund at one rate, while offering a
lesser rate of exchange should the Fund desire to resell that currency to the
dealer.
When required by the SEC guidelines, the Fund will set aside permissible
liquid assets in segregated accounts or otherwise cover its potential
obligations under currency-related derivatives instruments. To the extent the
Fund's assets are so set aside, they cannot be sold while the corresponding
currency position is open, unless they are replaced with similar assets. As a
result, if a large portion of the Fund's assets are so set aside, this could
impede portfolio management or the Fund's ability to meet redemption requests
or other current obligations.
14
<PAGE> 114
The Advisor's decision to engage in a transaction in a particular
currency-related derivative instrument will reflect the Advisor's judgment that
the transaction will provide value to the Fund and its shareholders and is
consistent with the Fund's objectives and policies. In making such a judgment,
the Advisor will analyze the benefits and risks of the transaction and weigh
them in the context of the Fund's entire portfolio and objectives. The
effectiveness of any transaction in a currency-related derivative instrument is
dependent on a variety of factors, including the Advisor's skill in analyzing
and predicting currency values and upon a correlation between price movements
of the currency instrument and the underlying security. There might be
imperfect correlation, or even no correlation, between price movements of an
instrument and price movements of investments being hedged. Such a lack of
correlation might occur due to factors unrelated to the value of the
investments being hedged, such as speculative or other pressures on the markets
in which these instruments are traded. In addition, the Fund's use of
currency-related derivative instruments is always subject to the risk that the
currency in question could be devalued by the foreign government. In such a
case, any long currency positions would decline in value and could adversely
affect any hedging position maintained by the Fund.
The Fund's dealing in currency-related derivative instruments will
generally be limited to the transactions described above. However, the Fund
reserves the right to use currency-related derivatives instruments for
different purposes and under different circumstances. Of course, the Fund is
not required to use currency-related derivatives instruments and will not do so
unless deemed appropriate by the Advisor. It also should be realized that use
of these instruments does not eliminate, or protect against, price movements in
the Fund's securities that are attributable to other (i.e., non-currency
related) causes. Moreover, while the use of currency-related derivatives
instruments may reduce the risk of loss due to a decline in the value of a
hedged currency, at the same time the use of these instruments tends to limit
any potential gain which may result from an increase in the value of that
currency.
SWAP AGREEMENTS. The Fund may enter into interest rate, securities index,
commodity, or security and currency exchange rate swap agreements for any
lawful purpose consistent with the Fund's investment objective, such as for the
purpose of attempting to obtain or preserve a particular desired return or
spread at a lower cost to the Fund than if the Fund had invested directly in an
instrument that yielded that desired return or spread. The Fund also may enter
into swaps in order to protect against an increase in the price of, or the
currency exchange rate applicable to, securities that the Fund anticipates
purchasing at a later date. Swap agreements are two-party contracts entered
into primarily by institutional investors for periods ranging from a few weeks
to several years. In a standard "swap" transaction, two parties agree to
exchange the returns (or differentials in rates of return) earned or realized
on particular predetermined investments or instruments. The gross returns to
be exchanged or "swapped" between the parties are calculated with respect to a
"notional amount," i.e., the return on or increase in value of a particular
dollar amount invested at a particular interest rate, in a particular foreign
currency, or in a "basket" of securities representing a particular index. Swap
agreements may include interest rate caps, under which, in return for a
premium, one party agrees to make payments to the other to the extent that
interest rates exceed a specified rate, or "cap;" interest rate floors, under
which, in return for a premium, one party agrees to make payments to the other
to the extent that interest rates fall below a specified level, or "floor;" and
interest rate collars, under which a party sells a cap and purchases a floor,
or vice versa, in an attempt to protect itself against interest rate movements
exceeding given minimum or maximum levels.
The "notional amount" of the swap agreement is the agreed upon basis for
calculating the obligations that the parties to a swap agreement have agreed to
exchange. Under most swap agreements entered into by the Fund, the obligations
of the parties would be exchanged on a "net basis." Consequently, the Fund's
obligation (or rights) under a swap agreement will generally be equal only to
the net amount to be paid or received under the agreement based on the relative
values of the positions held by each party to the agreement (the "net amount").
The Fund's obligation under a swap agreement will be accrued daily (offset
against amounts owed to the Fund) and any accrued but unpaid net amounts owed
to a swap counterparty will be covered by the maintenance of a segregated
account consisting of cash, or liquid high grade debt obligations.
Whether the Fund's use of swap agreements will be successful in furthering
its investment objective will depend, in part, on the Advisor's ability to
predict correctly whether certain types of investments are likely to produce
greater returns than other investments. Swap agreements may be considered to
be illiquid. Moreover, the Fund bears the risk of loss of the amount expected
to be received under a swap agreement in the event of the default or bankruptcy
of a swap agreement counterparty. Certain restrictions imposed on the Fund by
the Internal Revenue Code may limit the Fund's ability to use swap agreements.
The swaps market is largely unregulated.
15
<PAGE> 115
The Fund will enter swap agreements only with counterparties that the
Advisor reasonably believes are capable of performing under the swap
agreements. If there is a default by the other party to such a transaction,
the Fund will have to rely on its contractual remedies (which may be limited by
bankruptcy, insolvency or similar laws) pursuant to the agreements related to
the transaction.
ADDITIONAL DERIVATIVE INSTRUMENTS AND STRATEGIES. In addition to the
derivative instruments and strategies described above and in the Fund's
Prospectus, the Advisor expects to discover additional derivative instruments
and other hedging or risk management techniques. The Advisor may utilize these
new derivative instruments and techniques to the extent that they are consistent
with the Fund's investment objective and permitted by the Fund's investment
limitations, operating policies, and applicable regulatory authorities.
FOREIGN INVESTMENT COMPANIES
The Fund may invest, to a limited extent, in foreign investment
companies. Some of the countries in which the Fund invests may not permit
direct investment by outside investors. Investments in such countries may
only be permitted through foreign government-approved or -authorized
investment vehicles, which may include other investment companies. In
addition, it may be less expensive and more expedient for the Fund to invest
in a foreign investment company in a country which permits direct foreign
investment. Investing through such vehicles may involve frequent or layered
fees or expenses and may also be subject to limitation under the 1940 Act.
Under the 1940 Act, the Fund may invest up to 10% of its assets in shares of
other investment companies and up to 5% of its assets in any one investment
company as long as the investment does not represent more than 3% of the
voting stock of the acquired investment company. The Fund does not intend to
invest in such investment companies unless, in the judgment of the Advisor,
the potential benefits of such investments justify the payment of any
associated fees and expenses.
FOREIGN SECURITIES
Investing in foreign securities involves a series of risks not present in
investing in U.S. securities. Many of the foreign securities held by the Fund
will not be registered with the Securities and Exchange Commission (the "SEC"),
nor will the foreign issuers be subject to SEC reporting requirements.
Accordingly, there may be less publicly available information concerning
foreign issuers of securities held by the Fund than is available concerning
U.S. companies. Disclosure and regulatory standards in many respects are less
stringent in emerging market countries than in the U.S. and other major
markets. There also may be a lower level of monitoring and regulation of
emerging markets and the activities of investors in such markets, and
enforcement of existing regulations may be extremely limited. Foreign
companies, and in particular, companies in smaller and emerging capital markets
are not generally subject to uniform accounting, auditing and financial
reporting standards, or to other regulatory requirements comparable to those
applicable to U.S. companies. The Fund's net investment income and capital
gains from its foreign investment activities may be subject to non-U.S.
withholding taxes.
The costs attributable to foreign investing that the Fund must bear
frequently are higher than those attributable to domestic investing; this is
particularly true with respect to emerging capital markets. For example, the
cost of maintaining custody of foreign securities exceeds custodian costs for
domestic securities, and transaction and settlement costs of foreign investing
also frequently are higher than those attributable to domestic investing.
Costs associated with the exchange of currencies also make foreign investing
more expensive than domestic investing. Investment income on certain foreign
securities in which the Fund may invest may be subject to foreign withholding
or other government taxes that could reduce the return of these securities.
Tax treaties between the United States and foreign countries, however, may
reduce or eliminate the amount of foreign tax to which the Fund would be
subject.
Foreign markets also have different clearance and settlement procedures,
and in certain markets there have been times when settlements have failed to
keep pace with the volume of securities transactions, making it difficult to
conduct such transactions. Delays in settlement could result in temporary
periods when assets of the Fund are uninvested and no return is earned thereon.
The inability of the Fund to make intended security purchases due to
settlement problems could cause the Fund to miss investment opportunities.
Inability to dispose of a portfolio security due to settlement problems could
result either in losses to the Fund due to subsequent declines in the value of
such portfolio security or, if the Fund has entered into a contract to sell the
security, could result in possible liability to the purchaser.
16
<PAGE> 116
HIGH-YIELD (HIGH-RISK) SECURITIES
IN GENERAL. The Fund has the authority to invest up to 35% of its net
assets in non-investment grade debt obligations. Non-investment grade debt
obligations (hereinafter referred to as "lower-quality securities") include (i)
bonds rated as low as C by Moody's Investors Service, Inc. ("Moody's"),
Standard & Poor's Ratings Group ("S&P"), or Fitch Investors Service, Inc.
("Fitch"), or CCC by Duff & Phelps, Inc. ("D&P"); (ii) commercial paper rated
as low as C by S&P, Not Prime by Moody's, or Fitch 4 by Fitch; and (iii)
unrated debt obligations of comparable quality. Lower-quality securities,
while generally offering higher yields than investment grade securities with
similar maturities, involve greater risks, including the possibility of default
or bankruptcy. They are regarded as predominantly speculative with respect to
the issuer's capacity to pay interest and repay principal. The special risk
considerations in connection with investments in these securities are discussed
below. Refer to the Appendix for a discussion of securities ratings.
EFFECT OF INTEREST RATES AND ECONOMIC CHANGES. The lower-quality and
comparable unrated security market is relatively new and its growth has
paralleled a long economic expansion. As a result, it is not clear how this
market may withstand a prolonged recession or economic downturn. Such
conditions could severely disrupt the market for and adversely affect the value
of such securities.
All interest-bearing securities typically experience appreciation when
interest rates decline and depreciation when interest rates rise. The market
values of lower-quality and comparable unrated securities tend to reflect
individual corporate developments to a greater extent than do higher rated
securities, which react primarily to fluctuations in the general level of
interest rates. Lower-quality and comparable unrated securities also tend to
be more sensitive to economic conditions than are higher-rated securities. As
a result, they generally involve more credit risks than securities in the
higher-rated categories. During an economic downturn or a sustained period of
rising interest rates, highly leveraged issuers of lower-quality and comparable
unrated securities may experience financial stress and may not have sufficient
revenues to meet their payment obligations. The issuer's ability to service
its debt obligations may also be adversely affected by specific corporate
developments, the issuer's inability to meet specific projected business
forecasts or the unavailability of additional financing. The risk of loss due
to default by an issuer of these securities is significantly greater than
issuers of higher-rated securities because such securities are generally
unsecured and are often subordinated to other creditors. Further, if the
issuer of a lower-quality or comparable unrated security defaulted, the Fund
might incur additional expenses to seek recovery. Periods of economic
uncertainty and changes would also generally result in increased volatility in
the market prices of these securities and thus in the Fund's net asset value.
As previously stated, the value of a lower-quality or comparable unrated
security will decrease in a rising interest rate market and accordingly, so
will the Fund's net asset value. If the Fund experiences unexpected net
redemptions in such a market, it may be forced to liquidate a portion of its
portfolio securities without regard to their investment merits. Due to the
limited liquidity of lower-quality and comparable unrated securities (discussed
below), the Fund may be forced to liquidate these securities at a substantial
discount. Any such liquidation would force the Fund to sell the more liquid
portion of its portfolio.
PAYMENT EXPECTATIONS. Lower-quality and comparable unrated securities
typically contain redemption, call or prepayment provisions which permit the
issuer of such securities containing such provisions to, at its discretion,
redeem the securities. During periods of falling interest rates, issuers of
these securities are likely to redeem or prepay the securities and refinance
them with debt securities with a lower interest rate. To the extent an issuer
is able to refinance the securities, or otherwise redeem them, the Fund may
have to replace the securities with a lower yielding security, which would
result in a lower return for the Fund.
CREDIT RATINGS. Credit ratings issued by credit rating agencies are
designed to evaluate the safety of principal and interest payments of rated
securities. They do not, however, evaluate the market value risk of
lower-quality securities and, therefore, may not fully reflect the true risks
of an investment. In addition, credit rating agencies may or may not make
timely changes in a rating to reflect changes in the economy or in the
condition of the issuer that affect the market value of the security.
Consequently, credit ratings are used only as a preliminary indicator of
investment quality. Investments in lower-quality and comparable unrated
obligations will be more dependent on the Advisor's credit analysis than would
be the case with investments in investment-grade debt obligations. The Advisor
employs its own credit research and analysis, which includes a study of
existing debt, capital structure, ability to service debt and to pay dividends,
the issuer's sensitivity to economic
17
<PAGE> 117
conditions, its operating history and the current trend of earnings. The
Advisor continually monitors the investments in the Fund's portfolio and
carefully evaluates whether to dispose of or to retain lower-quality and
comparable unrated securities whose credit ratings or credit quality may have
changed.
LIQUIDITY AND VALUATION. The Fund may have difficulty disposing of
certain lower-quality and comparable unrated securities because there may be a
thin trading market for such securities. Because not all dealers maintain
markets in all lower-quality and comparable unrated securities, there is no
established retail secondary market for many of these securities. The Fund
anticipates that such securities could be sold only to a limited number of
dealers or institutional investors. To the extent a secondary trading market
does exist, it is generally not as liquid as the secondary market for
higher-rated securities. The lack of a liquid secondary market may have an
adverse impact on the market price of the security. As a result, the Fund's
asset value and ability to dispose of particular securities, when necessary to
meet the Fund's liquidity needs or in response to a specific economic event,
may be impacted. The lack of a liquid secondary market for certain securities
may also make it more difficult for the Fund to obtain accurate market
quotations for purposes of valuing the Fund's portfolio. Market quotations are
generally available on many lower-quality and comparable unrated issues only
from a limited number of dealers and may not necessarily represent firm bids of
such dealers or prices for actual sales. During periods of thin trading, the
spread between bid and asked prices is likely to increase significantly. In
addition, adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of lower-quality
and comparable unrated securities, especially in a thinly traded market.
LEGISLATION. Legislation may be adopted, from time to time designed to
limit the use of certain lower-quality and comparable unrated securities by
certain issuers. It is anticipated that if additional legislation is enacted
or proposed, it could have a material affect on the value of these securities
and the existence of a secondary trading market for the securities.
ILLIQUID SECURITIES
The Fund may invest in illiquid securities (i.e., securities that are not
readily marketable). However, the Fund will not acquire illiquid securities
if, as a result, they would comprise more than 15% of the value of the Fund's
net assets (or such other amounts as may be permitted under the 1940 Act).
However, as a matter of internal policy, the Advisor intends to limit the
Fund's investments in illiquid securities to 10% of its net assets.
The Board of Directors of the Fund, or its delegate, has the ultimate
authority to determine, to the extent permissible under the federal securities
laws, which securities are illiquid for purposes of this limitation. Certain
securities exempt from registration or issued in transactions exempt from
registration under the Securities Act of 1933, as amended (the "Securities
Act"), such as securities that may be resold to institutional investors under
Rule 144A under the Securities Act and Section 4(2) commercial paper, may be
considered liquid under guidelines adopted by the Fund's Board of Directors.
The Board of Directors of the Fund has delegated to the Advisor the
day-to-day determination of the liquidity of a security, although it has
retained oversight and ultimate responsibility for such determinations. The
Board of Directors has directed the Advisor to look to such factors as (i) the
frequency of trades or quotes for a security, (ii) the number of dealers
willing to purchase or sell the security and number of potential buyers, (iii)
the willingness of dealers to undertake to make a market in the security, (iv)
the nature of the security and nature of the marketplace trades, such as the
time needed to dispose of the security, the method of soliciting offers, and
the mechanics of transfer, (v) the likelihood that the security's marketability
will be maintained throughout the anticipated holding period, and (vi) any
other relevant factors. The Advisor may determine 4(2) commercial paper to be
liquid if (i) the 4(2) commercial paper is not traded flat or in default as to
principal and interest, (ii) the 4(2) commercial paper is rated in one of the
two highest rating categories by at least two nationally rated statistical
rating organizations ("NRSRO"), or if only one NRSRO rates the security, by
that NRSRO, or is determined by the Advisor to be of equivalent quality, and
(iii) the Advisor considers the trading market for the specific security taking
into account all relevant factors. With respect to the Fund's foreign
holdings, a foreign security may be considered liquid by the Advisor (despite
its restricted nature under the Securities Act) if the security can be freely
traded in a foreign securities market and all the facts and circumstances
support a finding of liquidity.
Restricted securities may be sold only in privately negotiated
transactions or in a public offering with respect to which a registration
statement is in effect under the Securities Act. Where registration is
required, the Fund may be obligated to pay all or part of the registration
expenses and a considerable period may elapse between the time of the decision
to sell and the
18
<PAGE> 118
time the Fund may be permitted to sell a security under an effective
registration statement. If, during such a period, adverse market conditions
were to develop, the Fund might obtain a less favorable price than prevailed
when it decided to sell. Restricted securities will be priced at fair value as
determined in good faith by the Board of Directors of the Fund. If through the
appreciation of restricted securities or the depreciation of unrestricted
securities, the Fund should be in a position where more than 15% of the value
of its net assets are invested in illiquid securities, including restricted
securities which are not readily marketable (except for 144A Securities and
4(2) commercial paper deemed to be liquid by the Advisor), the Fund will take
such steps as is deemed advisable, if any, to protect liquidity.
The Fund may sell over-the-counter ("OTC") options and, in connection
therewith, segregate assets or cover its obligations with respect to OTC
options written by the Fund. The assets used as cover for OTC options written
by the Fund will be considered illiquid unless the OTC options are sold to
qualified dealers who agree that the Fund may repurchase any OTC option it
writes at a maximum price to be calculated by a formula set forth in the option
agreement. The cover for an OTC option written subject to this procedure would
be considered illiquid only to the extent that the maximum repurchase price
under the formula exceeds the intrinsic value of the option.
LENDING OF PORTFOLIO SECURITIES
The Fund is authorized to lend up to 33 1/3% of the total value of its
portfolio securities to broker-dealers or institutional investors that the
Advisor deems qualified, but only when the borrower maintains with the Fund's
custodian bank collateral either in cash or money market instruments in an
amount at least equal to the market value of the securities loaned, plus
accrued interest and dividends, determined on a daily basis and adjusted
accordingly. Although the Fund is authorized to lend, the Fund does not
presently intend to engage in lending. In determining whether to lend
securities to a particular broker-dealer or institutional investor, the Advisor
will consider, and during the period of the loan will monitor, all relevant
facts and circumstances, including the creditworthiness of the borrower. The
Fund will retain authority to terminate any loans at any time. The Fund may
pay reasonable administrative and custodial fees in connection with a loan and
may pay a negotiated portion of the interest earned on the cash or money market
instruments held as collateral to the borrower or placing broker. The Fund
will receive reasonable interest on the loan or a flat fee from the borrower
and amounts equivalent to any dividends, interest or other distributions on the
securities loaned. The Fund will retain record ownership of loaned securities
to exercise beneficial rights, such as voting and subscription rights and
rights to dividends, interest or other distributions, when retaining such
rights is considered to be in the Fund's interest.
MORTGAGE- AND ASSET-BACKED SECURITIES
Mortgage-backed securities represent direct or indirect participations in,
or are secured by and payable from, mortgage loans secured by real property,
and include single- and multi-class pass-through securities and collateralized
mortgage obligations. Such securities may be issued or guaranteed by U.S.
government agencies or instrumentalities, such as the Government National
Mortgage Association and the Federal National Mortgage Association, or by
private issuers, generally originators and investors in mortgage loans,
including savings associations, mortgage bankers, commercial banks, investment
bankers, and special purpose entities (collectively, "private lenders").
Mortgage-backed securities issued by private lenders may be supported by pools
of mortgage loans or other mortgage-backed securities that are guaranteed,
directly or indirectly, by the U.S. government or one of its agencies or
instrumentalities, or they may be issued without any governmental guarantee of
the underlying mortgage assets but with some form of non-governmental credit
enhancement.
Asset-backed securities have structural characteristics similar to
mortgage-backed securities. Asset-backed debt obligations represent direct or
indirect participation in, or secured by and payable from, assets such as motor
vehicle installment sales contracts, other installment loan contracts, home
equity loans, leases of various types of property, and receivables from credit
card or other revolving credit arrangements. The credit quality of most
asset-backed securities depends primarily on the credit quality of the assets
underlying such securities, how well the entity issuing the security is
insulated from the credit risk of the originator or any other affiliated
entities, and the amount and quality of any credit enhancement of the
securities. Payments or distributions of principal and interest on
asset-backed debt obligations may be supported by non-governmental credit
enhancements including letters of credit, reserve funds, overcollateralization,
and guarantees by third parties. The market for privately issued asset-backed
debt obligations is smaller and less liquid than the market for government
sponsored mortgage-backed securities.
19
<PAGE> 119
The rate of principal payment on mortgage- and asset-backed securities
generally depends on the rate of principal payments received on the underlying
assets which in turn may be affected by a variety of economic and other
factors. As a result, the yield on any mortgage- and asset-backed security is
difficult to predict with precision and actual yield to maturity may be more or
less than the anticipated yield to maturity. The yield characteristics of
mortgage- and asset-backed securities differ from those of traditional debt
securities. Among the principal differences are that interest and principal
payments are made more frequently on mortgage-and asset-backed securities,
usually monthly, and that principal may be prepaid at any time because the
underlying mortgage loans or other assets generally may be prepaid at any time.
As a result, if the Fund purchases these securities at a premium, a prepayment
rate that is faster than expected will reduce yield to maturity, while a
prepayment rate that is slower than expected will have the opposite effect of
increasing the yield to maturity. Conversely, if the Fund purchases these
securities at a discount, a prepayment rate that is faster than expected will
increase yield to maturity, while a prepayment rate that is slower than
expected will reduce yield to maturity. Amounts available for reinvestment by
a Fund are likely to be greater during a period od declining interest rates
and, as a result, are likely to be reinvested at lower interest rates than
during a period of rising interest rates. Accelerated prepayments on
securities purchased by the Fund at a premium also impose a risk of loss of
principal because the premium may not have been fully amortized at the time
the principal is prepaid in full. The market for privately issued mortgage-and
asset-backed securities is smaller and less liquid than the market for
government-sponsored mortgage- backed securities.
While many mortgage- and asset-backed securities are issued with only one
class of security, many are issued in more than one class, each with different
payment terms. Multiple class mortgage- and asset-backed securities are issued
for two main reasons. First, multiple classes may be used as a method of
providing credit support. This is accomplished typically through creation of
one or more classes whose right to payments on the security is made subordinate
to the right to such payments of the remaining class or classes. Second,
multiple classes may permit the issuance of securities with payment terms,
interest rates, or other characteristics differing both from those of each
other and from those of the underlying assets. Examples include so-called
"strips" (mortgage - and asset-backed securities entitling the holder to
disproportionate interests with respect to the allocation of interest and
principal of the assets backing the security), and securities with class or
classes having characteristics which mimic the characteristics of non-mortgage-
or asset-backed securities, such as floating interest rates (i.e., interest
rates which adjust as a specified benchmark changes) or scheduled amortization
of principal.
The Fund may invest in stripped mortgage- or asset-backed securities,
which receive differing proportions of the interest and principal payments from
the underlying assets. The market value of such securities generally is more
sensitive to changes in prepayment and interest rates than is the case with
traditional mortgage- and asset-backed securities, and in some cases such
market value may be extremely volatile. With respect to certain stripped
securities, such as interest only and principal only classes, a rate of
prepayment that is faster or slower than anticipated may result in the Fund
failing to recover all or a portion of its investment, even though the
securities are rated investment grade.
Mortgage- and asset-backed securities backed by assets, other than as
described above, or in which the payment streams on the underlying assets are
allocated in a manner different than those described above may be issued in the
future. The Fund may invest in such securities if such investment is otherwise
consistent with its investment objectives and policies and with the investment
restrictions of the Fund.
MORTGAGE DOLLAR ROLLS AND REVERSE REPURCHASE AGREEMENTS
The Fund may engage in reverse repurchase agreements to facilitate
portfolio liquidity, a practice common in the mutual fund industry, or for
arbitrage transactions discussed below. In a reverse repurchase agreement, the
Fund would sell a security and enter into an agreement to repurchase the
security at a specified future date and price. The Fund generally retains the
right to interest and principal payments on the security. Since the Fund
receives cash upon entering into a reverse repurchase agreement, it may be
considered a borrowing. (See "Borrowing".) When required by guidelines of the
SEC, the Fund will set aside permissible liquid assets in a segregated account
to secure its obligations to repurchase the security.
The Fund may also enter into mortgage dollar rolls, in which the Fund
would sell mortgage-backed securities for delivery in the current month and
simultaneously contract to purchase substantially similar securities on a
specified future date. While the Fund would forego principal and interest paid
on the mortgage-backed securities during the roll period, the Fund would be
compensated by the difference between the current sales price and the lower
price for the future purchase as well as by any interest earned on the proceeds
of the initial sale. The Fund also could be compensated through the receipt of
fee
20
<PAGE> 120
income equivalent to a lower forward price. At the time the Fund would
enter into a mortgage dollar roll, it would set aside permissible liquid assets
in a segregated account to secure its obligation for the forward commitment to
buy mortgage-backed securities. Mortgage dollar roll transactions may be
considered a borrowing by the Fund. (See "Borrowing".)
The mortgage dollar rolls and reverse repurchase agreements entered into
by the Fund may be used as arbitrage transactions in which the Fund will
maintain an offsetting position in investment grade debt obligations or
repurchase agreements that mature on or before the settlement date on the
related mortgage dollar roll or reverse repurchase agreements. Since the Fund
will receive interest on the securities or repurchase agreements in which it
invests the transaction proceeds, such transactions may involve leverage.
However, since such securities or repurchase agreements will be high quality
and will mature on or before the settlement date of the mortgage dollar roll or
reverse repurchase agreement, the Advisor believes that such arbitrage
transactions do not present the risks to the Fund that are associated with
other types of leverage.
MUNICIPAL OBLIGATIONS
General obligation bonds are secured by the issuer's pledge of its full
faith, credit, and taxing power for the payment of interest and principal.
Revenue bonds are payable only from the revenues derived from a project or
facility or from the proceeds of a specified revenue source. Industrial
development bonds are generally revenue bonds secured by payments from and the
credit of private users. Municipal notes are issued to meet the short-term
funding requirements of state, regional, and local governments. Municipal
notes include tax anticipation notes, bond anticipation notes, revenue
anticipation notes, tax and revenue anticipation notes, construction loan
notes, short-term discount notes, tax-exempt commercial paper, demand notes,
and similar instruments. Municipal obligations include obligations, the
interest on which is exempt from federal income tax, that may become available
in the future as long as the Board of Directors of the Fund determines that an
investment in any such type of obligation is consistent with the Fund's
investment objective.
Municipal lease obligations may take the form of a lease, an installment
purchase, or a conditional sales contract. They are issued by state and local
governments and authorities to acquire land, equipment, and facilities, such as
state and municipal vehicles, telecommunications and computer equipment, and
other capital assets. The Fund may purchase these obligations directly, or it
may purchase participation interests in such obligations. Municipal leases are
generally subject to greater risks than general obligation or revenue bonds.
State constitutions and statutes set forth requirements that states or
municipalities must meet in order to issue municipal obligations. Municipal
leases may contain a covenant by the state or municipality to budget for,
appropriate, and make payments due under the obligation. Certain municipal
leases may, however, contain "non-appropriation" clauses which provide that the
issuer is not obligated to make payments on the obligation in future years
unless funds have been appropriated for this purpose each year. Accordingly,
such obligations are subject to "non-appropriation" risk. While municipal
leases are secured by the underlying capital asset, it may be difficult to
dispose of any such asset in the event of non-appropriation or other default.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with certain banks or
non-bank dealers. In a repurchase agreement, the Fund buys a security at one
price, and at the time of sale, the seller agrees to repurchase the obligation
at a mutually agreed upon time and price (usually within seven days). The
repurchase agreement, thereby, determines the yield during the purchaser's
holding period, while the seller's obligation to repurchase is secured by the
value of the underlying security. The Advisor will monitor, on an ongoing
basis, the value of the underlying securities to ensure that the value always
equals or exceeds the repurchase price plus accrued interest. Repurchase
agreements could involve certain risks in the event of a default or insolvency
of the other party to the agreement, including possible delays or restrictions
upon the Fund's ability to dispose of the underlying securities. Although no
definitive creditworthiness criteria are used, the Advisor reviews the
creditworthiness of the banks and non-bank dealers with which the Fund enters
into repurchase agreements to evaluate those risks. The Fund may, under
certain circumstances, deem repurchase agreements collateralized by U.S.
government securities to be investments in U.S. government securities.
SHORT SALES AGAINST THE BOX
The Fund may sell securities short against the box to hedge unrealized
gains on portfolio securities. Selling securities short against the box
involves selling a security that the Fund owns or has the right to acquire, for
delivery at a specified date in
21
<PAGE> 121
the future. If the Fund sells securities short against the box, it may
protect unrealized gains, but will lose the opportunity to profit on such
securities if the price rises.
SMALL AND MEDIUM COMPANIES
The Fund may invest a substantial portion of its assets in small and
medium companies. While small and medium companies generally have the
potential for rapid growth, investments in small and medium companies often
involve greater risks than investments in larger, more established companies
because small and medium companies may lack the management experience,
financial resources, product diversification, and competitive strengths of
larger companies. In addition, in many instances the securities of small and
medium companies are traded only over-the-counter or on a regional securities
exchange, and the frequency and volume of their trading is substantially less
than is typical of larger companies. Therefore, the securities of small and
medium companies may be subject to greater and more abrupt price fluctuations.
When making large sales, the Fund may have to sell portfolio holdings at
discounts from quoted prices or may have to make a series of small sales over
an extended period of time due to the trading volume of small and medium
company securities. Investors should be aware that, based on the foregoing
factors, an investment in the Fund may be subject to greater price fluctuations
than an investment in a fund that invests primarily in larger, more established
companies. The Advisor's research efforts may also play a greater role in
selecting securities for the Fund than in a fund that invests in larger, more
established companies.
SOVEREIGN DEBT
Sovereign debt differs from debt obligations issued by private entities in
that, generally, remedies for defaults must be pursued in the courts of the
defaulting party. Legal recourse is therefore limited. Political conditions,
especially a sovereign entity's willingness to meet the terms of its debt
obligations, are of considerable significance. Also, there can be no assurance
that the holders of commercial bank loans to the same sovereign entity may not
contest payments to the holders of sovereign debt in the event of default under
commercial bank loan agreements.
A sovereign debtor's willingness or ability to repay principal and pay
interest in a timely manner may be affected by a variety of factors, including
among others, its cash flow situation, the extent of its foreign reserves, the
availability of sufficient foreign exchange on the date a payment is due, the
relative size of the debt service burden to the economy as a whole, the
sovereign debtor's policy toward principal international lenders and the
political constraints to which a sovereign debtor may be subject. A country
whose exports are concentrated in a few commodities could be vulnerable to a
decline in the international price of such commodities. Increased
protectionism on the part of a country's trading partners, or political changes
in those countries, could also adversely affect its exports. Such events could
diminish a country's trade account surplus, if any, or the credit standing of a
particular local government or agency. Another factor bearing on the ability
of a country to repay sovereign debt is the level of the country's
international reserves. Fluctuations in the level of these reserves can affect
the amount of foreign exchange readily available for external debt payments
and, thus, could have a bearing on the capacity of the country to make payments
on its sovereign debt.
To the extent that a country has a current account deficit (generally when
it exports of merchandise and services are less than its country's imports of
merchandise and services plus net transfers (e.g., gifts of currency and goods)
to foreigners), it may need to depend on loans from foreign governments,
multilateral organizations or private commercial banks, aid payments from
foreign governments and inflows of foreign investment. The access of a country
to these forms of external funding may not be certain, and a withdrawal of
external funding could adversely affect the capacity of a government to make
payments on its obligations. In addition, the cost of servicing debt
obligations can be adversely affected, by a change in international interest
rates since the majority of these obligations carry interest rates that are
adjusted periodically based upon international rates.
With respect to sovereign debt of emerging market issuers, investors
should be aware that certain emerging market countries are among the largest
debtors to commercial banks and foreign governments. At times certain emerging
market countries have declared moratoria on the payment of principal and
interest on external debt.
Certain emerging market countries have experienced difficulty in servicing
their sovereign debt on a timely basis which led to defaults on certain
obligations and the restructuring of certain indebtedness. Restructuring
arrangements have included, among other things, reducing and rescheduling
interest and principal payments by negotiating new or amended credit
22
<PAGE> 122
agreements or converting outstanding principal and unpaid interest to Brady
Bonds (discussed below), and obtaining new credit to finance interest payments.
Holders of sovereign debt, including the Fund, may be requested to participate
in the rescheduling of such debt and to extend further loans to sovereign
debtors, and the interests of holders of sovereign debt could be adversely
affected in the course of restructuring arrangements or by certain other
factors referred to below. Furthermore, some of the participants in the
secondary market for sovereign debt may also be directly involved in
negotiating the terms of these arrangements and may therefore have access to
information not available to other market participants, such as the Fund.
Obligations arising from past restructuring agreements may affect the economic
performance and political and social stability of certain issuers of sovereign
debt. There is no bankruptcy proceeding by which sovereign debt on which a
sovereign has defaulted may be collected in whole or in part.
Foreign investment in certain sovereign debt is restricted or controlled
to varying degrees. These restrictions or controls may at times limit or
preclude foreign investment in such sovereign debt and increase the costs and
expenses of the Fund. Certain countries in which the Fund may invest require
governmental approval prior to investments by foreign persons, limit the amount
of investment by foreign persons in a particular issuer, limit the investment
by foreign persons only to a specific class of securities of an issuer that may
have less advantageous rights than the classes available for purchase by
domiciliaries of the countries, or impose additional taxes on foreign
investors. Certain issuers may require governmental approval for the
repatriation of investment income, capital or the proceeds of sales of
securities by foreign investors. In addition, if a deterioration occurs in a
country's balance of payments, the country could impose temporary restrictions
on foreign capital remittances. The Fund could be adversely affected by delays
in, or a refusal to grant, any required governmental approval for repatriation
of capital, as well as by the application to the Fund of any restrictions on
investments. Investing in local markets may require the Fund to adopt special
procedures, seek local government approvals or take other actions, each of
which may involve additional costs to the Fund.
The sovereign debt in which the Fund may invest includes Brady Bonds,
which are securities issued under the framework of the Brady Plan, an
initiative announced by former U.S. Treasury Secretary Nicholas F. Brady in
1989 as a mechanism for debtor nations to restructure their outstanding
external commercial bank indebtedness. In restructuring its external debt
under the Brady Plan framework, a debtor nation negotiates with its existing
bank lenders as well as multilateral institutions such as the International
Monetary Fund ("IMF"). The Brady Plan framework, as it has developed,
contemplates the exchange of commercial bank debt for newly issued Brady Bonds.
Brady Bonds may also be issued in respect of new money being advanced by
existing lenders in connection with the debt restructuring. The World Bank and
the IMF support the restructuring by providing funds pursuant to loan
agreements or other arrangements which enable the debtor nation to
collateralize the new Brady Bonds or to repurchase outstanding bank debt at a
discount.
There can be no assurance that the circumstances regarding the issuance of
Brady Bonds by these countries will not change. Investors should recognize
that Brady Bonds have been issued only recently, and accordingly do not have a
long payment history. Agreements implemented under the Brady Plan to date are
designed to achieve debt and debt-service reduction through specific options
negotiated by a debtor nation with its creditors. As a result, the financial
packages offered by each country differ. The types of options have included
the exchange of outstanding commercial bank debt for bonds issued at 100% of
face value of such debt, which carry a below-market stated rate of interest
(generally known as par bonds), bonds issued at a discount from the face value
of such debt (generally known as discount bonds), bonds bearing an interest
rate which increases over time, and bonds issued in exchange for the
advancement of new money by existing lenders. Regardless of the stated face
amount and stated interest rate of the various types of Brady Bonds, the Fund
will purchase Brady Bonds in secondary markets, as described below, in which
the price and yield to the investor reflect market conditions at the time of
purchase.
Certain Brady Bonds have been collateralized as to principal due at
maturity by U.S. Treasury zero coupon bonds with maturities equal to the final
maturity of such Brady Bonds. Collateral purchases are financed by the IMF,
the World Bank, and the debtor nations' reserves. In the event of a default
with respect to collateralized Brady Bonds as a result of which the payment
obligations of the issuer are accelerated, the U.S. Treasury zero coupon
obligations held as collateral for the payment of principal will not be
distributed to investors, nor will such obligations be sold and the proceeds
distributed. The collateral will be held by the collateral agent to the
scheduled maturity of the defaulted Brady Bonds, which will continue to be
outstanding, at which time the face amount of the collateral will equal the
principal payments which would have then been due on the Brady Bonds in the
normal course. In addition, interest payments on certain types of Brady Bonds
may be collateralized by cash or high grade securities in amounts that
typically represent between 12 and 18 months of interest accruals on these
23
<PAGE> 123
instruments with the balance of the interest accruals being uncollateralized.
Brady Bonds are often viewed as having several valuation components: (1) the
collateralized repayment of principal, if any, at final maturity, (2) the
collateralized interest payments, if any, (3) the uncollateralized interest
payments, and (4) any uncollateralized repayment of principal at maturity
(these uncollateralized amounts constitute the "residual risk"). In light of
the residual risk of Brady Bonds and, among other factors, the history of
defaults with respect to commercial bank loans by public and private entities
of countries issuing Brady Bonds, investments in Brady Bonds have speculative
characteristics. The Fund may purchase Brady Bonds with no or limited
collateralization, and will be relying for payment of interest and (except in
the case of principal collateralized Brady Bonds) principal primarily on the
willingness and ability of the foreign government to make payment in accordance
with the terms of the Brady Bonds. Brady Bonds issued to date are purchased
and sold in secondary markets through U.S. securities dealers and other
financial institutions and are generally maintained through European
transnational securities depositories.
TEMPORARY DEFENSIVE POSITION
When the Advisor determines that market conditions warrant a temporary
defensive position, the Fund may invest without limitation in cash and
short-term fixed income securities, including U.S. government securities,
commercial paper, banker's acceptances, certificates of deposit, and time
deposits.
VARIABLE-OR FLOATING-RATE SECURITIES
The Fund may invest in securities which offer a variable- or floating-rate
of interest. Variable-rate securities provide for automatic establishment of a
new interest rate at fixed intervals (e.g., daily, monthly, semi-annually,
etc.). Floating-rate securities generally provide for automatic adjustment of
the interest rate whenever some specified interest rate index changes. The
interest rate on variable- or floating-rate securities is ordinarily determined
by reference to or is a percentage of a bank's prime rate, the 90-day U.S.
Treasury bill rate, the rate of return on commercial paper or bank certificates
of deposit, an index of short-term interest rates, or some other objective
measure.
Variable-or floating-rate securities frequently include a demand feature
entitling the holder to sell the securities to the issuer at par. In many
cases, the demand feature can be exercised at any time on 7 days notice; in
other cases, the demand feature is exercisable at any time on 30 days notice or
on similar notice at intervals of not more than one year. Some securities
which do not have variable or floating interest rates may be accompanied by
puts producing similar results and price characteristics. When considering the
maturity of any instrument which may be sold or put to the issuer or a third
party, the Fund may consider that instrument's maturity to be shorter than its
stated maturity.
Variable-rate demand notes include master demand notes which are
obligations that permit the Fund to invest fluctuating amounts, which may
change daily without penalty, pursuant to direct arrangements between the Fund,
as lender, and the borrower. The interest rates on these notes fluctuate from
time to time. The issuer of such obligations normally has a corresponding
right, after a given period, to prepay in its discretion the outstanding
principal amount of the obligations plus accrued interest upon a specified
number of days' notice to the holders of such obligations. The interest rate
on a floating-rate demand obligation is based on a known lending rate, such as
a bank's prime rate, and is adjusted automatically each time such rate is
adjusted. The interest rate on a variable-rate demand obligation is adjusted
automatically at specified intervals. Frequently, such obligations are secured
by letters of credit or other credit support arrangements provided by banks.
Because these obligations are direct lending arrangements between the lender
and borrower, it is not contemplated that such instruments will generally be
traded. There generally is not an established secondary market for these
obligations, although they are redeemable at face value. Accordingly, where
these obligations are not secured by letters of credit or other credit support
arrangements, the Fund's right to redeem is dependent on the ability of the
borrower to pay principal and interest on demand. Such obligations frequently
are not rated by credit rating agencies and, if not so rated, the Fund may
invest in them only if the Advisor determines that at the time of investment
the obligations are of comparable quality to the other obligations in which the
Fund may invest. The Advisor, on behalf of the Fund, will consider on an
ongoing basis the creditworthiness of the issuers of the floating- and
variable-rate demand obligations in the Fund's portfolio.
The Fund will not invest more than 15% of its net assets in variable- and
floating-rate demand obligations that are not readily marketable (a variable-
or floating-rate demand obligation that may be disposed of on not more than
seven days notice will be deemed readily marketable and will not be subject to
this limitation). (See "Illiquid Securities" and "Investment Restrictions.")
In addition, each variable-or floating-rate obligation must meet the credit
quality requirements applicable to all
24
<PAGE> 124
the Fund's investments at the time of purchase. When determining whether such
an obligation meets the Fund's credit quality requirements, the Fund may look
to the credit quality of the financial guarantor providing a letter of credit
or other credit support arrangement.
In determining the Fund's weighted average portfolio maturity, the Fund
will consider a floating or variable rate security to have a maturity equal to
its stated maturity (or redemption date if it has been called for redemption),
except that it may consider (i) variable rate securities to have a maturity
equal to the period remaining until the next readjustment in the interest rate,
unless subject to a demand feature, (ii) variable rate securities subject to a
demand feature to have a remaining maturity equal to the longer of (a) the next
readjustment in the interest rate or (b) the period remaining until the
principal can be recovered through demand, and (iii) floating rate securities
subject to a demand feature to have a maturity equal to the period remaining
until the principal can be recovered through demand. Variable and floating
rate securities generally are subject to less principal fluctuation than
securities without these attributes since the securities usually trade at
amoritized cost following the readjustment in the interest rate.
WARRANTS
The Fund may acquire warrants. Warrants are securities giving the holder
the right, but not the obligation, to buy the stock of an issuer at a given
price (generally higher than the value of the stock at the time of issuance)
during a specified period or perpetually. Warrants may be acquired separately
or in connection with the acquisition of securities. Warrants acquired by the
Fund in units or attached to securities are not subject to these restrictions.
Warrants do not carry with them the right to dividends or voting rights with
respect to the securities that they entitle their holder to purchase, and they
do not represent any rights in the assets of the issuer. As a result, warrants
may be considered to have more speculative characteristics than certain other
types of investments. In addition, the value of a warrant does not necessarily
change with the value of the underlying securities, and a warrant ceases to
have value if it is not exercised prior to its expiration date.
WHEN-ISSUED SECURITIES
The Fund may from time to time purchase securities on a "when-issued"
basis. The price of debt obligations purchased on a when-issued basis, which
may be expressed in yield terms, generally is fixed at the time the commitment
to purchase is made, but delivery and payment for the securities take place at
a later date. Normally, the settlement date occurs within 45 days of the
purchase although in some cases settlement may take longer. During the period
between the purchase and settlement, no payment is made by the Fund to the
issuer and no interest on the debt obligations accrues to the Fund. Forward
commitments 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 value of the Fund's other assets. While when-issued securities may
be sold prior to the settlement date, the Fund intends to purchase such
securities with the purpose of actually acquiring them unless a sale appears
desirable for investment reasons. At the time the Fund makes the commitment to
purchase a security on a when-issued basis, it will record the transaction and
reflect the value of the security in determining its net asset value. The Fund
does not believe that its net asset value will be adversely affected by
purchases of securities on a when-issued basis.
To the extent required by the SEC, the Fund will maintain cash and
marketable securities equal in value to commitments for when-issued securities.
Such segregated securities either will mature or, if necessary, be sold on or
before the settlement date. When the time comes to pay for when-issued
securities, the Fund will meet its obligations from then-available cash flow,
sale of the securities held in the separate account, described above, sale of
other securities or, although it would not normally expect to do so, from the
sale of the when-issued securities themselves (which may have a market value
greater or less than the Fund's payment obligation).
ZERO-COUPON, STEP-COUPON AND PAY-IN-KIND SECURITIES
The Fund may invest in zero-coupon, step-coupon, and pay-in-kind
securities. These securities are debt securities that do not make regular cash
interest payments. Zero-coupon and step-coupon securities are sold at a deep
discount to their face value. Pay-in-kind securities pay interest through the
issuance of additional securities. Because such securities do not pay current
cash income, the price of these securities can be volatile when interest rates
fluctuate. While these securities do not pay current cash income, federal
income tax law requires the holders of zero-coupon, step-coupon, and
pay-in-kind securities to include in income each year the portion of the
original issue discount (or deemed discount) and other non-cash income on such
25
<PAGE> 125
securities accruing that year. In order to continue to qualify as a "regulated
investment company" under the Internal Revenue Code and avoid a certain excise
tax, the Fund may be required to distribute a portion of such discount and
income and may be required to dispose of other portfolio securities, which may
occur in periods of adverse market prices, in order to generate cash to meet
these distribution requirements.
26
<PAGE> 126
DIRECTORS AND OFFICERS OF THE CORPORATION
Directors and officers of the Corporation, together with information as to
their principal business occupations during the last five years, and other
information are shown below. Each director who is deemed an "interested
person," as defined in the 1940 Act, is indicated by an asterisk (*). Each
officer and director holds the same position with the 25 registered open-end
management investment companies consisting of 38 mutual funds, which are
managed by the Advisor (the "Strong Funds"). The Strong Funds, in the
aggregate, pays each Director who is not a director, officer, or employee of
the Advisor, or any affiliated company (a "disinterested director") an annual
fee of $50,000, plus $100 per Board meeting for each Strong Fund. In addition,
each disinterested director is reimbursed by the Strong Funds for travel and
other expenses incurred in connection with attendance at such meetings. Other
officers and directors of the Strong Funds receive no compensation or expense
reimbursement from the Strong Funds.
*RICHARD S. STRONG (DOB 5/12/42), Chairman of the Board and Director of the
Corporation.
Prior to August 1985, Mr. Strong was Chief Executive Officer of the
Advisor, which he founded in 1974. Since August 1985, Mr. Strong has been a
Security Analyst and Portfolio Manager of the Advisor. In October 1991, Mr.
Strong also became the Chairman of the Advisor. Mr. Strong is a director of
the Advisor. Mr. Strong has been in the investment management business since
1967. Mr. Strong has served the Corporation as a director since December 1990
and as Chairman of the Board since January 1992.
MARVIN E. NEVINS (DOB 7/9/18), Director of the Corporation.
Private Investor. From 1945 to 1980, Mr. Nevins was Chairman of Wisconsin
Centrifugal Inc.; a foundry. From July 1983 to December 1986, he was Chairman
of General Casting Corp., Waukesha, Wisconsin, a foundry. Mr. Nevins is a
former Chairman of the Wisconsin Association of Manufacturers & Commerce. He
was also a regent of the Milwaukee School of Engineering and a member of the
Board of Trustees of the Medical College of Wisconsin. Mr. Nevins has served
the Corporation as a director since December 1990.
WILLIE D. DAVIS (DOB 7/24/34), Director of the Corporation.
Mr. Davis has been director of Alliance Bank Since 1980, Sara Lee
Corporation (a food/consumer products company) since 1983, KMart Corporation (a
discount consumer products company) since 1985, YMCA Metropolitan - Los Angeles
since 1985, Dow Chemical Company since 1988, MGM Grand, Inc. (an
entertainment/hotel company) since 1990, WICOR, Inc. (a utility company) since
1990, Johnson Controls, Inc. (an industrial company) since 1992, L.A. Gear (a
footwear/sportswear company) since 1992, and Rally's Hamburger, Inc. since
1994. Mr. Davis has been a trustee of the University of Chicago since 1980,
Marquette University since 1988, and Occidental College since 1990. Since
1977, Mr. Davis has been President and Chief Executive Officer of All Pro
Broadcasting, Inc. Mr. Davis was a director of the Fireman's Fund (an
insurance company) from 1975 until 1990. Mr. Davis has served the Corporation
as a director since July 1994.
*JOHN DRAGISIC (DOB 11/26/40), President and Director of the Corporation.
Mr. Dragisic has been President of the Advisor since October 1995, and a
director of the Advisor since July 1994. Mr. Dragisic served as Vice Chairman
of the Advisor from July 1994 until October 1995. Mr. Dragisic was the
President and Chief Executive Officer of Grunau Company, Inc. (a mechanical
contracting and engineering firm), Milwaukee, Wisconsin from 1987 until July
1994. From 1981 to 1987, he was an Executive Vice President with Grunau
Company, Inc. From 1969 until 1973, Mr. Dragisic worked for the InterAmerican
Development Bank. Mr. Dragisic received his Ph.D. in Economics in 1971 from
the University of Wisconsin - Madison and his B.A. degree in Economics in 1962
from Lake Forest College. Mr. Dragisic has served the Corporation as Vice
Chairman from July 1994 until October 1995; as President since October 1995;
and as a director from July 1991 until July 1994, and since April 1995.
27
<PAGE> 127
STANLEY KRITZIK (DOB 1/9/30), Director of the Corporation.
Mr. Kritzik has been a Partner of Metropolitan Associates since 1962, a
Director of Aurora Health Care since 1987, and Health Network Ventures, Inc.
since 1992. Mr. Kritzik has served the Corporation as a director since April
1995.
WILLIAM F. VOGT (DOB 7/19/47), Director of the Corporation.
Mr. Vogt has been the President of Vogt Management Consulting, Inc. since
1990. From 1982 until 1990, he served as Executive Director of University
Physicians of the University of Colorado. Mr. Vogt is the Past President of
the Medical Group Management Association and a Fellow of the American College
of Medical Practice Executives. Mr. Vogt has served the Corporation as a
director since April 1995.
LAWRENCE A. TOTSKY (DOB 5/6/59), C.P.A., Vice President of the Corporation.
Mr. Totsky has been Senior Vice President of the Advisor since December
1994. Mr. Totsky acted as the Advisor's Manager of Shareholder Accounting and
Compliance from June 1987 to June 1991 when he was named Director of Mutual
Fund Administration. Mr. Totsky has served the Corporation as a Vice President
since May 1993.
THOMAS P. LEMKE (DOB 7/30/54), Vice President of the Corporation.
Mr. Lemke has been Senior Vice President, Secretary, and General Counsel
of the Advisor since September 1994. For two years prior to joining the
Advisor, Mr. Lemke acted as Resident Counsel for Funds Management at J.P.
Morgan & Co., Inc. From February 1989 until April 1992, Mr. Lemke acted as
Associate General Counsel to Sanford C. Bernstein Co., Inc. For two years
prior to that, Mr. Lemke was Of Counsel at the Washington, D.C. law firm of Tew
Jorden & Schulte, a successor of Finley, Kumble & Wagner. From August 1979
until December 1986, Mr. Lemke worked at the Securities and Exchange
Commission, most notably as the Chief Counsel to the Division of Investment
Management (November 1984 - December 1986), and as Special Counsel to the
Office of Insurance Products, Division of Investment Management (April 1982 -
October 1984). Mr. Lemke has served the Corporation as a Vice President since
October 1994.
STEPHEN J. SHENKENBERG (DOB 6/14/58), Vice President and Secretary of the
Corporation.
Mr. Shenkenberg has been Deputy General Counsel to the Advisor since
November 1996. From December 1992 until November 1996 Mr. Shenkenberg acted as
Associate Counsel to the Advisor. From June 1987 until December 1992, Mr.
Shenkenberg was an attorney for Godfrey & Kahn, S.C., a Milwaukee law firm.
Mr. Shenkenberg has served the Corporation as a Vice President since April 1996
and as Secretary since October 1996.
JOHN S. WEITZER (DOB 10/31/67), Vice President of the Corporation.
Mr. Weitzer has been an Associate Counsel of the Advisor since July 1993.
Mr. Weitzer has served the Corporation as a Vice President since January 1996.
Except for Messrs. Nevins, Davis, Kritzik and Vogt, the address of all of
the above persons is P.O. Box 2936, Milwaukee, Wisconsin 53201. Mr. Nevins'
address is 6075 Pelican Bay Boulevard, Naples, Florida 34108. Mr. Davis'
address is 161 North La Brea, Inglewood, California 90301. Mr. Kritzik's
address is 1123 North Astor Street, P.O. Box 92547, Milwaukee, Wisconsin
53202-0547. Mr. Vogt's address is 2830 East Third Avenue, Denver, Colorado
80206.
In addition to the positions listed above, the following individuals also
hold the following positions with Strong Holdings, Inc. ("Holdings"), a
Wisconsin corporation and subsidiary of the Advisor; Strong Funds Distributors,
Inc., the Fund's underwriter ("Distributors"), Heritage Reserve Development
Corporation ("Heritage"), and Strong Service
28
<PAGE> 128
Corporation ("SSC"), each of which is a Wisconsin corporation and subsidiary of
Holdings; Fussville Real Estate Holdings L.L.C. ("Real Estate Holdings") and
Sherwood Development L.L.C. ("Sherwood"), each of which is a Wisconsin Limited
Liability Company and subsidiary of the Advisor and Heritage; and Fussville
Development L.L.C. ("Fussville Development"), a Wisconsin Limited Liability
Company and subsidiary of the Advisor and Real Estate Holdings:
RICHARD S. STRONG:
CHAIRMAN AND A DIRECTOR - Holdings and Distributors (since October 1993);
Heritage (since January 1994); and SSC (since November 1995).
CHAIRMAN AND A MEMBER OF THE MANAGING BOARD - Real Estate Holdings and
Fussville Development (since December 1995 and February 1994,
respectively); and Sherwood (since October 1994).
JOHN DRAGISIC:
PRESIDENT AND A DIRECTOR - Holdings (since December 1995 and July 1994,
respectively); Distributors (since September 1996 and July 1994,
respectively); Heritage (since May 1994 and August 1994, respectively);
and SSC (since November 1995).
VICE CHAIRMAN AND A MEMBER OF THE MANAGING BOARD - Real Estate and
Fussville Development (since December 1995 and August 1994,
respectively); and Sherwood (since October 1994).
THOMAS P. LEMKE:
VICE PRESIDENT - Holdings, Heritage, Real Estate Holdings, and Fussville
Development (since December 1995); Distributors (since October 1996);
Sherwood (since October 1994); and SSC (since November 1995).
STEPHEN J. SHENKENBERG:
VICE PRESIDENT AND SECRETARY - Distributors (since December 1995).
SECRETARY - Holdings, Heritage, Fussville Development, Real Estate
Holdings, and Sherwood (since December 1995); and SSC (since November
1995).
As of March 31, 1997, the officers and directors of the Corporation in the
aggregate beneficially owned 20,282 shares of common stock of the Fund which
was 35.26% of the Fund's outstanding shares.
PRINCIPAL SHAREHOLDERS
Except for the organizational shares of the Fund, the Fund's shares are
held of record by an insurance company separate account. As of March 31, 1997,
the following persons owned of record or is known by the Fund to own of record
or beneficially more than 5% of the Fund's outstanding shares:
<TABLE>
<S> <C> <C>
Name and Address Shares Percent of Class
- -------------------------------------- ------ ----------------
Acacia National Life Insurance Company 37,245 64.74%
51 Louisiana Avenue, NW
Washington, DC 20001-2105
</TABLE>
A shareholder owning more than 25% of the Fund's shares may be considered
a "controlling person" of the Fund. Accordingly, its vote could have a more
significant effect on matters presented to shareholders for approval than the
vote of other Fund shareholders.
29
<PAGE> 129
INVESTMENT ADVISOR AND DISTRIBUTOR
The Advisor to the Fund is Strong Capital Management, Inc. Mr. Richard S.
Strong controls the Advisor. Mr. Strong is the Chairman and a director of the
Advisor, Mr. Dragisic is the President and a director of the Advisor, Mr.
Totsky is a Senior Vice President of the Advisor, Mr. Lemke is a Senior Vice
President, Secretary, and General Counsel of the Advisor, Mr. Shenkenberg is
Vice President, Assistant Secretary, and Deputy General Counsel of the Advisor,
and Mr. Weitzer is an Associate Counsel of the Advisor. A brief description of
the Fund's investment advisory agreement ("Advisory Agreement") is set forth in
the Prospectus under "Management."
The Fund's Advisory Agreement is dated July 10, 1995, and will remain in
effect as to the Fund for a period of two years. The Advisory Agreement was
approved by the Fund's initial shareholder on its first day of operations.
Thereafter, the Advisory Agreement is required to be approved annually by the
Board of Directors of the Corporation or by vote of a majority of the Fund's
outstanding voting securities (as defined in the 1940 Act). In either case,
each annual renewal must also be approved by the vote of a majority of the
Corporation's directors who are not parties to the Advisory Agreement or
interested persons of any such party, cast in person at a meeting called for
the purpose of voting on such approval. The Advisory Agreement is terminable,
without penalty, on 60 days' written notice by the Board of Directors of the
Corporation, by vote of a majority of the Fund's outstanding voting securities,
or by the Advisor. In addition, the Advisory Agreement will terminate
automatically in the event of its assignment.
Under the terms of the Advisory Agreement, the Advisor manages the Fund's
investments subject to the supervision of the Corporation's Board of Directors.
The Advisor is responsible for investment decisions and supplies investment
research and portfolio management. At its expense, the Advisor provides office
space and all necessary office facilities, equipment, and personnel for
servicing the investments of the Fund. The Advisor places all orders for the
purchase and sale of the Fund's securities at its expense.
Except for expenses assumed by the Advisor, as set forth above, or by the
Distributor, as described below with respect to the distribution of the Fund's
shares, the Fund is responsible for all its other expenses, including, without
limitation, interest charges, taxes, brokerage commissions and similar
expenses; organizational expenses; expenses of issue, sale, repurchase or
redemption of shares; expenses of registering or qualifying shares for sale
with the states and the SEC; expenses for printing and distributing
Prospectuses and quarterly financial statements to existing shareholders;
charges of custodians, transfer agent fees (including the printing and mailing
of reports and notices to shareholders), registrars, auditing and legal
services, clerical services related to recordkeeping and shareholder relations,
and printing of stock certificates; and fees for directors who are not
"interested persons" of the Advisor; and its allocable share of the
Corporation's expenses.
As compensation for its services, the Fund pays to the Advisor a monthly
management fee at the annual rate of .85% of the first $35,000,000 of the
Fund's average daily net asset value and at the annual rate of .80% of the
Fund's average daily net asset value in excess of $35,000,000. (See
"Additional Information - Calculation of Net Asset Value" in the Prospectus.)
From time to time, the Advisor may voluntarily waive all or a portion of its
management fee for the Fund. In 1995 and 1996, the Fund paid the Advisor $394
and $2,367, respectively in management fees. In 1996, the Advisor waived a
portion of its management fee. Without the waiver, the Fund would have paid
the Advisor $4,481 in management fees.
The Advisory Agreement requires the Advisor to reimburse the Fund in the
event that the expenses and charges payable by the Fund in any fiscal year,
including the management fee but excluding taxes, interest, brokerage
commissions, and similar fees and to the extent permitted extraordinary
expenses, exceed two percent (2%) of the average net asset value of the Fund
for such year, as determined by valuations made as of the close of each
business day of the year. Reimbursement of expenses in excess of the
applicable limitation will be made on a monthly basis and will be paid to the
Fund by reduction of the Advisor's fee, subject to later adjustment month by
month for the remainder of the Fund's fiscal year. The Advisor may from time
to time absorb expenses for the Fund in addition to the reimbursement of
expenses in excess of applicable limitations.
On July 12, 1994, the Securities and Exchange Commission (the "SEC") filed
an administrative action (the "Order") against the Advisor, Mr. Strong, and
another employee of the Advisor in connection with conduct that occurred
between 1987 and early 1990. In re Strong/Corneliuson Capital Management, Inc.;
et al. Admin. Proc. File No. 3-8411. The proceeding was
30
<PAGE> 130
settled by consent without admitting or denying the allegations in the Order.
The Order found that the Advisor and Mr. Strong aided and abetted violations of
Section 17(a) of the 1940 Act by effecting trades between mutual funds, and
between mutual funds and Harbour Investments Ltd. ("Harbour"), without
complying with the exemptive provisions of SEC Rule 17a-7 or otherwise
obtaining an exemption. It further found that the Advisor violated, and Mr.
Strong aided and abetted violations of, the disclosure provisions of the 1940
Act and the Investment Advisers Act of 1940 by misrepresenting the Advisor's
policy on personal trading and by failing to disclose trading by Harbour, an
entity in which principals of the Advisor owned between 18 and 25 percent of
the voting stock. As part of the settlement, the respondents agreed to a
censure and a cease and desist order and the Advisor agreed to various
undertakings, including adoption of certain procedures and a limitation for six
months on accepting certain types of new advisory clients.
On June 6, 1996, the Department of Labor (the "DOL") filed an action
against the Advisor for equitable relief alleging violations of the Employee
Retirement Income Security Act of 1974 ("ERISA") in connection with cross
trades that occurred between 1987 and late 1989 involving certain pension
accounts managed by the Advisor. Contemporaneous with this filing, the
Advisor, without admitting or denying the DOL's allegations, agreed to the
entry of a consent judgment resolving all matters relating to the allegations.
Reich V. Strong Capital Management, Inc., (U.S.D.C.E.D. WI)(the "Consent
Judgment"). Under the terms of the Consent Judgment, the Advisor agreed to
reimburse the affected accounts a total of $5.9 million. The settlement did
not have any material impact on the Advisor's financial position or operations.
The Fund and the Advisor have adopted a Code of Ethics (the "Code") which
governs the personal trading activities of all "Access Persons" of the Advisor.
Access Persons include every director and officer of the Advisor and the
investment companies managed by the Advisor, including the Fund, as well as
certain employees of the Advisor who have access to information relating to the
purchase or sale of securities by the Advisor on behalf of accounts managed by
it. The Code is based upon the principal that such Access Persons have a
fiduciary duty to place the interests of the Fund and the Advisor's other
clients ahead of their own.
The Code requires Access Persons (other than Access Persons who are
independent directors of the investment companies managed by the Advisor,
including the Fund) to, among other things, preclear their securities
transactions (with limited exceptions, such as transactions in shares of mutual
funds, direct obligations of the U.S. government and certain options on
broad-based securities market indexes) and to execute such transactions through
the Advisor's trading department. The Code, which applies to all Access Persons
(other than Access Persons who are independent directors of the investment
companies managed by the Advisor, including the Fund), includes a ban on
acquiring any securities in an initial public offering, other than a new
offering of a registered open-end investment company, and a prohibition from
profiting on short-term trading in securities. In addition, no Access Person
may purchase or sell any security which is contemporaneously being purchased or
sold, or to the knowledge of the Access Person, is being considered for
purchase or sale, by the Advisor on behalf of any mutual fund or other account
managed by it. Finally, the Code provides for trading "black out" periods of
seven calendar days during which time Access Persons who are portfolio managers
may not trade in securities which have been purchased or sold by any mutual
fund or other account managed by the portfolio manager.
From time to time the Advisor votes the shares owned by the Fund according
to its Statement of General Proxy Voting Policy ("Proxy Voting Policy"). The
general principal of the Proxy Voting Policy is to vote any beneficial interest
in an equity security prudently and solely in the best long-term economic
interest of the Fund and its beneficiaries considering all relevant factors and
without undue influence from individuals or groups who may have an economic
interest in the outcome of a proxy vote. Shareholders may obtain a copy of the
Proxy Voting Policy upon request from the Advisor.
The Advisor provides investment advisory services for multiple clients and
may give advice and take action, with respect to any client, that may differ
from the advice given, or the timing or nature of action taken, with respect to
any one account. However, the Advisor will allocate over a period of time, to
the extent practical, investment opportunities to each account on a fair and
equitable basis relative to other similarly-situated client accounts. The
Advisor, its principals and associates (to the extent not prohibited by the
Code), and other clients of the Advisor may have, acquire, increase, decrease,
or dispose of securities or interests therein at or about the same time that
the Advisor is purchasing or selling securities or interests therein for an
account that are or may be deemed to be inconsistent with the actions taken by
such persons.
Under a Distribution Agreement dated July 10, 1995 with the Corporation
(the "Distribution Agreement"), Strong Funds Distributors, Inc.
("Distributor"), a subsidiary of the Advisor, acts as underwriter of the Fund's
shares. The Distribution
31
<PAGE> 131
Agreement provides that the Distributor will use its best efforts to distribute
the Fund's shares. Shares are only offered and sold to the separate accounts
of certain insurance companies. Since the Fund is a "no-load" fund, no sales
commissions are charged on the purchase of Fund shares. Certain sales charges
may apply to the variable annuity or life insurance contract, which should be
described in the prospectus of the insurance company's separate account. The
Distribution Agreement further provides that the Distributor will bear the
additional costs of printing prospectuses and shareholder reports which are
used for selling purposes, as well as advertising and other costs attributable
to the distribution of the Fund's shares. The Distributor is an indirect
subsidiary of the Advisor and controlled by the Advisor and Richard S. Strong.
The Distribution Agreement is subject to the same termination and renewal
provisions as are described above with respect to the Advisory Agreement.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Advisor is responsible for decisions to buy and sell securities for
the Fund and for the placement of the Fund's investment business and the
negotiation of the commissions to be paid on such transactions. It is the
policy of the Advisor to seek the best execution at the best security price
available with respect to each transaction, in light of the overall quality of
brokerage and research services provided to the Advisor or the Fund. In
over-the-counter transactions, orders are placed directly with a principal
market maker unless it is believed that a better price and execution can be
obtained using a broker. The best price to the Fund means the best net price
without regard to the mix between purchase or sale price and commission, if
any. In selecting broker-dealers and in negotiating commissions, the Advisor
considers a variety of factors, including best price and execution, the full
range of brokerage services provided by the broker, as well as its capital
strength and stability, and the quality of the research and research services
provided by the broker. Brokerage will not be allocated based on the sale of
any shares of the Strong Funds.
The Advisor has adopted procedures that provide generally for the Advisor
to seek to bunch orders for the purchase or sale of the same security for the
Fund, other mutual funds managed by the Advisor, and other advisory clients
(collectively, the "client accounts"). The Advisor will bunch orders when it
deems it to be appropriate and in the best interest of the client accounts.
When a bunched order is filled in its entirety, each participating client
account will participate at the average share price for the bunched order on
the same business day, and transaction costs shall be shared pro rata based on
each client's participation in the bunched order. When a bunched order is only
partially filled, the securities purchased will be allocated on a pro rata
basis to each client account participating in the bunched order based upon the
initial amount requested for the account, subject to certain exceptions, and
each participating account will participate at the average share price for the
bunched order on the same business day.
Section 28(e) of the Securities Exchange Act of 1934 ("Section 28(e)")
permits an investment advisor, under certain circumstances, to cause an account
to pay a broker or dealer a commission for effecting a transaction in excess of
the amount of commission another broker or dealer would have charged for
effecting the transaction in recognition of the value of the brokerage and
research services provided by the broker or dealer. Brokerage and research
services include (a) furnishing advice as to the value of securities, the
advisability of investing in, purchasing or selling securities, and the
availability of securities or purchasers or sellers of securities; (b)
furnishing analyses and reports concerning issuers, industries, securities,
economic factors and trends, portfolio strategy, and the performance of
accounts; and (c) effecting securities transactions and performing functions
incidental thereto (such as clearance, settlement, and custody).
In carrying out the provisions of the Advisory Agreement, the Advisor may
cause the Fund to pay a broker, which provides brokerage and research services
to the Advisor, a commission for effecting a securities transaction in excess
of the amount another broker would have charged for effecting the transaction.
The Advisor believes it is important to its investment decision-making process
to have access to independent research. The Advisory Agreement provides that
such higher commissions will not be paid by the Fund unless (a) the Advisor
determines in good faith that the amount is reasonable in relation to the
services in terms of the particular transaction or in terms of the Advisor's
overall responsibilities with respect to the accounts as to which it exercises
investment discretion; (b) such payment is made in compliance with the
provisions of Section 28(e), other applicable state and federal laws, and the
Advisory Agreement; and (c) in the opinion of the Advisor, the total
commissions paid by the Fund will be reasonable in relation to the benefits to
the Fund over the long term. The investment management fee paid by the Fund
under the Advisory Agreement is not reduced as a result of the Advisor's
receipt of research services.
32
<PAGE> 132
Generally, research services provided by brokers may include information
on the economy, industries, groups of securities, individual companies,
statistical information, accounting and tax law interpretations, political
developments, legal developments affecting portfolio securities, technical
market action, pricing and appraisal services, credit analysis, risk
measurement analysis, performance analysis, and analysis of corporate
responsibility issues. Such research services are received primarily in the
form of written reports, telephone contacts, and personal meetings with
security analysts. In addition, such research services may be provided in the
form of access to various computer-generated data, computer hardware and
software, and meetings arranged with corporate and industry spokespersons,
economists, academicians, and government representatives. In some cases,
research services are generated by third parties but are provided to the
Advisor by or through brokers. Such brokers may pay for all or a portion of
computer hardware and software costs relating to the pricing of securities.
Where the Advisor itself receives both administrative benefits and
research and brokerage services from the services provided by brokers, it makes
a good faith allocation between the administrative benefits and the research
and brokerage services, and will pay for any administrative benefits with cash.
In making good faith allocations of costs between administrative benefits and
research and brokerage services, a conflict of interest may exist by reason of
the Advisor's allocation of the costs of such benefits and services between
those that primarily benefit the Advisor and those that primarily benefit the
Fund and other advisory clients.
From time to time, the Advisor may purchase new issues of securities for
the Fund in a fixed price offering. In these situations, the seller may be a
member of the selling group that will, in addition to selling the securities to
the Fund and other advisory clients, provide the Advisor with research. The
National Association of Securities Dealers has adopted rules expressly
permitting these types of arrangements under certain circumstances. Generally,
the seller will provide research "credits" in these situations at a rate that
is higher than that which is available for typical secondary market
transactions. These arrangements may not fall within the safe harbor of Section
28(e).
Each year, the Advisor considers the amount and nature of research and
research services provided by brokers, as well as the extent to which such
services are relied upon, and attempts to allocate a portion of the brokerage
business of the Fund and other advisory clients on the basis of that
consideration. In addition, brokers may suggest a level of business they would
like to receive in order to continue to provide such services. The actual
brokerage business received by a broker may be more or less than the suggested
allocations, depending upon the Advisor's evaluation of all applicable
considerations.
The Advisor has informal arrangements with various brokers whereby, in
consideration for providing research services and subject to Section 28(e), the
Advisor allocates brokerage to those firms, provided that their brokerage and
research services are satisfactory to the Advisor and their execution
capabilities were compatible with the Advisor's policy of seeking best
execution at the best security price available, as discussed above. In no case
will the Advisor make binding commitments as to the level of brokerage
commissions it will allocate to a broker, nor will it commit to pay cash if any
informal targets are not met. The Advisor anticipates it will continue to
enter into such brokerage arrangements.
The Advisor may direct the purchase of securities on behalf of the Fund
and other advisory clients in secondary market transactions, in public
offerings directly from an underwriter, or in privately negotiated transactions
with an issuer. When the Advisor believes the circumstances so warrant,
securities purchased in public offerings may be resold shortly after
acquisition in the immediate aftermarket for the security in order to take
advantage of price appreciation from the public offering price or for other
reasons. Short-term trading of securities acquired in public offerings, or
otherwise, may result in higher portfolio turnover and associated brokerage
expenses.
The Advisor places portfolio transactions for other advisory accounts,
including other mutual funds managed by the Advisor. Research services
furnished by firms through which the Fund effects its securities transactions
may be used by the Advisor in servicing all of its accounts; not all of such
services may be used by the Advisor in connection with the Fund. In the
opinion of the Advisor, it is not possible to measure separately the benefits
from research services to each of the accounts (including the Fund) managed by
the Advisor. Because the volume and nature of the trading activities of the
accounts are not uniform, the amount of commissions in excess of those charged
by another broker paid by each account for brokerage and research services will
vary. However, in the opinion of the Advisor, such costs to the Fund will not
be disproportionate to the benefits received by the Fund on a continuing basis.
33
<PAGE> 133
The Advisor seeks to allocate portfolio transactions equitably whenever
concurrent decisions are made to purchase or sell securities by the Fund and
another advisory account. In some cases, this procedure could have an adverse
effect on the price or the amount of securities available to the Fund. In
making such allocations between the Fund and other advisory accounts, the main
factors considered by the Advisor are the respective investment objectives, the
relative size of portfolio holdings of the same or comparable securities, the
availability of cash for investment, the size of investment commitments
generally held, and the opinions of the persons responsible for recommending
the investment.
Where consistent with a client's investment objectives, investment
restrictions, and risk tolerance, the Advisor may purchase securities sold in
underwritten public offerings for client accounts, commonly referred to as
"deal" securities. The Advisor has adopted deal allocation procedures (the
"procedures"), summarized below, that reflect the Advisor's overriding policy
that deal securities must be allocated among participating client accounts in a
fair and equitable manner and that deal securities may not be allocated in a
manner that unfairly discriminates in favor of certain clients or types of
clients.
The procedures provide that, in determining which client accounts a
portfolio manager team will seek to have purchase deal securities, the team
will consider all relevant factors including, but not limited to, the nature,
size, and expected allocation to the Advisor of deal securities; the size of
the account(s); the accounts' investment objectives and restrictions; the risk
tolerance of the client; the client's tolerance for possibly higher portfolio
turnover; the amount of commissions generated by the account during the past
year; and the number of other deals the client has participated in during the
past year.
Where more than one of the Advisor's portfolio manager team seeks to have
client accounts participate in a deal and the amount of deal securities
allocated to the Advisor by the underwriting syndicate is less than the
aggregate amount ordered by the Advisor (a "reduced allocation"), the deal
securities will be allocated among the portfolio manager teams based on all
relevant factors. The primary factor shall be assets under management,
although other factors that may be considered in the allocation decision
include, but are not limited to, the nature, size, and expected allocation of
the deal; the amount of brokerage commissions or other amounts generated by the
respective participating portfolio manager teams; and which portfolio manager
team is primarily responsible for the Advisor receiving securities in the deal.
Based on the relevant factors, the Advisor has established general allocation
percentages for its portfolio manager teams, and these percentages are reviewed
on a regular basis to determine whether asset growth or other factors make it
appropriate to use different general allocation percentages for reduced
allocations.
When a portfolio manager team receives a reduced allocation of deal
securities, the portfolio manager team will allocate the reduced allocation
among client accounts in accordance with the allocation percentages set forth
in the team's initial allocation instructions for the deal securities, except
where this would result in a de minimis allocation to any client account. On a
regular basis, the Advisor reviews the allocation of deal securities to ensure
that they have been allocated in a fair and equitable manner that does not
unfairly discriminate in favor of certain clients or types of clients.
During 1995 and 1996 the Fund paid approximately $0 and $161,
respectively, in brokerage commissions.
CUSTODIAN
As custodian of the Fund's assets, Firstar Trust Company, P.O. Box 761,
Milwaukee, Wisconsin 53201, has custody of all securities and cash of the Fund,
delivers and receives payment for securities sold, receives and pays for
securities purchased, collects income from investments, and performs other
duties, all as directed by officers of the Corporation. The custodian is in no
way responsible for any of the investment policies or decisions of the Fund.
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT
The Advisor acts as transfer agent and dividend-disbursing agent for the
Fund at no cost.
34
<PAGE> 134
ADMINISTRATIVE SERVICES
From time to time the Fund and/or the Advisor may enter into arrangements
under which certain administrative services may be performed by the insurance
companies that purchase shares in the Fund. These administrative services may
include, among other things, responding to ministerial inquiries concerning the
Fund's investment objective, investment program, policies and performance,
transmitting, on behalf of the Fund, proxy statements, annual reports, updated
prospectuses, and other communications regarding the Fund, and providing only
related services as the Fund or its shareholders may reasonably request.
Depending on the arrangements, the Fund and/or Advisor may compensate such
insurance companies or their agents directly or indirectly for the
administrative services. To the extent the Fund compensates the insurance
company for these services, the Fund will pay the insurance company an annual
fee that will vary depending upon the number of contract holders that utilize
the Fund as the funding medium for their contracts. The insurance company may
impose other account or service charges. See the prospectus for the separate
account of the insurance company for additional information regarding such
charges.
TAXES
GENERAL
As indicated under "Additional Information - Distributions and Taxes" in
the Prospectus, the Fund intends to continue to qualify annually for treatment
as a regulated investment company ("RIC") under the Internal Revenue Code of
1986, as amended (the "Code"). This qualification does not involve government
supervision of the Fund's management practices or policies.
In order to qualify for treatment as a RIC under the Code, the Fund must
distribute to its shareholders for each taxable year at least 90% of its
investment company taxable income (consisting generally of net investment
income, net short-term capital gain, and net gains from certain foreign
currency transactions) ("Distribution Requirement") and must meet several
additional requirements. Among these requirements are the following: (1) the
Fund must derive at least 90% of its gross income each taxable year from
dividends, interest, payments with respect to securities loans, and gains from
the sale or other disposition of securities or foreign currencies, or other
income (including gains from options, futures, or forward contracts) derived
with respect to its business of investing in securities or those currencies
("Income Requirement"); (2) the Fund must derive less than 30% of its gross
income each taxable year from the sale or other disposition of securities, or
any of the following, that were held for less than three months - options or
futures (other than those on foreign currencies), or foreign currencies (or
options, futures, or forward contracts thereon) that are not directly related
to the Fund's principal business or investing in securities (or options and
futures with respect to securities) ("30% Limitation"); (3) at the close of
each quarter of the Fund's taxable year, at least 50% of the value of its total
assets must be represented by cash and cash items, U.S. government securities,
securities of other RICs, and other securities, with these other securities
limited, in respect of any one issuer, to an amount that does not exceed 5% of
the value of the Fund's total assets and that does not represent more than 10%
of the issuer's outstanding voting securities; and (4) at the close of each
quarter of the Fund's taxable year, not more than 25% of the value of its total
assets may be invested in securities (other than U.S. government securities or
the securities of other RICs) of any one issuer. From time to time the Advisor
may find it necessary to make certain types of investments for the purpose of
ensuring that the Fund continues to qualify for treatment as a RIC under the
Code.
If Fund shares are sold at a loss after being held for six months or less,
the loss will be treated as long-term, instead of short-term, capital loss to
the extent of any capital gain distributions received on those shares.
In addition, the Fund must satisfy the diversification requirements of
Section 817(h) of the Code. In general, for the Fund to meet these investment
diversification requirements, Treasury regulations require that no more than
55% of the total value of the assets of the Fund may be represented by any one
investment, no more than 70% by two investments, no more than 80% by three
investments and no more than 90% by four investments. Generally, for purposes
of the regulations, all securities of the same issuer are treated as a single
investment. With respect to the United States Government securities (including
any security that is issued, guaranteed or insured by the United States or an
instrumentality of the United States),
35
<PAGE> 135
each governmental agency or instrumentality is treated as a separate issuer.
Compliance with the regulations is tested on the last day of each calendar year
quarter. There is a 30-day period after the end of each calendar year quarter
in which to cure any non-compliance with these requirements.
FOREIGN TRANSACTIONS
Interest and dividends received by the Fund may be subject to income,
withholding, or other taxes imposed by foreign countries and U.S. possessions
that would reduce the yield on its securities. Tax conventions between certain
countries and the United States may reduce or eliminate these foreign taxes,
however, and many foreign countries do not impose taxes on capital gains in
respect of investments by foreign investors.
The Fund maintains its accounts and calculates its income in U.S. dollars.
In general, gain or loss (1) from the disposition of foreign currencies and
forward currency contracts, (2) from the disposition of
foreign-currency-denominated debt securities that are attributable to
fluctuations in exchange rates between the date the securities are acquired and
their disposition date, and (3) attributable to fluctuations in exchange rates
between the time the Fund accrues interest or other receivables or expenses or
other liabilities denominated in a foreign currency and the time the Fund
actually collects those receivables or pays those liabilities, will be treated
as ordinary income or loss. A foreign-currency-denominated debt security
acquired by the Fund may bear interest at a high normal rate that takes into
account expected decreases in the value of the principal amount of the security
due to anticipated currency devaluations; in that case, the Fund would be
required to include the interest in income as it accrues but generally would
realize a currency loss with respect to the principal only when the principal
was received (through disposition or upon maturity).
The Fund may invest in the stock of "passive foreign investment companies"
("PFICs"). A PFIC is a foreign corporation that, in general, meets either of
the following tests: (1) at least 75% of its gross income is passive or (2) an
average of at least 50% of its assets produce, or are held for the production
of, passive income. Under certain circumstances, the Fund will be subject to
federal income tax on a portion of any "excess distribution" received on the
stock or of any gain on disposition of the stock (collectively, "PFIC income"),
plus interest thereon, even if the Fund distributes the PFIC income to its
shareholders. The balance of the PFIC income will be included in the Fund's
investment company taxable income and, accordingly, will not be taxable to it
to the extent that income is distributed to its shareholders. If the Fund
invests in a PFIC and elects to treat the PFIC as a "qualified electing fund,"
then in lieu of the foregoing tax and interest obligation, the Fund will be
required to include in income each year its pro rata share of the qualified
electing fund's annual ordinary earnings and net capital gain (the excess of
net long-term capital gain over net short-term capital loss) -- which probably
would have to be distributed to its shareholders to satisfy the Distribution
Requirement -- even if those earnings and gain were not received by the Fund.
In most instances it will be very difficult, if not impossible, to make this
election because of certain requirements thereof.
DERIVATIVE INSTRUMENTS
The use of derivatives strategies, such as purchasing and selling
(writing) options and futures and entering into forward currency contracts,
involves complex rules that will determine for income tax purposes the
character and timing of recognition of the gains and losses the Fund realizes
in connection therewith. Gains from the disposition of foreign currencies
(except certain gains therefrom that may be excluded by future regulations),
and income from transactions in options, futures, and forward currency
contracts derived by the Fund with respect to its business of investing in
securities or foreign currencies, will qualify as permissible income under the
Income Requirement. However, income from the disposition of options and
futures (other than those on foreign currencies) will be subject to the 30%
Limitation if they are held for less than three months. Income from the
disposition of foreign currencies, and options, futures, and forward contracts
on foreign currencies, that are not directly related to the Fund's principal
business of investing in securities (or options and futures with respect to
securities) also will be subject to the 30% Limitation if they are held for
less than three months.
If the Fund satisfies certain requirements, any increase in value of a
position that is part of a "designated hedge" will be offset by any decrease in
value (whether realized or not) of the offsetting hedging position during the
period of the hedge for purposes of determining whether the Fund satisfies the
30% Limitation. Thus, only the net gain (if any) from the designated hedge
will be included in gross income for purposes of that limitation. The Fund
intends that, when it engages in hedging strategies, the hedging transactions
will qualify for this treatment, but at the present time it is not clear
whether this treatment will be available for all of the Fund's hedging
transactions. To the extent this treatment is not available or is not elected
by the
36
<PAGE> 136
Fund, it may be forced to defer the closing out of certain options, futures, or
forward currency contracts beyond the time when it otherwise would be
advantageous to do so, in order for the Fund to continue to qualify as a RIC.
For federal income tax purposes, the Fund is required to recognize as
income for each taxable year its net unrealized gains and losses on options,
futures, and forward currency contracts that are subject to section 1256 of the
Code ("Section 1256 Contracts") and are held by the Fund as of the end of the
year, as well as gains and losses on Section 1256 Contracts actually realized
during the year. Except for Section 1256 Contracts that are part of a "mixed
straddle" and with respect to which the Fund makes a certain election, any gain
or loss recognized with respect to Section 1256 Contracts is considered to be
60% long-term capital gain or loss and 40% short-term capital gain or loss,
without regard to the holding period of the Section 1256 Contract. Unrealized
gains on Section 1256 Contracts that have been held by the Fund for less than
three months as of the end of its taxable year, and that are recognized for
federal income tax purposes as described above, will not be considered gains on
investments held for less than three months for purposes of the 30% Limitation.
ZERO-COUPON, STEP-COUPON, AND PAY-IN-KIND SECURITIES
The Fund may acquire zero-coupon, step-coupon, or other securities issued
with original issue discount. As a holder of those securities, the Fund must
include in its income the original issue discount that accrues on the
securities during the taxable year, even if the Fund receives no corresponding
payment on the securities during the year. Similarly, the Fund must include in
its income securities it receives as "interest" on pay-in-kind securities.
Because the Fund annually must distribute substantially all of its investment
company taxable income, including any original issue discount and other
non-cash income, to satisfy the Distribution Requirement, it may be required in
a particular year to distribute as a dividend an amount that is greater than
the total amount of cash it actually receives. Those distributions may be made
from the proceeds on sales of portfolio securities, if necessary. The Fund may
realize capital gains or losses from those sales, which would increase or
decrease its investment company taxable income or net capital gain, or both.
In addition, any such gains may be realized on the disposition of securities
held for less than three months. Because of the 30% Limitation, any such gains
would reduce the Fund's ability to sell other securities, or certain options,
futures, or forward currency contracts, held for less that three months that
it might wish to sell in the ordinary course of its portfolio management.
The foregoing federal tax discussion as well as the tax discussion
contained within the Prospectus under "Additional Information - Distributions
and Taxes" is intended to provide you with an overview of the impact of federal
income tax provisions on the Fund or its shareholders. These tax provisions
are subject to change by legislative or administrative action at the federal,
state, or local level, and any changes may be applied retroactively. Any such
action that limits or restricts the Fund's current ability to pass-through
earnings without taxation at the Fund level, or otherwise materially changes
the Fund's tax treatment, could adversely affect the value of a shareholder's
investment in the Fund. Because the Fund's taxes are a complex matter, you
should consult your tax adviser for more detailed information concerning the
taxation of the Fund and the federal, state, and local tax consequences to
shareholders of an investment in the Fund.
DETERMINATION OF NET ASSET VALUE
A more complete discussion of the Fund's determination of net asset value
is contained in the Prospectus. Generally, the net asset value of the Fund
will be determined as of the close of trading on each day the New York Stock
Exchange (the "NYSE") is open for trading. The NYSE is open for trading Monday
through Friday except New Year's Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
Additionally, if any of the aforementioned holidays falls on a Saturday, the
NYSE will not be open for trading on the preceding Friday, and when any such
holiday falls on a Sunday, the NYSE will not be open for trading on the
succeeding Monday, unless unusual business conditions exist, such as the ending
of a monthly or the yearly accounting period.
FUND ORGANIZATION
The Fund is a series of Strong Variable Insurance Funds, Inc., a Wisconsin
corporation (the "Corporation"). The Corporation (formerly known as Strong
Discovery Fund II, Inc., formerly known as Strong D Fund, Inc.) was organized
on December 28, 1990 and is authorized to issue an indefinite number of shares
of common stock and series and classes of series
37
<PAGE> 137
of shares of common stock, with a par value of $.00001 per share. The
Corporation is authorized to issue an indefinite number of shares of common
stock of the Fund. Each share of the Corporation has one vote, and all shares
of a series participate equally in dividends and other capital gains
distributions and in the residual assets of that Fund in the event of
liquidation. Fractional shares have the same rights proportionately as do full
shares. Shares of the Corporation have no preemptive, conversion, or
subscription rights. The Corporation currently has seven series of common
stock outstanding. The assets belonging to each series of shares is held
separately by a custodian, and in effect each series is a separate fund. All
holders of shares of the Corporation would vote on each matter presented to
shareholders for action except with respect to any matter which affects only
one or more series or classes, in which case only the shares of the affected
series or class shall be entitled to vote. Because of current federal
securities law requirements the Corporation expects that its shareholders will
offer to owners of variable annuity and variable life insurance contracts the
opportunity to instruct them as to how shares allocable to their contracts will
be voted with respect to certain matters, such as approval of changes to the
investment advisory agreement.
PERFORMANCE INFORMATION
As described under "Additional Information - Performance Information" in
the Prospectus, the Fund's historical performance or return may be shown in the
form of "average annual total return," "total return," and "cumulative total
return." From time to time, the Advisor may voluntarily waive all or a portion
of its management fee and/or absorb certain expenses for the Fund. Total
returns contained in advertisements include the effect of deducting the Fund's
expenses, but may not include charges and expenses attributable to any
particular insurance product. Since shares may only be purchased by the
separate accounts of certain insurance companies, contracts owners should
carefully review the prospectus of the separate account for information on fees
and expenses. Excluding such fees and expenses from the Fund's total return
quotations has the effect of increasing the performance quoted.
AVERAGE ANNUAL TOTAL RETURN
The Fund's average annual total return quotation is computed in accordance
with a standardized method prescribed by rules of the SEC. The average annual
total return for the Fund for a specific period is found by first taking a
hypothetical $10,000 investment ("initial investment") in the Fund's shares on
the first day of the period and computing the "redeemable value" of that
investment at the end of the period. The redeemable value is then divided by
the initial investment, and this quotient is taken to the Nth root (N
representing the number of years in the period) and one is subtracted from the
result, which is then expressed as a percentage. The calculation assumes that
all income and capital gains dividends paid by the Fund have been reinvested at
net asset value on the reinvestment dates during the period.
TOTAL RETURN
Calculation of the Fund's total return is not subject to a standardized
formula. Total return performance for a specific period is calculated by first
taking an investment (assumed below to be $10,000) ("initial investment") in
the Fund's shares on the first day of the period and computing the "ending
value" of that investment at the end of the period. The total return
percentage is then determined by subtracting the initial investment from the
ending value and dividing the remainder by the initial investment and
expressing the result as a percentage. The calculation assumes that all income
and capital gains dividends paid by the Fund have been reinvested at net asset
value on the reinvestment dates during the period. Total return may also be
shown as the increased dollar value of the hypothetical investment over the
period.
CUMULATIVE TOTAL RETURN
Cumulative total return represents the simple change in value of our
investment over a stated period and may be quoted as a percentage or as a
dollar amount. Total returns and cumulative total returns may be broken down
into their components of income and capital (including capital gains and
changes in share price) in order to illustrate the relationship between these
factors and their contributions to total return.
38
<PAGE> 138
The Fund's performance figures are based upon historical results and do
not represent future performance. The Fund's shares are sold at net asset
value per share. The Fund's returns and net asset value will fluctuate and
shares are redeemable at the then current net asset value of the Fund, which
may be more or less than original cost. Factors affecting the Fund's
performance include general market conditions, operating expenses and
investment management. Any additional fees charged by a dealer or other
financial services firm would reduce the returns described in this section.
The table below shows performance information for various periods ended
December 31, 1996. Securities prices fluctuated during these periods.
ASSET ALLOCATION FUND II
<TABLE>
<CAPTION>
Average
Total Return Annual Total Return
------------------- -------------------
Initial $10,000 Ending Value Percentage Increase Percentage
Investment December 31, 1996 ------------------- Increase
-------------------- --------------------
<S> <C> <C> <C> <C>
Life of Fund* $10,000 $11,316 13.16% 12.09%
One Year $10,000 $11,294 12.94% 12.94%
</TABLE>
* Commenced operations on November 30, 1995.
The Fund's total return for the three months ending March 31, 1997, was
1.10%.
COMPARISONS
(1) U.S. TREASURY BILLS, NOTES, OR BONDS
Investors may also wish to compare the performance of the Fund to that of
United States Treasury bills, notes, or bonds, which are issued by the U.S.
government, because such instruments represent alternative income producing
products. Treasury obligations are issued in selected denominations. Rates of
Treasury obligations are fixed at the time of issuance and payment of principal
and interest is backed by the full faith and credit of the United States
Treasury. The market value of such instruments will generally fluctuate
inversely with interest rates prior to maturity and will equal par value at
maturity.
(2) CERTIFICATES OF DEPOSIT
Investors may wish to compare the Fund's performance to that of
certificates of deposit offered by banks and other depositary institutions.
Certificates of deposit represent an alternative income producing product.
Certificates of deposit may offer fixed or variable interest rates and
principal is guaranteed and may be insured. Withdrawal of the deposits prior to
maturity normally will be subject to a penalty. Rates offered by banks and
other depositary institutions are subject to change at any time specified by
the issuing institution.
(3) MONEY MARKET FUNDS
Investors may also want to compare performance of the Fund to that of
money market funds. Money market fund yields will fluctuate and an investment
in money market fund shares is neither insured nor guaranteed by the U.S.
government, but share values usually remain stable.
(4) LIPPER ANALYTICAL SERVICES, INC. ("LIPPER") AND OTHER INDEPENDENT RANKING
ORGANIZATIONS
From time to time, in marketing and other fund literature, the Fund's
performance may be compared to the performance of other mutual funds in general
or to the performance of particular types of mutual funds, with similar
investment goals, as tracked by independent organizations. Among these
organizations, Lipper, a widely used independent research firm which ranks
mutual funds by overall performance, investment objectives, and assets, may be
cited. Lipper performance figures are based on changes in net asset value,
with all income and capital gain dividends reinvested. Such calculations do
not include the effect of any sales charges imposed by other funds. The Fund
will be compared to Lipper's appropriate fund category, that is, by fund
objective and portfolio holdings.
(5) MORNINGSTAR, INC.
39
<PAGE> 139
The Fund's performance may also be compared to the performance of other
mutual funds by Morningstar, Inc. which rates funds on the basis of historical
risk and total return. Morningstar's ratings range from five stars (highest)
to one star (lowest) and represent Morningstar's assessment of the historical
risk level and total return of the Fund as a weighted average for 3, 5, and 10
year periods. Ratings are not absolute and do not represent future results.
(6) VARDS REPORT
The Fund's performance may also be compared to the performance of other
variable annuity products in general or to the performance of particular types
of variable annuity products, with similar investment goals, as tracked by the
VARDS Report (Variable Annuity Research and Data Service Report) produced by
Financial Planning Resources, Inc. The VARDS Report is a monthly performance
analysis of the variable annuity industry.
(7) INDEPENDENT SOURCES
Evaluations of Fund performance made by independent sources may also be
used in advertisements concerning the Fund, including reprints of, or
selections from, editorials or articles about the Fund, especially those with
similar objectives. Sources for Fund performance information and articles
about the Fund may include publications such as Money, Forbes, Kiplinger's,
Smart Money, Morningstar, Inc., Financial World, Business Week, U.S. News and
World Report, The Wall Street Journal, Barron's, and a variety of investment
newsletters.
(8) INDICES
The Fund may compare its performance to a wide variety of indices
including the following:
(a) The Consumer Price Index
(b) Dow Jones Average of 30 Industrials
(c) Standard & Poor's 500 Stock Index
(d) NASDAQ Over-the-Counter Composite Index
(e) Russell 2000 Small Stock Index
(f) Russell 3000 Stock Index
(g) Salomon Brothers 3-month Treasury Bill Index
(h) Salomon Brothers Broad Investment-Grade Bond Index
(i) Lehman Brothers Aggregate Bond Index
(j) Lehman Brothers Intermediate Government/Corporate Bond Index
(k) A blended index consisting of: Standard & Poor's
500 Stock Index (40% weighted), Salomon Brothers Broad
Investment Grade Bond Index (40% weighted), and Salomon
Brothers 3-Month Treasury Bill Index (20% weighted).
There are differences and similarities between the investments that the
Fund may purchase and the investments measured by the indices which are noted
herein.
(9) HISTORICAL ASSET CLASS RETURNS
From time to time, marketing materials may portray the historical returns
of various asset classes. Such presentations will typically compare the
average annual rates of return of inflation, U.S. Treasury bills, bonds, common
stocks, and small stocks. There are important differences between each of these
investments that should be considered in viewing any such comparison. The
market value of stocks will fluctuate with market conditions, and small-stock
prices generally will fluctuate more than large-stock prices. Stocks are
generally more volatile than bonds. In return for this volatility, stocks have
generally performed better than bonds or cash over time. Bond prices generally
will fluctuate inversely with interest rates and other market conditions, and
the prices of bonds with longer maturities generally will fluctuate more than
those of shorter-maturity bonds. Interest rates for bonds may be fixed at the
time of issuance, and payment of principal and interest may be guaranteed by
the issuer and, in the case of U.S. Treasury obligations, backed by the full
faith and credit of the U.S. Treasury.
(10) STRONG VARIABLE INSURANCE FUNDS
The Strong Variable Insurance Funds offer a range of investment options.
All of the members of the Strong Variable Insurance Funds and their investment
objectives are listed below. The Fund is listed in ascending order of risk and
return, as determined by the Fund's Advisor.
40
<PAGE> 140
<TABLE>
<CAPTION>
FUND NAME INVESTMENT OBJECTIVE
<S> <C>
Current income with a very low degree of
Strong Advantage Fund II share-price fluctuation.
- ------------------------ ------------------------------------------
Strong Government Securities Fund II Total return by investing for a high
level of current income with a moderate
degree of share-price fluctuation.
- ------------------------------------ ------------------------------------------
Strong Asset Allocation Fund II High total return consistent with
reasonable risk over the long term.
- ------------------------------- ------------------------------------------
Strong Special Fund II Capital growth.
- ---------------------- ---------------
Strong Growth Fund II Capital growth.
- --------------------- ---------------
Strong Discovery Fund II Capital growth.
- ------------------------ ---------------
Strong International Stock Fund II Capital growth.
- ---------------------------------- ---------------
</TABLE>
The Fund may from time to time be compared to the other Funds in the
Strong Variable Insurance Funds based on a risk/reward spectrum. In general,
the amount of risk associated with any investment product is commensurate with
that product's potential level of reward. The Strong Variable Insurance Funds'
risk/reward continuum or any Fund's position on the continuum may be described
or diagrammed in marketing materials. The Strong Variable Insurance Funds'
risk/reward continuum positions the risk and reward potential of the Fund
relative to the other Strong Variable Insurance Funds, but is not intended to
position any Fund relative to other mutual funds or investment products.
Marketing materials may also discuss the relationship between risk and reward
as it relates to an individual investor's portfolio. Financial goals vary from
person to person. You may choose one or more of the Strong Variable Insurance
Funds to help you reach your financial goals.
The Advisor also serves as advisor to the Strong Family of Funds, which is
a retail fund complex composed of 26 open-end management investment companies.
ADDITIONAL FUND INFORMATION
(1) PORTFOLIO CHARACTERISTICS
In order to present a more complete picture of the Fund's portfolio,
marketing materials may include various actual or estimated portfolio
characteristics, including but not limited to median market capitalizations,
earnings per share, alphas, betas, price/earnings ratios, returns on equity,
dividend yields, capitalization ranges, growth rates, price/book ratios, top
holdings, sector breakdowns, asset allocations, quality breakdowns, and
breakdowns by geographic region.
(2) MEASURES OF VOLATILITY AND RELATIVE PERFORMANCE
Occasionally statistics may be used to specify Fund volatility or risk.
The general premise is that greater volatility connotes greater risk undertaken
in achieving performance. Measures of volatility or risk are generally used to
compare the Fund's net asset value or performance relative to a market index.
One measure of volatility is beta. Beta is the volatility of a fund relative
to the total market as represented by the Standard & Poor's 500 Stock Index. A
beta of more than 1.00 indicates volatility greater than the market, and a beta
of less than 1.00 indicates volatility less than the market. Another measure
of volatility or risk is standard deviation. Standard deviation is a
statistical tool that measures the degree to which a fund's performance has
varied from its average performance during a particular time period.
Standard deviation is calculated using the following formula:
<TABLE>
<S> <C>
2
Standard deviation = the square root of E(x - x )
i m
--------
n-1
where E = "the sum of",
x = each individual return during the time period,
i
x = the average return over the time period, and
m
n = the number of individual returns during the time period.
</TABLE>
41
<PAGE> 141
Statistics may also be used to discuss the Fund's relative performance.
One such measure is alpha. Alpha measures the actual return of a fund compared
to the expected return of a fund given its risk (as measured by beta). The
expected return is based on how the market as a whole performed, and how the
particular fund has historically performed against the market. Specifically,
alpha is the actual return less the expected return. The expected return is
computed by multiplying the advance or decline in a market representation by
the fund's beta. A positive alpha quantifies the value that the fund manager
has added, and a negative alpha quantifies the value that the fund manager has
lost.
Other measures of volatility and relative performance may be used as
appropriate. However, all such measures will fluctuate and do not represent
future results.
GENERAL INFORMATION
BUSINESS PHILOSOPHY
The Advisor is an independent, Midwestern-based investment advisor, owned
by professionals active in its management. Recognizing that investors are the
focus of its business, the Advisor strives for excellence both in investment
management and in the service provided to investors. This commitment affects
many aspects of the business, including professional staffing, product
development, investment management, and service delivery.
The increasing complexity of the capital markets requires specialized
skills and processes for each asset class and style. Therefore, the Advisor
believes that active management should produce greater returns than a passively
managed index. The Advisor has brought together a group of top-flight
investment professionals with diverse product expertise, and each concentrates
on their investment specialty. The Advisor believes that people are the firm's
most important asset. For this reason, continuity of professionals is critical
to the firm's long-term success.
INVESTMENT ENVIRONMENT
Discussions of economic, social, and political conditions and their impact
on the Fund may be used in advertisements and sales materials. Such factors
that may impact the Fund include, but are not limited to, changes in interest
rates, political developments, the competitive environment, consumer behavior,
industry trends, technological advances, macroeconomic trends, and the supply
and demand of various financial instruments. In addition, marketing materials
may cite the portfolio management's views or interpretations of such factors.
EIGHT BASIC PRINCIPLES FOR SUCCESSFUL MUTUAL FUND INVESTING
These common sense rules are followed by many successful investors. They
make sense for beginners, too. If you have a question on these principles, or
would like to discuss them with us, please contact us at 1-800-368-3863.
1. Have a plan - even a simple plan can help you take control of your
financial future. Review your plan once a year, or if your circumstances
change.
2. Start investing as soon as possible. Make time a valuable ally. Let it
put the power of compounding to work for you, while helping to reduce your
potential investment risk.
3. Diversify your portfolio. By investing in different asset classes -
stocks, bonds, and cash - you help protect against poor performance in one
type of investment while including investments most likely to help you
achieve your important goals.
4. Invest regularly. Investing is a process, not a one-time event. By
investing regularly over the long term, you reduce the impact of
short-term market gyrations, and you attend to your long-term plan before
you're tempted to spend those assets on short-term needs.
5. Maintain a long-term perspective. For most individuals, the best
discipline is staying invested as market conditions change. Reactive,
emotional investment decisions are all too often a source of regret - and
principal loss.
42
<PAGE> 142
6. Consider stocks to help achieve major long-term goals. Over time, stocks
have provided the more powerful returns needed to help the value of your
investments stay well ahead of inflation.
7. Keep a comfortable amount of cash in your portfolio. To meet current
needs, including emergencies, use a money market fund or a bank account -
not your long-term investment assets.
8. Know what you're buying. Make sure you understand the potential risks and
rewards associated with each of your investments. Ask questions... request
information... make up your own mind. And choose a fund company that helps
you make informed investment decisions.
PORTFOLIO MANAGEMENT
Each portfolio manager works with a team of analysts, traders, and
administrative personnel. From time to time, marketing materials may discuss
various members of the team, including their education, investment experience,
and other credentials.
The Advisor believes that active management is the best way to achieve the
Fund's objective. This policy is based on the fundamental belief that economic
and financial conditions create favorable and unfavorable investment periods
(or seasons) and that these different seasons require different investment
approaches. During favorable investment periods, the Fund seeks to generate
real (inflation plus) growth, and its portfolio may be more heavily weighted in
equities. During uncertain periods, income and capital preservation may be
emphasized, and the Fund's portfolio may be more heavily weighted in bonds or
short-term securities. Through their understanding and willingness to change
with investment cycles or periods, the co-managers of the Fund seek to achieve
the Fund's objectives throughout the seasons of investment.
The Fund's co-managers intend to employ an investment strategy which will
permit it to participate in a rising market in equities with less risk and
volatility and more income than a fund which concentrates its investments in
stocks. On the other hand, since the Fund's portfolio will generally have
significant holdings in equities, it will be subject to greater volatility and
produce less income than a fund which concentrates its investments solely in
bonds or money market instruments.
In allocating the Fund's assets among equities, bonds, and short-term
securities, the team's lead portfolio manager will employ top-down fundamental
analysis in evaluating the attractiveness of the three asset components on the
basis of economic trends such as inflation, growth of corporate profits and
Federal Reserve Board policies in conjunction with measures of market valuation
such as price-earnings ratios, dividend yields and real interest rates. The
relative weights of the Fund's three asset components are adjusted gradually,
perhaps as often as several times a year, rather than making dramatic
reallocations in anticipation of a major shift in the attractiveness of one
asset category over another. Therefore, the Fund should be viewed as a
long-term investment suitable for investors with an investment horizon of five
years or more. In light of the nature of the Fund and its long-term investment
horizon, it may be most appropriate for persons attempting to achieve long-term
goals such as accumulating funds for retirement, college tuition or a better
life for one's family.
INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P., 411 East Wisconsin Avenue, Milwaukee, Wisconsin
53202, have been selected as the independent accountants for the Fund,
providing audit services and assistance and consultation with respect to the
preparation of filings with the SEC.
LEGAL COUNSEL
Godfrey & Kahn, S.C., 780 North Water Street, Milwaukee, Wisconsin 53202,
acts as outside legal counsel for the Fund.
43
<PAGE> 143
FINANCIAL STATEMENTS
The Annual Report for the year ended December 31, 1996 that is attached
hereto contains the following financial information for the Fund:
(a) Schedule of Investments in Securities.
(b) Statement of Operations.
(c) Statement of Assets and Liabilities.
(d) Statement of Changes in Net Assets.
(e) Notes to Financial Statements.
(f) Financial Highlights.
(g) Report of Independent Accountants.
44
<PAGE> 144
APPENDIX
BOND RATINGS
STANDARD & POOR'S DEBT RATINGS
A Standard & Poor's corporate or municipal debt rating is a current
assessment of the creditworthiness of an obligor with respect to a specific
obligation. This assessment may take into consideration obligors such as
guarantors, insurers, or lessees.
The debt rating is not a recommendation to purchase, sell, or hold a
security, inasmuch as it does not comment as to market price or suitability for
a particular investor.
The ratings are based on current information furnished by the issuer or
obtained by S&P from other sources it considers reliable. S&P does not perform
an audit in connection with any rating and may, on occasion, rely on unaudited
financial information. The ratings may be changed, suspended, or withdrawn as
a result of changes in, or unavailability of, such information, or based on
other circumstances.
The ratings are based, in varying degrees, on the following
considerations:
1. Likelihood of default capacity and willingness of
the obligor as to the timely payment of interest and repayment
of principal in accordance with the terms of the obligation.
2. Nature of and provisions of the obligation.
3. Protection afforded by, and relative position of,
the obligation in the event of bankruptcy, reorganization, or
other arrangement under the laws of bankruptcy and other laws
affecting creditors' rights.
INVESTMENT GRADE
AAA Debt rated 'AAA' has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA Debt rated 'AA' has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree.
A Debt rated 'A' has a strong capacity to pay interest and repay
principal, although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher-rated
categories.
BBB Debt rated 'BBB' is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
SPECULATIVE GRADE
Debt rated 'BB', 'B', 'CCC', 'CC' and 'C' is regarded as having
predominantly speculative characteristics with respect to capacity to pay
interest and repay principal. 'BB' indicates the least degree of speculation
and 'C' the highest. While such debt will likely have some quality and
protective characteristics, these are outweighed by large uncertainties or
major exposures to adverse conditions.
BB Debt rated 'BB' has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The 'BB'
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied 'BBB-' rating.
A-1
<PAGE> 145
B Debt rated 'B' has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial, or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The 'B' rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied 'BB' or 'BB-' rating.
CCC Debt rated 'CCC' has a currently identifiable vulnerability to
default, and is dependent upon favorable business, financial, and economic
conditions to meet timely payment of interest and repayment of principal. In
the event of adverse business, financial, or economic conditions, it is not
likely to have the capacity to pay interest and repay principal. The 'CCC'
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied 'B' or 'B-' rating.
CC Debt rated 'CC' typically is applied to debt subordinated to senior
debt that is assigned an actual or implied 'CCC' rating.
C Debt rated 'C' typically is applied to debt subordinated to senior debt
which is assigned an actual or implied 'CCC-' rating. The 'C' rating may be
used to cover a situation where a bankruptcy petition has been filed, but debt
service payments are continued.
CI The rating 'CI' is reserved for income bonds on which no interest is
being paid.
D Debt rated 'D' is in payment default. The 'D' rating category is used
when interest payments or principal payments are not made on the date due, even
if the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grade period. The 'D' rating also will be
used upon the filing of a bankruptcy petition if debt service payments are
jeopardized.
MOODY'S LONG-TERM DEBT RATINGS
Aaa - Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edged". Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa - Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risk appear somewhat larger than in Aaa
securities.
A - Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper-medium grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may be
present which suggest a susceptibility to impairment some time in the future.
Baa - Bonds which are rated Baa are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest
payments and principal security appear adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable over
any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba - Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate, and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
maintenance of other terms of the contract over any long period of time may be
small.
A-2
<PAGE> 146
Caa - Bonds which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to principal
or interest.
Ca - Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other marked
shortcomings.
C - Bonds which are rated C are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
FITCH INVESTORS SERVICE, INC. BOND RATINGS
Fitch investment grade bond and preferred stock ratings provide a guide to
investors in determining the credit risk associated with a particular security.
The ratings represent Fitch's assessment of the issuer's ability to meet the
obligations of a specific debt or preferred issue in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the
issuer's future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided
by insurance policies or financial guaranties unless otherwise indicated.
Bonds and preferred stock carrying the same rating are of similar but not
necessarily identical credit quality since the rating categories do not fully
reflect small differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for other reasons.
AAA Bonds and preferred stock considered to be investment grade
and of the highest credit quality. The obligor has an exceptionally
strong ability to pay interest and/or dividends and repay principal,
which is unlikely to be affected by reasonably foreseeable events.
AA Bonds and preferred stock considered to be investment grade
and of very high credit quality. The obligor's ability to pay
interest and/or dividends and repay principal is very strong,
although not quite as strong as bonds rated 'AAA'. Because bonds
and preferred stock rated in the 'AAA' and 'AA' categories are not
significantly vulnerable to foreseeable future developments,
short-term debt of the issuers is generally rated 'F-1+'.
A Bonds and preferred stock considered to be investment grade
and of high credit quality. The obligor's ability to pay interest
and/or dividends and repay principal is considered to be strong,
but may be more vulnerable to adverse changes in economic
conditions and circumstances than debt or preferred securities with
higher ratings.
BBB Bonds and preferred stock considered to be investment grade
and of satisfactory credit quality. The obligor's ability to pay
interest or dividends and repay principal is considered to be
adequate. Adverse changes in economic conditions and circumstances,
however, are more likely to have adverse impact on these securities
and, therefore, impair timely payment. The likelihood that the
ratings of these bonds or preferred will fall below investment grade
is higher than for securities with higher ratings.
A-3
<PAGE> 147
Fitch speculative grade bond or preferred stock ratings provide a guide to
investors in determining the credit risk associated with a particular security.
The ratings ('BB' to 'C') represent Fitch's assessment of the likelihood of
timely payment of principal and interest or dividends in accordance with the
terms of obligation for issues not in default. For defaulted bonds or
preferred stock, the rating ('DDD' to 'D') is an assessment of the ultimate
recovery value through reorganization or liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer or possible recovery value in
bankruptcy, the current and prospective financial condition and operating
performance of the issuer and any guarantor, as well as the economic and
political environment that might affect the issuer's future financial strength.
Bonds or preferred stock that have the same rating are of similar but not
necessarily identical credit quality since the rating categories cannot fully
reflect the differences in the degrees of credit risk.
BB Bonds or preferred stock are considered speculative. The
obligor's ability to pay interest or dividends and repay principal
may be affected over time by adverse economic changes. However,
business and financial alternatives can be identified, which could
assist the obligor in satisfying its debt service requirements.
B Bonds or preferred stock are considered highly speculative.
While bonds in this class are currently meeting debt service
requirements or paying dividends, the probability of continued
timely payment of principal and interest reflects the obligor's
limited margin of safety and the need for reasonable business and
economic activity throughout the life of the issue.
CCC Bonds or preferred stock have certain identifiable
characteristics that, if not remedied, may lead to default. The
ability to meet obligations requires an advantageous business and
economic environment.
CC Bonds or preferred stock are minimally protected. Default
in payment of interest and/or principal seems probable over time.
C Bonds are in imminent default in payment of interest or
principal or suspension of preferred stock dividends is imminent.
DDD, DD,
and D Bonds are in default on interest and/or principal payments
or preferred stock dividends are suspended. Such securities are
extremely speculative and should be valued on the basis of their
ultimate recovery value in liquidation or reorganization of the
obligor. 'DDD' represents the highest potential for recovery of
these securities, and 'D' represents the lowest potential for
recovery.
DUFF & PHELPS, INC. LONG-TERM DEBT RATINGS
These ratings represent a summary opinion of the issuer's long-term
fundamental quality. Rating determination is based on qualitative and
quantitative factors which may vary according to the basic economic and
financial characteristics of each industry and each issuer. Important
considerations are vulnerability to economic cycles as well as risks related to
such factors as competition, government action, regulation, technological
obsolescence, demand shifts, cost structure, and management depth and
expertise. The projected viability of the obligor at the trough of the cycle
is a critical determination.
Each rating also takes into account the legal form of the security, (e.g.,
first mortgage bonds, subordinated debt, preferred stock, etc.). The extent of
rating dispersion among the various classes of securities is determined by
several factors including relative weightings of the different security classes
in the capital structure, the overall credit strength of the issuer, and the
nature of covenant protection. Review of indenture restrictions is important
to the analysis of a company's operating and financial constraints. From time
to time, Duff & Phelps Credit Rating Co. places issuers or security classes on
Rating Watch. The Rating Watch Status results from a need to notify investors
and the issuer that there are conditions present leading us to re-evaluate the
current rating(s). A listing on Rating Watch, however, does not mean a rating
change is inevitable. The Rating Watch Status can either be resolved quickly
or over a longer period of time, depending on the reasons surrounding the
A-4
<PAGE> 148
placement on Rating Watch. The "up" designation means a rating may be
upgraded; the "down" designation means a rating may be downgraded, and the
uncertain designation means a rating may be raised or lowered.
The Credit Rating Committee formally reviews all ratings once per quarter
(more frequently, if necessary). Ratings of 'BBB-' and higher fall within the
definition of investment grade securities, as defined by bank and insurance
supervisory authorities. Structured finance issues, including real estate,
asset-backed and mortgage-backed financings, use this same rating scale with
minor modification in the definitions. Thus, an investor can compare the
credit quality of investment alternatives across industries and structural
types. A "Cash Flow Rating" (as noted for specific ratings) addresses the
likelihood that aggregate principal and interest will equal or exceed the rated
amount under appropriate stress conditions.
<TABLE>
<S> <C>
RATING SCALE DEFINITION
- ------------------------------------------------------------------------------------------------
AAA Highest credit quality. The risk factors are negligible, being only slightly more
than for risk-free U.S. Treasury debt.
- ------------------------------------------------------------------------------------------------
AA+ High credit quality. Protection factors are strong. Risk is modest, but may
AA vary slightly from time to time because of economic conditions.
AA-
- ------------------------------------------------------------------------------------------------
A+ Protection factors are average but adequate. However, risk factors are more
A variable and greater in periods of economic stress.
A-
- ------------------------------------------------------------------------------------------------
BBB+ Below-average protection factors but still considered sufficient for prudent
BBB investment. Considerable variability in risk during economic cycles.
BBB-
- ------------------------------------------------------------------------------------------------
BB+ Below investment grade but deemed likely to meet obligations when due.
BB Present or prospective financial protection factors fluctuate according to
BB- industry conditions or company fortunes. Overall quality may move up or
down frequently within this category.
- ------------------------------------------------------------------------------------------------
B+ Below investment grade and possessing risk that obligations will not be met
B when due. Financial protection factors will fluctuate widely according to
B- economic cycles, industry conditions and/or company fortunes. Potential
exists for frequent changes in the rating within this category or into a higher
or lower rating grade.
- ------------------------------------------------------------------------------------------------
CCC Well below investment grade securities. Considerable uncertainty exists as to
timely payment of principal, interest or preferred dividends.
Protection factors are narrow and risk can be substantial with unfavorable
economic/industry conditions, and/or with unfavorable company developments.
- ------------------------------------------------------------------------------------------------
DD Defaulted debt obligations. Issuer failed to meet scheduled principal and/or
interest payments.
DP Preferred stock with dividend arrearages.
- ------------------------------------------------------------------------------------------------
</TABLE>
A-5
<PAGE> 149
IBCA LONG-TERM DEBT RATINGS
AAA - Obligations for which there is the lowest expectation of investment
risk. Capacity for timely repayment of principal and interest is substantial,
such that adverse changes in business, economic or financial conditions are
unlikely to increase investment risk substantially.
AA - Obligations for which there is a very low expectation of investment
risk. Capacity for timely repayment of principal and interest is substantial.
Adverse changes in business, economic or financial conditions may increase
investment risk, albeit not very significantly.
A - Obligations for which there is a low expectation of investment risk.
Capacity for timely repayment of principal and interest is strong, although
adverse changes in business, economic or financial conditions may lead to
increased investment risk.
BBB - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial
conditions are more likely to lead to increased investment risk than for
obligations in other categories.
BB - Obligations for which there is a possibility of investment risk
developing. Capacity for timely repayment of principal and interest exists,
but is susceptible over time to adverse changes in business, economic or
financial conditions.
B - Obligations for which investment risk exists. Timely repayment of
principal and interest is not sufficiently protected against adverse changes in
business, economic or financial conditions.
CCC - Obligations for which there is a current perceived possibility of
default. Timely repayment of principal and interest is dependent on favorable
business, economic or financial conditions.
CC - Obligations which are highly speculative or which have a high risk of
default.
C - Obligations which are currently in default.
NOTES: "+" or "-" may be appended to a rating below AAA to denote relative
status within major rating categories. Ratings of BB and below are assigned
where it is considered that speculative characteristics are present.
THOMSON BANKWATCH LONG-TERM DEBT RATINGS
Long-Term Debt Ratings assigned by Thomson BankWatch also weigh heavily
government ownership and support. The quality of both the company's management
and franchise are of even greater importance in the Long-Term Debt Rating
decisions. Long-Term Debt Ratings look out over a cycle and are not adjusted
frequently for what we believe are short-term performance aberrations.
Long-Term Debt Ratings can be restricted to local currency debt - ratings
will be identified by the designation LC. In addition, Long-Term Debt Ratings
may include a plus (+) or minus (-) to indicate where within the category the
issue is placed. BankWatch Long-Term Debt Ratings are based on the following
scale:
Investment Grade
AAA (LC-AAA) - Indicates that the ability to repay principal and interest
on a timely basis is extremely high.
AA (LC-AA) - Indicates a very strong ability to repay principal and
interest on a timely basis, with limited incremental risk compared to issues
rated in the highest category.
A (LC-A) - Indicates the ability to repay principal and interest is
strong. Issues rated A could be more vulnerable to adverse developments (both
internal and external) than obligations with higher ratings.
A-6
<PAGE> 150
BBB (LC-BBB) - The lowest investment-grade category; indicates an
acceptable capacity to repay principal and interest. BBB issues are more
vulnerable to adverse developments (both internal and external) than
obligations with higher ratings.
Non-Investment Grade - may be speculative in the likelihood of timely repayment
of principal and interest
BB (LC-BB) - While not investment grade, the BB rating suggests that the
likelihood of default is considerably less than for lower-rated issues.
However, there are significant uncertainties that could affect the ability to
adequately service debt obligations.
B (LC-B) - Issues rated B show higher degree of uncertainty and therefore
greater likelihood of default than higher-rated issues. Adverse developments
could negatively affect the payment of interest and principal on a timely
basis.
CCC (LC-CCC) - Issues rated CCC clearly have a high likelihood of default,
with little capacity to address further adverse changes in financial
circumstances.
CC (LC-CC) - CC is applied to issues that are subordinate to other
obligations rated CCC and are afforded less protection in the event of
bankruptcy or reorganization.
D (LC-D) - Default.
SHORT-TERM RATINGS
STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt considered short-term in the relevant
market.
Ratings are graded into several categories, ranging from 'A-1' for the
highest quality obligations to 'D' for the lowest. These categories are as
follows:
A-1 This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus sign (+) designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated 'A-1'.
A-3 Issues carrying this designation have adequate capacity for timely
payment. They are, however, more vulnerable to the adverse effects of changes
in circumstances than obligations carrying the higher designations.
B Issues rated 'B' are regarded as having only speculative capacity for
timely payment.
C This rating is assigned to short-term debt obligations with doubtful
capacity for payment.
D Debt rated 'D' is in payment default. The 'D' rating category is used
when interest payments or principal payments are not made on the date due, even
if the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grace period.
STANDARD & POOR'S NOTE RATINGS
An S&P note rating reflects the liquidity factors and market-access risks
unique to notes. Notes maturing in three years or less will likely receive a
note rating. Notes maturing beyond three years will most likely receive a
long-term debt rating.
A-7
<PAGE> 151
The following criteria will be used in making the assessment:
- Amortization schedule - the larger the final maturity
relative to other maturities, the more likely the issue is to be
treated as a note.
- Source of payment - the more the issue depends on the market
for its refinancing, the more likely it is to be treated as a note.
Note rating symbols and definitions are as follows:
SP-1 Strong capacity to pay principal and interest. Issues determined to
possess very strong characteristics are given a plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term of the
notes.
SP-3 Speculative capacity to pay principal and interest.
MOODY'S SHORT-TERM RATINGS
Moody's short-term debt ratings are opinions of the ability of issuers to
repay punctually senior debt obligations. These obligations have an original
maturity not exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment ability of rated issuers:
Issuers rated Prime-1 (or supporting institutions) have a superior ability
for repayment of senior short-term debt obligations. Prime-1 repayment ability
will often be evidenced by many of the following characteristics: (i) leading
market positions in well-established industries, (ii) high rates of return on
funds employed, (iii) conservative capitalization structure with moderate
reliance on debt and ample asset protection, (iv) broad margins in earnings
coverage of fixed financial charges and high internal cash generation, and (v)
well established access to a range of financial markets and assured sources of
alternate liquidity.
Issuers rated Prime-2 (or supporting institutions) have a strong ability
for repayment of senior short-term debt obligations. This will normally be
evidenced by many of the characteristics cited above, but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be
more affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The effect of industry
characteristics and market compositions may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt
protection measurements and may require relatively high financial leverage.
Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
FITCH INVESTORS SERVICE, INC. SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes.
A-8
<PAGE> 152
The short-term rating places greater emphasis than a long-term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
F-1+ Exceptionally Strong Credit Quality. Issues assigned this
rating are regarded as having the strongest degree of assurance for
timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating
reflect an assurance of timely payment only slightly less in degree
than issues rated 'F-1+'.
F-2 Good Credit Quality. Issues assigned this rating have a
satisfactory degree of assurance for timely payment but the margin
of safety is not as great as for issues assigned 'F-1+' and 'F-1'
ratings.
F-3 Fair Credit Quality. Issues assigned this rating have
characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause
these securities to be rated below investment grade.
F-S Weak Credit Quality. Issues assigned this rating have
characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial
and economic conditions.
D Default. Issues assigned this rating are in actual or
imminent payment default.
LOC The symbol LOC indicates that the rating is based on a letter
of credit issued by a commercial bank.
DUFF & PHELPS, INC. SHORT-TERM DEBT RATINGS
Duff & Phelps' short-term ratings are consistent with the rating criteria
used by money market participants. The ratings apply to all obligations with
maturities of under one year, including commercial paper, the uninsured portion
of certificates of deposit, unsecured bank loans, master notes, bankers
acceptances, irrevocable letters of credit, and current maturities of long-term
debt. Asset-backed commercial paper is also rated according to this scale.
Emphasis is placed on liquidity which is defined as not only cash from
operations, but also access to alternative sources of funds including trade
credit, bank lines, and the capital markets. An important consideration is the
level of an obligor's reliance on short-term funds on an ongoing basis.
The distinguishing feature of Duff & Phelps' short-term ratings is the
refinement of the traditional '1' category. The majority of short-term debt
issuers carry the highest rating, yet quality differences exist within that
tier. As a consequence, Duff & Phelps has incorporated gradations of '1+' (one
plus) and '1-' (one minus) to assist investors in recognizing those
differences.
From time to time, Duff & Phelps places issuers or security classes on
Rating Watch. The Rating Watch status results from a need to notify investors
and the issuer that there are conditions present leading us to re-evaluate the
current rating(s). A listing on Rating Watch, however, does not mean a rating
change is inevitable.
The Rating Watch status can either be resolved quickly or over a longer
period of time, depending on the reasons surrounding the placement on Rating
Watch. The "up" designation means a rating may be upgraded; the "down"
designation means a rating may be downgraded, and the "uncertain" designation
means a rating may be raised or lowered.
<TABLE>
<S> <C>
Rating Scale: Definition
- ------------- ----------
High Grade
----------
</TABLE>
A-9
<PAGE> 153
D-1+ Highest certainty of timely payment. Short-Term liquidity,
including internal operating factors and/or access to alternative
sources of funds, is outstanding, and safety is just below risk-
free U.S. Treasury short-term obligations.
D-1 Very high certainty of timely payment. Liquidity factors are
excellent and supported by good fundamental protection factors.
Risk factors are minor.
D-1- High certainty of timely payment. Liquidity factors are
strong and supported by good fundamental protection factors. Risk
factors are very small.
Good Grade
----------
D-2 Good certainty of timely payment. Liquidity factors and
company fundamentals are sound. Although ongoing funding needs
may enlarge total financing requirements, access to capital
markets is good. Risk factors are small.
Satisfactory Grade
------------------
D-3 Satisfactory liquidity and other protection factors qualify
issues as to investment grade. Risk factors are larger and
subject to more variation. Nevertheless, timely payment is
expected.
Non-Investment Grade
--------------------
D-4 Speculative investment characteristics. Liquidity is not
sufficient to insure against disruption in debt service.
Operating factors and market access may be subject to a high
degree of variation.
Default
-------
D-5 Issuer failed to meet scheduled principal and/or interest
payments.
THOMSON BANKWATCH (TBW) SHORT-TERM RATINGS
The TBW Short-Term Ratings apply, unless otherwise noted, to specific debt
instruments of the rated entities with a maturity of one year or less. TBW
Short-Term Ratings are intended to assess the likelihood of an untimely or
incomplete payments of principal or interest.
TBW-1 The highest category; indicates a very high likelihood that
principal and interest will be paid on a timely basis.
TBW-2 The second highest category; while the degree of safety regarding
timely repayment of principal and interest is strong, the relative degree of
safety is not as high as for issues rated "TBW-1".
TBW-3 The lowest investment-grade category; indicates that while the
obligation is more susceptible to adverse developments (both internal and
external) than those with higher ratings, the capacity to service principal and
interest in a timely fashion is considered adequate.
TBW-4 The lowest rating category; this rating is regarded as
non-investment grade and therefore speculative.
IBCA SHORT-TERM RATINGS
IBCA Short-Term Ratings assess the borrowing characteristics of banks and
corporations, and the capacity for timely repayment of debt obligations. The
Short-Term Ratings relate to debt which has a maturity of less than one year.
A-10
<PAGE> 154
A1 Obligations supported by the highest capacity for timely repayment.
Where issues possess a particularly strong credit feature, a
rating of A1+ is assigned.
A2 Obligations supported by a good capacity for timely repayment.
A3 Obligations supported by a satisfactory capacity for timely
repayment.
B Obligations for which there is an uncertainty as to the capacity
to ensure timely repayment.
C Obligations for which there is a high risk of default or which are
currently in default.
A-11
<PAGE> 155
STRONG INTERNATIONAL STOCK FUND II
Strong International Stock Fund II (the "Fund") is a diversified series of
the Strong Variable Insurance Funds, Inc. (the "Corporation"), an open-end
management investment company, commonly called a mutual fund. The Fund seeks
capital growth. The Fund invests primarily in the equity securities of issuers
located outside the United States.
Shares of the Fund are only offered and sold to the separate accounts of
certain insurance companies for the purpose of funding variable annuity and
variable life insurance contracts. This Prospectus should be read together with
the prospectus of the separate account of the specific insurance product which
preceded or accompanies this Prospectus.
This Prospectus contains information that you should consider before you
invest. Please read it carefully and keep it for future reference. A Statement
of Additional Information for the Fund, dated May 1, 1997, which contains
further information, is incorporated by reference into this Prospectus, and has
been filed with the Securities and Exchange Commission ("SEC"). This Statement,
which may be revised from time to time, is available upon request and without
charge by writing to the Fund at P.O. Box 2936, Milwaukee, Wisconsin 53201 or by
calling 1-800-368-1683.
============================================================================
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
- ----------------------------------------------------------------------------
May 1, 1997
-------------------
PROSPECTUS PAGE 1
<PAGE> 156
TABLE OF CONTENTS
<TABLE>
<S> <C> <C>
THE FUND................................. 2
FINANCIAL HIGHLIGHTS..................... 3
INVESTMENT OBJECTIVE AND POLICIES........ 4
IMPLEMENTATION OF POLICIES AND RISKS..... 5
SPECIAL CONSIDERATIONS................... 12
MANAGEMENT............................... 14
ADDITIONAL INFORMATION................... 16
</TABLE>
No person has been authorized to give any information or to make any
representations other than those contained in this Prospectus and the Statement
of Additional Information and, if given or made, such information or
representations may not be relied upon as having been authorized by the Fund.
This Prospectus does not constitute an offer to sell securities to any person in
any state or jurisdiction in which such offering may not lawfully be made.
THE FUND
The Fund is a diversified series of the Corporation, which is an open-end
management investment company. The Fund offers and sells its shares only to
separate accounts of insurance companies for the purpose of funding variable
annuity and variable life insurance contracts. The Fund does not impose any
sales or redemption charges. Strong Capital Management, Inc. (the "Advisor") is
the investment advisor for the Fund.
-------------------
PROSPECTUS PAGE 2
<PAGE> 157
FINANCIAL HIGHLIGHTS
The following annual Financial Highlights for the Fund have been audited by
Coopers & Lybrand L.L.P., independent certified public accountants. Their report
for the fiscal year ended December 31, 1996 is included in the Fund's Annual
Report that is contained in the Fund's Statement of Additional Information. The
Financial Highlights should be read in conjunction with the Financial Statements
and related notes included in the Fund's Annual Report. Additional information
about the performance of the Fund is contained in the Fund's Annual Report,
which may be obtained without charge by calling or writing Strong Funds. Please
note that the total return shown in the Financial Highlights does not reflect
expenses that apply to the separate account or the related insurance policies.
Inclusion of these charges would reduce the total return for the periods shown.
The following presents information relating to a share of common stock
outstanding for the entire period ended as indicated.
<TABLE>
<CAPTION>
12-31-96 12-31-95(1)
-------- -----------
<S> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $ 10.22 $10.00
INCOME FROM INVESTMENT OPERATIONS:
Net Investment Income 0.03 0.01
Net Realized and Unrealized Gains
on Investments 1.03 0.25
------- ------
Total from Investment Operations 1.06 0.26
LESS DISTRIBUTIONS:
From Net Investment Income (0.03) (0.01)
In Excess of Net Investment Income (0.02) (0.03)
------- ------
Total Distributions (0.05) (0.04)
------- ------
Net Asset Value, End of Period $ 11.23 $10.22
======= ======
Total Return +10.4% +2.6%
RATIOS AND SUPPLEMENTAL DATA
Net Assets, End of Period (In Thousands) $75,151 $1,805
Ratio of Expenses to Average Net Assets 1.9% 2.0%*
Ratio of Net Investment Income to
Average Net Assets 0.4% 1.0%*
Portfolio Turnover Rate 126.0% 26.9%
Average Commission Rate Paid(2) $0.0100
</TABLE>
*Calculated on an annualized basis.
(1)Inception date is October 20, 1995. Total return and portfolio turnover rate
are not annualized.
(2)Disclosure required, effective for reporting periods beginning after
September 1, 1995.
-------------------
PROSPECTUS PAGE 3
<PAGE> 158
INVESTMENT OBJECTIVE AND POLICIES
The Fund has adopted certain fundamental investment restrictions that are set
forth in the Fund's Statement of Additional Information ("SAI"). Those
restrictions, the Fund's investment objective and any other investment policies
identified as "fundamental" cannot be changed without shareholder approval. To
further guide investment activities, the Fund has also instituted a number of
non-fundamental operating policies, which are described throughout this
Prospectus and in the SAI. Although these additional policies may be changed by
the Corporation's Board of Directors without shareholder approval, the Fund will
promptly notify shareholders of any material change in operating policies.
The Fund seeks capital growth. The Fund invests primarily in the equity
securities of issuers located outside the United States.
The Fund will invest at least 65% of its total assets in foreign equity
securities, including common stocks, preferred stocks, and securities that are
convertible into common or preferred stocks, such as warrants and convertible
bonds, that are issued by companies whose principal headquarters are located
outside the United States.
Under normal market conditions, the Fund expects to invest at least 90% of
its net assets in foreign equity securities. The Fund may, however, invest up to
35% of its total assets in equity securities of U.S. issuers or debt
obligations, including debt obligations of U.S. issuers or foreign-government
entities. When the Advisor determines that market conditions warrant a temporary
defensive position, the Fund may invest without limitation in cash (U.S.
dollars, foreign currencies, or multicurrency units) and short-term fixed-income
securities. Although the debt obligations in which it invests will be primarily
investment grade, the Fund may invest up to 5% of its net assets in
non-investment-grade debt obligations. (See "Implementation of Policies and
Risks - Debt Obligations.")
The Fund will normally invest in securities of issuers located in at least
three foreign countries. As market and global conditions change, the Fund will
change its allocations among the countries of the world, and nothing herein will
limit the Fund's ability to invest in or avoid any particular countries or
regions. In allocating the Fund's assets among various countries, the Advisor
will seek economic and market environments favorable for capital appreciation
and, with respect to developing countries, economic, political, and stock-market
environments that show signs of stabilizing or improving. (See "Implementation
of Policies and Risks - Foreign Securities and Currencies" for a discussion of
the special risks involved in investing in foreign securities.)
-------------------
PROSPECTUS PAGE 4
<PAGE> 159
In analyzing foreign companies for investment, the Advisor will ordinarily
look for one or more of the following characteristics in relation to the
company's prevailing stock price:
- - prospects for above-average sales and earnings growth and high return on
invested capital;
- - overall financial strength, including sound financial and accounting policies
and a strong balance sheet;
- - significant competitive advantages, including innovative products and
efficient service;
- - effective research, product development, and marketing;
- - stable, capable management; and
- - other general operating characteristics that will enable the company to
compete successfully in its marketplace.
IMPLEMENTATION OF POLICIES AND RISKS
In addition to the Fund's investment policies described above (and subject to
certain restrictions described herein), the Fund may invest in some or all of
the following securities and employ some or all of the following investment
techniques, some of which may present special risks as described below. The Fund
may also engage in reverse repurchase agreements and mortgage dollar roll
transactions. A more complete discussion of these securities and investment
techniques and their associated risks is contained in the Fund's SAI.
FOREIGN SECURITIES AND CURRENCIES
The Fund may invest in foreign securities either directly or indirectly
through the use of depositary receipts. Depositary receipts are generally issued
by banks or trust companies and evidence ownership of underlying foreign
securities. Foreign investments involve special risks, including:
- - expropriation, confiscatory taxation, and withholding taxes on dividends and
interest;
- - less extensive regulation of foreign brokers, securities markets, and issuers;
- - less publicly available information and different accounting standards;
- - costs incurred in conversions between currencies, possible delays in
settlement in foreign securities markets, limitations on the use or transfer
of assets (including suspension of the ability to transfer currency from a
given country), and difficulty of enforcing obligations in other countries;
and
- - diplomatic developments and political or social instability.
Foreign economies may differ favorably or unfavorably from the U.S. economy
in various respects, including growth of gross domestic product, rates of
inflation, currency depreciation, capital reinvestment, resource
self-sufficiency,
-------------------
PROSPECTUS PAGE 5
<PAGE> 160
and balance-of-payments positions. Many foreign securities may be less liquid
and their prices more volatile than comparable U.S. securities. Although the
Fund generally invests only in securities that are regularly traded on
recognized exchanges or in over-the-counter markets, from time to time foreign
securities may be difficult to liquidate rapidly without adverse price effects.
Certain costs attributable to foreign investing, such as custody charges and
brokerage costs, may be higher than those attributable to domestic investing.
The Fund may invest a significant portion of its assets in securities of
issuers in developing or emerging markets and economies, including Asia and the
Pacific Basin. Investing in securities of issuers in Asia and the Pacific Basin
involves special risks. Risks of investing in developing or emerging markets
include:
- - less social, political, and economic stability;
- - smaller securities markets and lower trading volume, which may result in a
lack of liquidity and greater price volatility;
- - certain national policies that may restrict the Fund's investment
opportunities, including restrictions on investments in issuers or industries
deemed sensitive to national interests, or expropriation or confiscation of
assets or property, which could result in the Fund's loss of its entire
investment in that market; and
- - less developed legal structures governing private or foreign investment or
allowing for judicial redress for injury to private property.
In addition, brokerage commissions, custodial services, withholding taxes,
and other costs relating to investment in emerging markets generally are more
expensive than in the U.S. and certain more established foreign markets.
Economies in emerging markets generally are heavily dependent upon international
trade and, accordingly, have been and may continue to be affected adversely by
trade barriers, exchange controls, managed adjustments in relative currency
values, and other protectionist measures negotiated or imposed by the countries
with which they trade.
Because most foreign securities are denominated in non-U.S. currencies, the
investment performance of the Fund could be affected by changes in foreign
currency exchange rates to some extent. The value of the Fund's assets
denominated in foreign currencies will increase or decrease in response to
fluctuations in the value of those foreign currencies relative to the U.S.
dollar. Currency exchange rates can be volatile at times in response to supply
and demand in the currency exchange markets, international balances of payments,
governmental intervention, speculation, and other political and economic
conditions.
The Fund may purchase and sell foreign currency on a spot basis and may
engage in forward currency contracts, currency options, and futures transactions
for hedging or any other lawful purpose. (See "Derivative Instruments.")
-------------------
PROSPECTUS PAGE 6
<PAGE> 161
FOREIGN INVESTMENT COMPANIES
The Fund may invest, to a limited extent, in foreign investment companies.
Some of the countries in which the Fund invests may not permit direct investment
by outside investors. Investments in such countries may only be permitted
through foreign government-approved or -authorized investment vehicles, which
may include other investment companies. In addition, it may be less expensive
and more expedient for the Fund to invest in a foreign investment company in a
country which permits direct foreign investment. Investing through such vehicles
may involve frequent or layered fees or expenses and may also be subject to
limitation under the Investment Company Act of 1940 (the "1940 Act"). The Fund
does not intend to invest in such investment companies unless, in the judgment
of the Advisor, the potential benefits of such investments justify the payment
of any associated fees or expenses.
DERIVATIVE INSTRUMENTS
The Fund may use derivative instruments for any lawful purpose consistent
with the Fund's investment objective such as hedging or managing risk.
Derivative instruments are commonly defined to include securities or contracts
whose values depend on (or "derive" from) the value of one or more other assets,
such as securities, currencies, or commodities. These "other assets" are
commonly referred to as "underlying assets."
A derivative instrument generally consists of, is based upon, or exhibits
characteristics similar to options or forward contracts. Options and forward
contracts are considered to be the basic "building blocks" of derivatives. For
example, forward-based derivatives include forward contracts, swap contracts, as
well as exchange-traded futures. Option-based derivatives include privately
negotiated, over-the-counter (OTC) options (including caps, floors, collars, and
options on forward and swap contracts) and exchange-traded options on futures.
Diverse types of derivatives may be created by combining options or forward
contracts in different ways, and by applying these structures to a wide range of
underlying assets.
An option is a contract in which the "holder" (the buyer) pays a certain
amount (the "premium") to the "writer" (the seller) to obtain the right, but not
the obligation, to buy from the writer (in a "call") or sell to the writer (in a
"put") a specific asset at an agreed upon price at or before a certain time. The
holder pays the premium at inception and has no further financial obligation.
The holder of an option-based derivative generally will benefit from favorable
movements in the price of the underlying asset but is not exposed to
corresponding losses due to adverse movements in the value of the underlying
asset. The writer of an option-based derivative generally will receive fees or
premiums but generally is exposed to losses due to changes in the value of the
underlying asset.
-------------------
PROSPECTUS PAGE 7
<PAGE> 162
A forward is a sales contract between a buyer (holding the "long" position)
and a seller (holding the "short" position) for an asset with delivery deferred
until a future date. The buyer agrees to pay a fixed price at the agreed future
date and the seller agrees to deliver the asset. The seller hopes that the
market price on the delivery date is less than the agreed upon price, while the
buyer hopes for the contrary. The change in value of a forward-based derivative
generally is roughly proportional to the change in value of the underlying
asset.
Derivative instruments may include (i) options; (ii) futures; (iii) options
on futures; (iv) short sales against the box, in which the Fund sells a security
it owns for delivery at a future date; (v) swaps, in which two parties agree to
exchange a series of cash flows in the future, such as interest-rate payments;
(vi) interest-rate caps, under which, in return for a premium, one party agrees
to make payments to the other to the extent that interest rates exceed a
specified rate, or "cap"; (vii) interest-rate floors, under which, in return for
a premium, one party agrees to make payments to the other to the extent that
interest rates fall below a specified level, or "floor"; (viii) forward currency
contracts and foreign currency exchange-related securities; and (ix) structured
instruments which combine the foregoing in different ways.
Derivatives may be exchange-traded or traded in OTC transactions between
private parties. OTC transactions are subject to additional risks, such as the
credit risk of the counterparty to the instrument and are less liquid than
exchange-traded derivatives since they often can only be closed out with the
other party to the transaction. Derivative instruments may include elements of
leverage and, accordingly, the fluctuation of the value of the derivative
instrument in relation to the underlying asset may be magnified. When required
by SEC guidelines, the Fund will set aside permissible liquid assets in a
segregated account to secure its obligations under the derivative.
The successful use of derivatives by the Fund is dependent upon a variety of
factors, particularly the Advisor's ability to correctly anticipate trends in
the underlying asset. In a hedging transaction, if the Advisor incorrectly
anticipates trends in the underlying asset, the Fund may be in a worse position
than if no hedging had occurred. In addition, there may be imperfect correlation
between the Fund's derivative transactions and the instruments being hedged. To
the extent that the Fund is engaging in derivative transactions for risk
management, the Fund's successful use of such transactions is more dependent
upon the Advisor's ability to correctly anticipate such trends, since losses in
these transactions may not be offset in gains in the Fund's portfolio or in
lower purchase prices for assets it intends to acquire. The Advisor's prediction
of trends in underlying assets may prove to be inaccurate, which could result in
substantial losses to the Fund.
-------------------
PROSPECTUS PAGE 8
<PAGE> 163
In addition to the derivative instruments and strategies described above, the
Advisor expects to discover additional derivative instruments and other trading
techniques. The Advisor may utilize these new derivative instruments and
techniques to the extent that they are consistent with the Fund's investment
objective and permitted by the Fund's investment limitations, operating
policies, and applicable regulatory authorities.
ILLIQUID SECURITIES
The Fund may invest up to 15% of its net assets in illiquid securities.
Illiquid securities are those securities that are not readily marketable,
including restricted securities and repurchase obligations maturing in more than
seven days. Certain restricted securities that may be resold to institutional
investors pursuant to Rule 144A under the Securities Act of 1933 and Section
4(2) commercial paper may be determined to be liquid under guidelines adopted by
the Corporation's Board of Directors.
SMALL AND MEDIUM COMPANIES
The Fund may invest a substantial portion of its assets in small and medium
companies. While small and medium companies generally have potential for rapid
growth, investments in small and medium companies often involve greater risks
than investments in larger, more established companies because small and medium
companies may lack the management experience, financial resources, product
diversification, and competitive strengths of larger companies. In addition, in
many instances the securities of small and medium companies are traded only
over-the-counter or on a regional securities exchange, and the frequency and
volume of their trading is substantially less than is typical of larger
companies. Therefore, the securities of small and medium companies may be
subject to greater and more abrupt price fluctuations. When making large sales,
the Fund may have to sell portfolio holdings at discounts from quoted prices or
may have to make a series of small sales over an extended period of time due to
the trading volume of small and medium company securities. Investors should be
aware that, based on the foregoing factors, an investment in the Fund may be
subject to greater price fluctuations than an investment in a fund that invests
primarily in larger, more established companies. The Advisor's research efforts
may also play a greater role in selecting securities for the Fund than in a fund
that invests in larger, more established companies.
DEBT OBLIGATIONS
IN GENERAL. Debt obligations in which the Fund may invest will be primarily
investment-grade debt obligations, although the Fund may invest up to 5% of its
net assets in non-investment-grade debt obligations. The market value of all
debt obligations is affected by changes in the prevailing interest rates. The
-------------------
PROSPECTUS PAGE 9
<PAGE> 164
market value of such instruments generally reacts inversely to interest rate
changes. If the prevailing interest rates decline, the market value of debt
obligations generally increases. If the prevailing interest rates increase, the
market value of debt obligations generally decreases. In general, the longer the
maturity of a debt obligation, the greater its sensitivity to changes in
interest rates.
Investment-grade debt obligations include:
- - U.S. government securities (as defined below);
- - bonds or bank obligations rated in one of the four highest rating categories
(e.g., BBB or higher by Standard & Poor's Ratings Group or "S&P");
- - short-term notes rated in one of the two highest rating categories (e.g., SP-2
or higher by S&P);
- - short-term bank obligations that are rated in one of the three highest
categories (e.g., A-3 or higher by S&P), with respect to obligations maturing
in one year or less;
- - commercial paper rated in one of the three highest ratings categories by any
NRSRO (e.g., A-3 or higher by S&P);
- - unrated debt obligations which are determined by the Advisor to be of
comparable quality; and
- - repurchase agreements involving investment-grade debt obligations.
Investment-grade debt obligations are generally believed to have relatively
low degrees of credit risk. All ratings are determined at the time of
investment. Any subsequent rating downgrade of a debt obligation will be
monitored by the Advisor to consider what action, if any, the Fund should take
consistent with its investment objective. For purposes of determining whether a
security is investment grade, the Advisor may use the highest rating assigned to
that security by any nationally recognized statistical rating organization
("NRSRO"). Securities rated in the fourth-highest category (e.g., BBB by S&P),
although considered investment grade, have speculative characteristics and may
be subject to greater fluctuations in value than higher-rated securities.
Non-investment-grade debt obligations include:
- - securities rated as low as C by S&P or their equivalents;
- - commercial paper rated as low as C by S&P or its equivalents; and
- - unrated debt securities judged to be of comparable quality by the Advisor.
GOVERNMENT SECURITIES
U.S. government securities are issued or guaranteed by the U.S. government or
its agencies or instrumentalities. Securities issued by the government include
U.S. Treasury obligations, such as Treasury bills, notes, and bonds.
---------------------
PROSPECTUS PAGE 10
<PAGE> 165
Securities issued by government agencies or instrumentalities include, for
example, obligations of the following:
- - the Federal Housing Administration, Farmers Home Administration, Export-Import
Bank of the United States, Small Business Administration, and the Government
National Mortgage Association, including GNMA pass-through certificates, whose
securities are supported by the full faith and credit of the United States;
- - the Federal Home Loan Banks, Federal Intermediate Credit Banks, and the
Tennessee Valley Authority, whose securities are supported by the right of the
agency to borrow from the U.S. Treasury;
- - the Federal National Mortgage Association, whose securities are supported by
the discretionary authority of the U.S. government to purchase certain
obligations of the agency or instrumentality; and
- - the Student Loan Marketing Association, the Interamerican Development Bank,
and International Bank for Reconstruction and Development, whose securities
are supported only by the credit of such agencies.
Although the U.S. government provides financial support to such U.S.
government-sponsored agencies or instrumentalities, no assurance can be given
that it will always do so. The U.S. government and its agencies and
instrumentalities do not guarantee the market value of their securities;
consequently, the value of such securities will fluctuate.
WHEN-ISSUED SECURITIES
The Fund may invest in securities purchased on a when-issued or delayed-
delivery basis. Although the payment and interest terms of these securities are
established at the time the purchaser enters into the commitment, these
securities may be delivered and paid for at a future date, generally within 45
days. Purchasing when-issued securities allows the Fund to lock in a fixed price
or yield on a security it intends to purchase. However, when the Fund purchases
a when-issued security, it immediately assumes the risk of ownership, including
the risk of price fluctuation.
The greater the Fund's outstanding commitments for these securities, the
greater the exposure to potential fluctuations in the net asset value of the
Fund. Purchasing when-issued securities may involve the additional risk that the
yield available in the market when the delivery occurs may be higher or the
market price lower than that obtained at the time of commitment. Although the
Fund may be able to sell these securities prior to the delivery date, it will
purchase when-issued securities for the purpose of actually acquiring the
securities, unless after entering into the commitment a sale appears desirable
for investment reasons. When required by SEC guidelines, the Fund will set aside
permissible liquid assets in a segregated account to secure its outstanding
commitments for when-issued securities.
---------------------
PROSPECTUS PAGE 11
<PAGE> 166
CASH MANAGEMENT
The Fund may invest directly in cash and short-term fixed income securities,
including, for this purpose, shares of one or more money market funds managed by
the Advisor (collectively, the "Strong Money Funds"). The Strong Money Funds
seek current income, a stable share price of $1.00, and daily liquidity. All
money market instruments can change in value when interest rates or an issuer's
creditworthiness change dramatically. The Strong Money Funds cannot guarantee
that they will always be able to maintain a stable net asset value of $1.00 per
share.
PORTFOLIO TURNOVER
The Fund's historical portfolio turnover rate is listed under "Financial
Highlights." The annual portfolio turnover rate indicates changes in the Fund's
portfolio. The turnover rate may vary from year to year, as well as within a
year. It may also be affected by sales of portfolio securities necessary to meet
cash requirements for redemption of shares. High portfolio turnover in any year
will result in the payment by the Fund of above-average amounts of transaction
costs.
SPECIAL CONSIDERATIONS
The Fund is designed as an investment vehicle for variable annuity and
variable life insurance contracts funded by separate accounts of certain
insurance companies. Section 817(h) of the Internal Revenue Code of 1986, as
amended (the "Code") and the regulations thereunder impose certain
diversification standards on the investments underlying variable annuity and
variable life insurance contracts in order for such contracts to be treated for
tax purposes as annuities or life insurance. Section 817(h) of the Code provides
that a variable annuity and variable life insurance contract based on a separate
account shall not be treated as an annuity or life insurance contract for any
period (and any subsequent period) for which the account's investments are not
adequately diversified. These diversification requirements are in addition to
the diversification requirements applicable to the Fund under Subchapter M of
the Code and the 1940 Act and may affect the composition of the Fund's
investments.
Since the shares of the Fund are currently sold to segregated asset accounts
underlying such variable annuity and variable life insurance contracts, the Fund
intends to comply with the diversification requirements as set forth in the
regulations. The Secretary of the Treasury may in the future issue additional
regulations or revenue rulings that may prescribe the circumstances in which a
contract owner's control of the investments of a separate account may cause the
contract owner, rather than the insurance company, to be
---------------------
PROSPECTUS PAGE 12
<PAGE> 167
treated as the owner of assets of the separate account. Failure to comply with
Section 817(h) of the Code or any regulation thereunder, or with any future
regulations or revenue rulings on contract owner control, would cause earnings
regarding a contract owner's interest in an insurance company's separate account
to be includible in the contract owner's gross income in the year earned. Such
standards may apply only prospectively, although retroactive application is
possible. In the event that any such regulations or revenue rulings are adopted,
the Fund may not be able to continue to operate as currently described in this
prospectus, or maintain its investment program.
The Fund will be managed in such a manner as to comply with the requirements
of Subchapter L of the Code. It is possible that in order to comply with such
requirements, less desirable investment decisions may be made which would affect
the investment performance of the Fund.
The Fund may sell its shares to the separate accounts of various insurance
companies, which are not affiliated with each other, for the purpose of funding
variable annuity and variable life insurance contracts. The Fund currently does
not foresee any disadvantages to contract owners arising out of the fact that it
offers its shares to separate accounts of various insurance companies, which are
not affiliated with each other, to serve as an investment medium for their
variable products. However, it is theoretically possible that the interests of
owners of various contracts participating in the Fund through the separate
accounts might at some time be in conflict. The Board of Directors of the
Corporation, however, will monitor events in order to identify any material
irreconcilable conflicts which may possibly arise and to determine what action,
if any, should be taken in response to such conflicts. If such a conflict were
to occur, one or more insurance companies' separate accounts might be required
to withdraw its investments in the Fund, and shares of another Fund may be
substituted. This might force the Fund to sell securities at disadvantageous
prices. In addition, the Board of Directors may refuse to sell Fund shares to
any separate account or may suspend or terminate the offering of Fund shares if
such action is required by law or regulatory authority or is in the best
interest of the shareholders of the Fund.
Except for the organizational shares of the Fund, the Fund's shares may be
held of record only by insurance company separate accounts. As of March 31,
1996, Nationwide Life Insurance Company owned approximately 97% of the Fund.
Nationwide Life insurance Company's ownership of greater than 25% of the Fund's
shares may result in it being deemed to be the controlling entity of the Fund.
It may continue to be deemed as such until other insurance companies, if any,
selling significant numbers of variable annuity and variable life insurance
contracts, have made substantial investments in the Fund's shares.
---------------------
PROSPECTUS PAGE 13
<PAGE> 168
MANAGEMENT
The Board of Directors of the Corporation is responsible for managing the
Fund's business and affairs. The Fund has entered into an investment advisory
agreement (an "Advisory Agreement") with the Advisor. Under the terms of the
Advisory Agreement, the Advisor manages the Fund's investments and business
affairs, subject to the supervision of the Board of Directors.
The Advisor began conducting business in 1974. Since then, its principal
business has been providing continuous investment supervision for individuals
and institutional accounts, such as pension funds and profit-sharing plans, as
well as mutual funds, several of which are funding vehicles for variable
insurance products. As of March 31, 1997, the Advisor had over $23 billion under
management. The Advisor's principal mailing address is P.O. Box 2936, Milwaukee,
Wisconsin 53201. Mr. Richard S. Strong, the Chairman of the Board of the
Corporation, is the controlling shareholder of the Advisor.
As compensation for its services, the Fund pays the Advisor a monthly
management fee. The annual fee is 1.00% of the average daily net asset value of
the Fund. Under the terms of the Advisory Agreement, the Advisor provides office
space and all necessary office facilities, equipment, and personnel for
servicing the investments of the Fund. From time to time, the Advisor may
voluntarily waive all or a portion of its management fee and/or absorb certain
expenses for the Fund without further notification of the commencement or
termination of any such waiver or absorption. Any such waiver or absorption will
have the effect of lowering the overall expense ratio of the Fund and increasing
the Fund's return to investors at the time such amounts were waived and/or
absorbed.
Except for expenses assumed by the Advisor or Strong Funds Distributors,
Inc., the Fund is responsible for all its other expenses, including, without
limitation, interest charges, taxes, brokerage commissions and similar expenses;
expenses of issue, sale, repurchase, or redemption of shares; expenses of
registering or qualifying shares for sale with the states and the SEC; expenses
of printing and distribution of prospectuses to existing shareholders; charges
of custodians (including fees as custodian for keeping books and similar
services for the Fund), transfer agents (including the printing and mailing of
reports and notices to shareholders), registrars, auditing and legal services,
and clerical services related to recordkeeping and shareholder relations;
printing of stock certificates; fees for directors who are not "interested
persons" of the Advisor; expenses of indemnification; extraordinary expenses;
and costs of shareholder and director meetings.
The Advisor permits portfolio managers and other persons who may have access
to information about the purchase or sale of securities in the Fund's portfolio
("access persons") to purchase and sell securities for their own accounts,
subject to the Advisor's policy governing personal investing. The policy
requires access persons to conduct their personal investment activities
---------------------
PROSPECTUS PAGE 14
<PAGE> 169
in a manner that the Advisor believes is not detrimental to the Fund or to the
Advisor's other advisory clients. Among other things, the policy requires access
persons to obtain preclearance before executing personal trades and prohibits
access persons from keeping profits derived from the purchase or sale of the
same security within 60 calendar days. See the SAI for more information.
PRIOR PERFORMANCE OF SIMILAR FUND MANAGED BY THE ADVISOR. The Strong
International Stock Fund II, which commenced operations on October 20, 1995, has
been modeled after the Strong International Stock Fund, an existing retail fund
managed by the Advisor. The Strong International Stock Fund began operations on
March 4, 1992 and, as of March 31, 1997, had 294 million in assets. The
investment objective, policies, and strategies of the Strong International Stock
Fund are identical to those of the Strong International Stock Fund II and the
Funds have substantially comparable expense ratios. The average annual and
cumulative total returns for the Strong International Stock Fund II and Strong
International Stock Fund as of March 31, 1997 are presented in the table below.
These performance returns have been audited through December 31, 1996, and are
unaudited thereafter.
<TABLE>
<CAPTION>
PERFORMANCE STRONG INTERNATIONAL STRONG INTERNATIONAL
RETURNS(1) STOCK FUND II STOCK FUND
<S> <C> <C>
Average Annual Returns
1 Year 6.05% 3.52%
5 Year -- 12.11%
Since inception 10.98% 11.46%
Cumulative Returns 16.27% 73.40%
- --------------------------------------------------------------------------
</TABLE>
(1)Average annual and cumulative total returns reflect changes in share prices
and reinvestment of dividends and distributions and are net of fund expenses.
Historical performance does not indicate future performance. THE STRONG
INTERNATIONAL STOCK FUND IS A SEPARATE FUND AND ITS HISTORICAL PERFORMANCE IS
NOT INDICATIVE OF THE PRESENT OR FUTURE PERFORMANCE OF THE STRONG INTERNATIONAL
STOCK FUND II. THE PERFORMANCE OF THE STRONG INTERNATIONAL STOCK FUND II MAY BE
GREATER OR LESS THAN THE PERFORMANCE OF THE STRONG INTERNATIONAL STOCK FUND DUE
TO, AMONG OTHER THINGS, DIFFERENCES IN EXPENSES AND CASH FLOWS. Share prices and
investment returns will fluctuate.
PORTFOLIO MANAGER. Mr. Anthony L.T. Cragg joined the Advisor in April 1993 to
develop the Advisor's international investment activities. During the prior
seven years, he helped establish Dillon, Read International Asset Man-
---------------------
PROSPECTUS PAGE 15
<PAGE> 170
agement, where he was in charge of Japanese, Asian, and Australian investments.
A graduate of Christ Church, Oxford University, Mr. Cragg began his investment
career in 1980 at Gartmore, Ltd., as an international investment manager, where
his tenure included assignments in London, Hong Kong, and Tokyo. He has managed
the Fund since its inception in June 1995.
ADDITIONAL INFORMATION
HOW TO INVEST. Investments in the Fund may only be made by separate accounts
established and maintained by insurance companies for purposes of funding
variable annuity and variable life insurance contracts. For instructions on how
to direct a separate account to purchase shares in the Fund, please refer to the
prospectus of the insurance company's separate account. The Fund does not impose
any sales charge or 12b-1 fee. Certain sales charges may apply to the variable
annuity or variable life insurance contract, which should be described in the
prospectus of the insurance company's separate account. The Fund may decline to
accept a purchase order upon receipt when, in the judgment of the Advisor, it
would not be in the best interest of the existing shareholders to accept the
order. Shares of the Fund will be sold at the net asset value next determined
after receipt by the Fund of a purchase order in proper form placed by an
insurance company investing in the Fund. Certificates for shares in the Fund
will not be issued.
CALCULATION OF NET ASSET VALUE. The net asset value ("NAV") per share for the
Fund is determined as of the close of trading on the New York Stock Exchange
(the "Exchange"), currently 3:00 p.m. Central Time, on days the Exchange is open
for business. The NAV will not be determined for the Fund on days during which
the Fund receives no orders to purchase shares and no shares are tendered for
redemption. The Fund's NAV is calculated by taking the fair value of the Fund's
total assets, subtracting all its liabilities, and dividing by the total number
of shares outstanding. Expenses are accrued daily and applied when determining
the NAV.
The Fund's portfolio securities are valued based on market quotations or at
fair value as determined by the method selected by the Corporation's Board of
Directors. Equity securities traded on a national securities exchange or NASDAQ
are valued at the last sales price on the national securities exchange or NASDAQ
on which such securities are primarily traded. Securities traded on NASDAQ for
which there were no transactions on a given day or securities not listed on an
exchange or NASDAQ are valued at the average of the most recent bid and asked
prices. Other exchange-traded securities (generally foreign securities) will be
valued based on market quotations.
Securities quoted in foreign currency are valued daily in U.S. dollars at the
foreign currency exchange rates that are prevailing at the time the daily NAV
per share is determined. Although the Fund values its foreign assets in U.S.
dollars on a daily basis, the Fund does not intend to convert its holdings of
---------------------
PROSPECTUS PAGE 16
<PAGE> 171
foreign currencies into U.S. dollars on a daily basis. Foreign currency exchange
rates are generally determined prior to the close of trading on the Exchange.
Occasionally, events affecting the value of foreign investments and such
exchange rates occur between the time at which they are determined and the close
of trading on the Exchange. Such events would not normally be reflected in a
calculation of the Fund's NAV on that day. If events that materially affect the
value of the Fund's foreign investments or the foreign currency exchange rates
occur during such period, the investments will be valued at their fair value as
determined in good faith by or under the direction of the Board of Directors.
The Fund's portfolio securities, from time to time, may be listed primarily on
foreign exchanges that trade on other days than those on which the Exchange is
open for business, (e.g., Saturday). As a result, the NAV of the Fund may be
significantly affected by such trading on days when shareholders cannot effect
transactions on their accounts.
HOW TO REDEEM SHARES. Shares of the Fund may be redeemed on any business day.
The price received upon redemption will be the net asset value next determined
after the redemption request in proper form is received by the Fund. (See
"Calculation of Net Asset Value.") Contract owners should refer to the
withdrawal or surrender instructions in the prospectus of the separate account
for instructions on how to redeem shares. Once the redemption request is
received in proper form, the Fund will ordinarily forward payment to the
separate account no later than seven days after receipt.
The right of redemption may be suspended during any period in which: (i)
trading on the Exchange is restricted, as determined by the SEC, or the Exchange
is closed for other than weekends and holidays; (ii) the SEC has permitted such
suspension by order; or (iii) an emergency, as determined by the SEC, exists
which makes disposal of portfolio securities or valuation of net assets of the
Fund not reasonably practicable.
DISTRIBUTIONS AND TAXES. The policy of the Fund is to pay dividends to the
insurance company's separate accounts from net investment income quarterly and
to distribute substantially all net realized capital gains, after using any
available capital loss carryovers, annually. All dividends and capital gain
distributions paid to the insurance company's separate accounts will be
automatically reinvested in additional Fund shares.
The Fund intends to continue to qualify for treatment as a Regulated
Investment Company or "RIC" under Subchapter M of the Code and, if so qualified,
will not be liable for federal income tax on earnings and gains distributed to
its shareholders in a timely manner. If the Fund does not so qualify, however,
it would be treated for tax purposes as an ordinary corporation and would
receive no tax deduction for distributions made to its shareholders. For more
information regarding tax implications for owners of variable annuity or
variable life insurance contracts investing in the Fund, please refer to the
prospectus of your insurance company's separate account. See "Special Con-
---------------------
PROSPECTUS PAGE 17
<PAGE> 172
siderations" for a discussion of special tax considerations relating to the
Fund's compliance with Subchapter L of the Code, as an investment vehicle for
variable annuity and variable life insurance contracts of certain insurance
companies.
This section is not intended to be a full discussion of present or proposed
federal income tax law and its effect on the Fund and investors. (See the SAI
for a further discussion.) Investors are urged to consult their own tax adviser.
ORGANIZATION. The Fund is a series of common stock of the Corporation, which
is a Wisconsin corporation. The Corporation is authorized to issue an indefinite
number of shares of common stock and series and classes of series of shares of
common stock. All holders of shares of the Corporation would vote on each matter
presented to shareholders for action except with respect to any matter which
affects only one or more series or classes, in which case only the shares of the
affected series or class shall be entitled to vote.
All shares participate equally in dividends and other capital gains
distributions by the Fund and in the residual assets of the Fund in the event of
liquidation. Generally, the Corporation will not hold an annual meeting of
shareholders unless required by the 1940 Act.
The insurance company separate accounts, as the record shareholders in the
Fund, have the right to vote on matters submitted for a shareholder vote. Under
current interpretations of the 1940 Act, these insurance companies must solicit
voting instructions from contract owners and vote Fund shares in accordance with
the instructions received or, for Fund shares for which no voting instructions
were received, in the same proportion as those Fund shares for which
instructions were received. Contract owners should refer to the prospectus of
the insurance company's separate account for a complete description of their
voting rights.
TRANSFER AGENT, DIVIDEND-DISBURSING AGENT, AND DISTRIBUTOR. The Advisor, P.O.
Box 2936, Milwaukee, Wisconsin 53201, acts as transfer agent and
dividend-disbursing agent for the Fund. Strong Funds Distributors, Inc., P.O.
Box 2936, Milwaukee, Wisconsin 53201, an indirect subsidiary of the Advisor,
acts as distributor of the shares of the Fund.
PERFORMANCE INFORMATION. The Fund may advertise a variety of types of
performance information, including "average annual total return," "total
return," and "cumulative total return." Each of these figures is based upon
historical results and does not represent the future performance of the Fund.
Average annual total return and total return figures measure both the net
investment income generated by, and the effect of any realized and unrealized
appreciation or depreciation of, the underlying investments in the Fund assuming
the reinvestment of all dividends and distributions. Total return figures are
not annualized and simply represent the aggregate change of the Fund's
investments over a specified period of time.
---------------------
PROSPECTUS PAGE 18
<PAGE> 173
The Fund's shares are sold at the net asset value per share of the Fund.
Returns and net asset value will fluctuate. Shares of the Fund are redeemable by
the separate accounts of insurance companies at the then current net asset value
per share for the Fund, which may be more or less than the original cost. TOTAL
RETURNS CONTAINED IN ADVERTISEMENTS INCLUDE THE EFFECT OF DEDUCTING THE FUND'S
EXPENSES, BUT MAY NOT INCLUDE CHARGES AND EXPENSES ATTRIBUTABLE TO ANY
PARTICULAR INSURANCE PRODUCT. SINCE SHARES MAY ONLY BE PURCHASED BY THE SEPARATE
ACCOUNTS OF CERTAIN INSURANCE COMPANIES, CONTRACT OWNERS SHOULD CAREFULLY REVIEW
THE PROSPECTUS OF THE SEPARATE ACCOUNT FOR INFORMATION ON FEES AND EXPENSES.
Excluding such fees and expenses from the Fund's total return quotations has the
effect of increasing the performance quoted. The Fund will not use information
concerning its investment performance in advertisements or sales materials
unless appropriate information concerning the relevant separate account is also
included. Additional information concerning the Fund's performance appears in
the SAI.
---------------------
PROSPECTUS PAGE 19
<PAGE> 174
NOTES
---------------------
<PAGE> 175
STATEMENT OF ADDITIONAL INFORMATION
STRONG INTERNATIONAL STOCK FUND II
P.O. Box 2936
Milwaukee, Wisconsin 53201
Toll-Free: (800) 368-1683
Strong International Stock Fund II (the "Fund" ) is a diversified series
of the Strong Variable Insurance Funds, Inc. (the "Corporation" ), an open-end
management investment company designed to provide an investment vehicle for
variable annuity and variable life insurance contracts of certain insurance
companies. Shares in the Fund are only offered and sold to the separate
accounts of such insurance companies. The Fund is described herein and in the
Prospectus for the Fund dated May 1, 1997.
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the Prospectus for the Fund dated May 1, 1997 and the
prospectus for the separate account of the specific insurance product.
Requests for copies of the Fund's Prospectus may be made by calling one of the
numbers listed above. The financial statements appearing in the Fund's Annual
Report, which accompanies this Statement of Additional Information, are
incorporated by reference.
This Statement of Additional Information is dated May 1, 1997.
<PAGE> 176
STRONG INTERNATIONAL STOCK FUND II
<TABLE>
<CAPTION>
TABLE OF CONTENTS PAGE
<S> <C>
INVESTMENT RESTRICTIONS....................................................................... 3
INVESTMENT POLICIES AND TECHNIQUES............................................................ 4
Borrowing................................................................................... 5
Convertible Securities...................................................................... 5
Debt Obligations............................................................................ 5
Depositary Receipts......................................................................... 6
Derivative Instruments...................................................................... 7
Foreign Investment Companies................................................................ 16
Foreign Securities.......................................................................... 16
High-Yield (High-Risk) Securities........................................................... 17
Illiquid Securities......................................................................... 18
Lending of Portfolio Securities............................................................. 19
Mortgage- and Asset-Backed Securities....................................................... 19
Mortgage Dollar Rolls and Reverse Repurchase Agreements..................................... 20
Repurchase Agreements....................................................................... 21
Short Sales Against the Box................................................................. 21
Small and Medium Companies.................................................................. 21
Temporary Defensive Position................................................................ 22
Warrants.................................................................................... 22
When-Issued Securities...................................................................... 22
Zero-Coupon, Step-Coupon and Pay-in-Kind Securities......................................... 22
DIRECTORS AND OFFICERS OF THE CORPORATION..................................................... 23
PRINCIPAL SHAREHOLDERS........................................................................ 26
INVESTMENT ADVISOR AND DISTRIBUTOR............................................................ 27
PORTFOLIO TRANSACTIONS AND BROKERAGE.......................................................... 29
CUSTODIAN..................................................................................... 31
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT.................................................. 32
ADMINISTRATIVE SERVICES....................................................................... 32
TAXES......................................................................................... 32
DETERMINATION OF NET ASSET VALUE.............................................................. 34
ADDITIONAL SHAREHOLDER INFORMATION............................................................ 35
FUND ORGANIZATION............................................................................. 35
PERFORMANCE INFORMATION....................................................................... 35
GENERAL INFORMATION........................................................................... 40
PORTFOLIO MANAGEMENT.......................................................................... 41
INDEPENDENT ACCOUNTANTS....................................................................... 42
LEGAL COUNSEL................................................................................. 42
FINANCIAL STATEMENTS.......................................................................... 42
APPENDIX..................................................................................... A-1
</TABLE>
______________________________
No person has been authorized to give any information or to make any
representations other than those contained in this Statement of Additional
Information and the Prospectus dated May 1, 1997 and, if given or made, such
information or representations may not be relied upon as having been authorized
by the Fund.
This Statement of Additional Information does not constitute an offer to sell
securities.
2
<PAGE> 177
INVESTMENT RESTRICTIONS
The investment objective of the Fund is to seek capital growth. The
Fund's investment objective and policies are described in detail in the
Prospectus under the caption "Investment Objective and Policies." The
following are the Fund's fundamental investment limitations which cannot be
changed without shareholder approval.
The Fund:
1. May not with respect to 75% of its total assets, purchase the securities
of any issuer (except securities issued or guaranteed by the U.S.
government or its agencies or instrumentalities) if, as a result, (i) more
than 5% of the Fund's total assets would be invested in the securities of
that issuer, or (ii) the Fund would hold more than 10% of the outstanding
voting securities of that issuer.
2. May (i) borrow money from banks and (ii) make other investments or engage
in other transactions permissible under the Investment Company Act of 1940
(the "1940 Act") which may involve a borrowing, provided that the
combination of (i) and (ii) shall not exceed 33 1/3% of the value of the
Fund's total assets (including the amount borrowed), less the Fund's
liabilities (other than borrowings), except that the Fund may borrow up to
an additional 5% of its total assets (not including the amount borrowed)
from a bank for temporary or emergency purposes (but not for leverage or
the purchase of investments). The Fund may also borrow money from the
other Strong Funds or other persons to the extent permitted by applicable
law.
3. May not issue senior securities, except as permitted under the 1940 Act.
4. May not act as an underwriter of another issuer's securities, except to
the extent that the Fund may be deemed to be an underwriter within the
meaning of the Securities Act of 1933 in connection with the purchase and
sale of portfolio securities.
5. May not purchase or sell physical commodities unless acquired as a result
of ownership of securities or other instruments (but this shall not
prevent the Fund from purchasing or selling options, futures contracts, or
other derivative instruments, or from investing in securities or other
instruments backed by physical commodities).
6. May not make loans if, as a result, more than 33 1/3% of the Fund's total
assets would be lent to other persons, except through (i) purchases of
debt securities or other debt instruments, or (ii) engaging in repurchase
agreements.
7. May not purchase the securities of any issuer if, as a result, more than
25% of the Fund's total assets would be invested in the securities of
issuers, the principal business activities of which are in the same
industry.
8. May not purchase or sell real estate unless acquired as a result of
ownership of securities or other instruments (but this shall not prohibit
the Fund from purchasing or selling securities or other instruments backed
by real estate or of issuers engaged in real estate activities).
9. May, notwithstanding any other fundamental investment policy or
restriction, invest all of its assets in the securities of a single
open-end management investment company with substantially the same
fundamental investment objective, policies, and restrictions as the Fund.
3
<PAGE> 178
The following are the Fund's non-fundamental operating policies which may
be changed by the Board of Directors of the Corporation without shareholder
approval.
The Fund may not:
1. Sell securities short, unless the Fund owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short, or
unless it covers such short sale as required by the current rules and
positions of the Securities and Exchange Commission or its staff, and
provided that transactions in options, futures contracts, options on
futures contracts, or other derivative instruments are not deemed to
constitute selling securities short.
2. Purchase securities on margin, except that the Fund may obtain such
short-term credits as are necessary for the clearance of transactions; and
provided that margin deposits in connection with futures contracts,
options on futures contracts, or other derivative instruments shall not
constitute purchasing securities on margin.
3. Invest in illiquid securities if, as a result of such investment, more
than 15% of its net assets would be invested in illiquid securities, or
such other amounts as may be permitted under the 1940 Act.
4. Purchase securities of other investment companies except in compliance
with the 1940 Act and applicable state law.
5. Invest all of its assets in the securities of a single open-end
investment management company with substantially the same fundamental
investment objective, restrictions and policies as the Fund.
6. Engage in futures or options on futures transactions which are
impermissible pursuant to Rule 4.5 under the Commodity Exchange Act and,
in accordance with Rule 4.5, will use futures or options on futures
transactions solely for bona fide hedging transactions (within the meaning
of the Commodity Exchange Act), provided, however, that the Fund may, in
addition to bona fide hedging transactions, use futures and options on
futures transactions if the aggregate initial margin and premiums required
to establish such positions, less the amount by which any such options
positions are in the money (within the meaning of the Commodity Exchange
Act), do not exceed 5% of the Fund's net assets.
7. Borrow money except (i) from banks or (ii) through reverse repurchase
agreements or mortgage dollar rolls, and will not purchase securities when
bank borrowings exceed 5% of its total assets.
8. Make any loans other than loans of portfolio securities, except through
(i) purchases of debt securities or other debt instruments, or (ii)
engaging in repurchase agreements.
Except for the fundamental investment limitations listed above and the
Fund's investment objective, the other investment policies described in the
Prospectus and this Statement of Additional Information are not fundamental and
may be changed with approval of the Corporation's Board of Directors. Unless
noted otherwise, if a percentage restriction is adhered to at the time of
investment, a later increase or decrease in percentage resulting from a change
in the Fund's assets (i.e., due to cash inflows or redemptions) or in market
value of the investment or the Fund's assets will not constitute a violation of
that restriction.
INVESTMENT POLICIES AND TECHNIQUES
The following information supplements the discussion of the Fund's
investment objective, policies, and techniques that are described in detail in
the Prospectus under the captions "Investment Objective and Policies" and
"Implementation of Policies and Risks."
4
<PAGE> 179
BORROWING
The Fund may borrow money from banks and make other investments or engage
in other transactions permissible under the 1940 Act which may be considered a
borrowing (such as mortgage dollar rolls and reverse repurchase agreements) as
discussed under "Investment Restrictions." However, the Fund may not purchase
securities when bank borrowings exceed 5% of the Fund's total assets.
Presently, the Fund only intends to borrow from banks for temporary or
emergency purposes.
The Fund has established a line-of-credit (LOC) with certain banks by
which they may borrow funds for temporary or emergency purposes. A borrowing
is presumed to be for temporary or emergency purposes if it is repaid by the
Fund within sixty days and is not extended or renewed. The Fund intends to use
the LOC to meet large or unexpected redemptions that would otherwise force the
Fund to liquidate securities under circumstances which are unfavorable to the
Fund's remaining shareholders. The Fund pays a commitment fee to the banks for
the LOC.
CONVERTIBLE SECURITIES
The Fund may invest in convertible securities, which are bonds,
debentures, notes, preferred stocks, or other securities that may be converted
into or exchanged for a specified amount of common stock of the same or a
different issuer within a particular period of time at a specified price or
formula. A convertible security entitles the holder to receive interest
normally paid or accrued on debt or the dividend paid on preferred stock until
the convertible security matures or is redeemed, converted, or exchanged.
Convertible securities have unique investment characteristics in that they
generally (i) have higher yields than common stocks, but lower yields than
comparable non-convertible securities, (ii) are less subject to fluctuation in
value than the underlying stock since they have fixed income characteristics,
and (iii) provide the potential for capital appreciation if the market price of
the underlying common stock increases. Most convertible securities currently
are issued by U.S. companies, although a substantial Eurodollar convertible
securities market has developed, and the markets for convertible securities
denominated in local currencies are increasing.
The value of a convertible security is a function of its "investment
value" (determined by its yield in comparison with the yields of other
securities of comparable maturity and quality that do not have a conversion
privilege) and its "conversion value" (the security's worth, at market value,
if converted into the underlying common stock). The investment value of a
convertible security is influenced by changes in interest rates, with
investment value declining as interest rates increase and increasing as
interest rates decline. The credit standing of the issuer and other factors
also may have an effect on the convertible security's investment value. The
conversion value of a convertible security is determined by the market price of
the underlying common stock. If the conversion value is low relative to the
investment value, the price of the convertible security is governed principally
by its investment value. Generally, the conversion value decreases as the
convertible security approaches maturity. To the extent the market price of
the underlying common stock approaches or exceeds the conversion price, the
price of the convertible security will be increasingly influenced by its
conversion value. A convertible security generally will sell at a premium over
its conversion value by the extent to which investors place value on the right
to acquire the underlying common stock while holding a fixed income security.
A convertible security may be subject to redemption at the option of the
issuer at a price established in the convertible security's governing
instrument. If a convertible security held by the Fund is called for
redemption, the Fund will be required to permit the issuer to redeem the
security, convert it into the underlying common stock, or sell it to a third
party.
DEBT OBLIGATIONS
The Fund may invest a portion of its assets in debt obligations. Issuers
of debt obligations have a contractual obligation to pay interest at a
specified rate on specified dates and to repay principal on a specified
maturity date. Certain debt obligations (usually intermediate- and long-term
bonds) have provisions that allow the issuer to redeem or "call" a bond before
its maturity. Issuers are most likely to call such securities during periods
of falling interest rates and the Fund may have to replace such securities with
lower yielding securities, which could result in a lower return for the Fund.
5
<PAGE> 180
PRICE VOLATILITY. The market value of debt obligations is affected
primarily by changes in prevailing interest rates. The market value of a debt
obligation generally reacts inversely to interest-rate changes, meaning, when
prevailing interest rates decline, an obligation's price usually rises, and
when prevailing interest rates rise, an obligation's price usually declines.
MATURITY. In general, the longer the maturity of a debt obligation, the
higher its yield and the greater its sensitivity to changes in interest rates.
Conversely, the shorter the maturity, the lower the yield but the greater the
price stability. Commercial paper is generally considered the shortest form of
debt obligation.
CREDIT QUALITY. The values of debt obligations may also be affected by
changes in the credit rating or financial condition of their issuers.
Generally, the lower the quality rating of a security, the higher the degree of
risk as to the payment of interest and return of principal. To compensate
investors for taking on such increased risk, those issuers deemed to be less
creditworthy generally must offer their investors higher interest rates than do
issuers with better credit ratings.
In conducting its credit research and analysis, the Advisor considers both
qualitative and quantitative factors to evaluate the creditworthiness of
individual issuers. The Advisor also relies, in part, on credit ratings
compiled by a number of Nationally Recognized Statistical Rating Organizations
("NRSROs"). Refer to the Appendix for a discussion of securities ratings.
DEPOSITARY RECEIPTS
The Fund may invest in foreign securities by purchasing depositary
receipts, including American Depositary Receipts ("ADRs") and European
Depositary Receipts ("EDRs"), or other securities convertible into securities
of foreign issuers. These securities may not necessarily be denominated in the
same currency as the securities into which they may be converted. Generally,
ADRs, in registered form, are denominated in U.S. dollars and are designed for
use in the U.S. securities markets, while EDRs, in bearer form, may be
denominated in other currencies and are designed for use in the European
securities markets. ADRs are receipts typically issued by a U.S. bank or
trust company evidencing ownership of the underlying securities. EDRs are
European receipts evidencing a similar arrangement. For purposes of the Fund's
investment policies, ADRs and EDRs are deemed to have the same classification
as the underlying securities they represent, except that ADRs and EDRs shall be
treated as indirect foreign investments. Thus, an ADR or EDR representing
ownership of common stock will be treated as common stock. ADR and EDR
depositary receipts do not eliminate all of the risks associated with directly
investing in the securities of foreign issuers.
ADR facilities may be established as either "unsponsored" or "sponsored."
While ADRs issued under these two types of facilities are in some respects
similar, there are distinctions between them relating to the rights and
obligations of ADR holders and the practices of market participants.
A depositary may establish an unsponsored facility without participation
by (or even necessarily the acquiescence of) the issuer of the deposited
securities, although typically the depositary requests a letter of
non-objection from such issuer prior to the establishment of the facility.
Holders of unsponsored ADRs generally bear all the costs of such facilities.
The depositary usually charges fees upon the deposit and withdrawal of the
deposited securities, the conversion of dividends into U.S. dollars, the
disposition of non-cash distributions, and the performance of other services.
The depositary of an unsponsored facility frequently is under no obligation to
pass through voting rights to ADR holders in respect of the deposited
securities. In addition, an unsponsored facility is generally not obligated to
distribute communications received from the issuer of the deposited securities
or to disclose material information about such issuer in the U.S. and thus
there may not be a correlation between such information and the market value of
the depositary receipts.
Sponsored ADR facilities are created in generally the same manner as
unsponsored facilities, except that the issuer of the deposited securities
enters into a deposit agreement with the depositary. The deposit agreement
sets out the rights and responsibilities of the issuer, the depositary, and the
ADR holders. With sponsored facilities, the issuer of the deposited securities
generally will bear some of the costs relating to the facility (such as
dividend payment fees of the depositary), although ADR holders continue to bear
certain other costs (such as deposit and withdrawal fees). Under the terms of
most sponsored arrangements, depositories agree to distribute notices of
shareholder meetings and voting instructions, and to provide shareholder
communications and other information to the ADR holders at the request of the
issuer of the deposited securities.
6
<PAGE> 181
DERIVATIVE INSTRUMENTS
IN GENERAL. The Fund may use derivative instruments for any lawful
purpose consistent with the Fund's investment objective such as hedging or
managing risk. Derivative instruments are commonly defined to include
securities or contracts whose values depend on (or "derive" from) the value of
one or more other assets, such as securities, currencies, or commodities.
These "other assets" are commonly referred to as "underlying assets."
A derivative instrument generally consists of, is based upon, or exhibits
characteristics similar to options or forward contracts. Options and forward
contracts are considered to be the basic "building blocks" of derivatives. For
example, forward-based derivatives include forward contracts, swap contracts,
as well as exchange-traded futures. Option-based derivatives include privately
negotiated, over-the-counter (OTC) options (including caps, floors, collars,
and options on forward and swap contracts) and exchange-traded options on
futures. Diverse types of derivatives may be created by combining options or
forward contracts in different ways, and by applying these structures to a wide
range of underlying assets.
An option is a contract in which the "holder" (the buyer) pays a certain
amount (the "premium") to the "writer" (the seller) to obtain the right, but
not the obligation, to buy from the writer (in a "call") or sell to the writer
(in a "put") a specific asset at an agreed upon price at or before a certain
time. The holder pays the premium at inception and has no further financial
obligation. The holder of an option-based derivative generally will benefit
from favorable movements in the price of the underlying asset but is not
exposed to corresponding losses due to adverse movements in the value of the
underlying asset. The writer of an option-based derivative generally will
receive fees or premiums but generally is exposed to losses due to changes in
the value of the underlying asset.
A forward is a sales contract between a buyer (holding the "long"
position) and a seller (holding the "short" position) for an asset with
delivery deferred until a future date. The buyer agrees to pay a fixed price
at the agreed future date and the seller agrees to deliver the asset. The
seller hopes that the market price on the delivery date is less than the agreed
upon price, while the buyer hopes for the contrary. The change in value of a
forward-based derivative generally is roughly proportional to the change in
value of the underlying asset.
HEDGING. The Fund may use derivative instruments to protect against
possible adverse changes in the market value of securities held in, or are
anticipated to be held in, the Fund's portfolio. Derivatives may also be used
by the Fund to "lock-in" the Fund's realized but unrecognized gains in the
value of its portfolio securities. Hedging strategies, if successful, can
reduce the risk of loss by wholly or partially offsetting the negative effect
of unfavorable price movements in the investments being hedged. However,
hedging strategies can also reduce the opportunity for gain by offsetting the
positive effect of favorable price movements in the hedged investments.
MANAGING RISK. The Fund may also use derivative instruments to manage the
risks of the Fund's portfolio. Risk management strategies include, but are not
limited to, facilitating the sale of portfolio securities, managing the
effective maturity or duration of debt obligations in the Fund's portfolio,
establishing a position in the derivatives markets as a substitute for buying
or selling certain securities, or creating or altering exposure to certain
asset classes, such as equity, debt, and foreign securities. The use of
derivative instruments may provide a less expensive, more expedient or more
specifically focused way for the Fund to invest than "traditional" securities
(i.e., stocks or bonds) would.
EXCHANGE OR OTC DERIVATIVES. Derivative instruments may be
exchange-traded or traded in OTC transactions between private parties.
Exchange-traded derivatives are standardized options and futures contracts
traded in an auction on the floor of a regulated exchange. Exchange contracts
are generally very liquid. The exchange clearinghouse is the counterparty of
every contract. Thus, each holder of an exchange contract bears the credit
risk of the clearinghouse (and has the benefit of its financial strength)
rather than that of a particular counterparty. Over-the-counter transactions
are subject to additional risks, such as the credit risk of the counterparty to
the instrument and are less liquid than exchange-traded derivatives since they
often can only be closed out with the other party to the transaction.
7
<PAGE> 182
RISKS AND SPECIAL CONSIDERATIONS. The use of derivative instruments
involves risks and special considerations as described below. Risks pertaining
to particular derivative instruments are described in the sections that follow.
(1) MARKET RISK. The primary risk of derivatives is the same as the risk
of the underlying assets, namely that the value of the underlying asset may go
up or down. Adverse movements in the value of an underlying asset can expose
the Fund to losses. Derivative instruments may include elements of leverage
and, accordingly, the fluctuation of the value of the derivative instrument in
relation to the underlying asset may be magnified. The successful use of
derivative instruments depends upon a variety of factors, particularly Strong
Capital Management, Inc.'s (the "Advisor") ability to predict movements of the
securities, currencies, and commodity markets, which requires different skills
than predicting changes in the prices of individual securities. There can be
no assurance that any particular strategy adopted will succeed. The Advisor's
decision to engage in a derivative instrument will reflect the Advisor's
judgment that the derivative transaction will provide value to the Fund and its
shareholders and is consistent with the Fund's objectives, investment
limitations, and operating policies. In making such a judgment, the Advisor
will analyze the benefits and risks of the derivative transaction and weigh
them in the context of the Fund's entire portfolio and investment objective.
(2) CREDIT RISK. The Fund will be subject to the risk that a loss may be
sustained by the Fund as a result of the failure of a counterparty to comply
with the terms of a derivative instrument. The counterparty risk for
exchange-traded derivative instruments is generally less than for
privately-negotiated or OTC derivative instruments, since generally a clearing
agency, which is the issuer or counterparty to each exchange-traded instrument,
provides a guarantee of performance. For privately-negotiated instruments,
there is no similar clearing agency guarantee. In all transactions, the Fund
will bear the risk that the counterparty will default, and this could result in
a loss of the expected benefit of the derivative transaction and possibly other
losses to the Fund. The Fund will enter into transactions in derivative
instruments only with counterparties that the Advisor reasonably believes are
capable of performing under the contract.
(3) CORRELATION RISK. When a derivative transaction is used to completely
hedge another position, changes in the market value of the combined position
(the derivative instrument plus the position being hedged) result from an
imperfect correlation between the price movements of the two instruments. With
a perfect hedge, the value of the combined position remains unchanged for any
change in the price of the underlying asset. With an imperfect hedge, the
values of the derivative instrument and its hedge are not perfectly correlated.
Correlation risk is the risk that there might be imperfect correlation, or
even no correlation, between price movements of an instrument and price
movements of investments being hedged. For example, if the value of a
derivative instruments used in a short hedge (such as writing a call option,
buying a put option, or selling a futures contract) increased by less than the
decline in value of the hedged investments, the hedge would not be perfectly
correlated. Such a lack of correlation might occur due to factors unrelated to
the value of the investments being hedged, such as speculative or other
pressures on the markets in which these instruments are traded. The
effectiveness of hedges using instruments on indices will depend, in part, on
the degree of correlation between price movements in the index and price
movements in the investments being hedged.
(4) LIQUIDITY RISK. Derivatives are also subject to liquidity risk.
Liquidity risk is the risk that a derivative instrument cannot be sold, closed
out, or replaced quickly at or very close to its fundamental value. Generally,
exchange contracts are very liquid because the exchange clearinghouse is the
counterparty of every contract. OTC transactions are less liquid than
exchange-traded derivatives since they often can only be closed out with the
other party to the transaction. The Fund might be required by applicable
regulatory requirement to maintain assets as "cover," maintain segregated
accounts, and/or make margin payments when it takes positions in derivative
instruments involving obligations to third parties (i.e., instruments other
than purchased options). If the Fund was unable to close out its positions in
such instruments, it might be required to continue to maintain such assets or
accounts or make such payments until the position expired, matured, or was
closed out. The requirements might impair the Fund's ability to sell a
portfolio security or make an investment at a time when it would otherwise be
favorable to do so, or require that the Fund sell a portfolio security at a
disadvantageous time. The Fund's ability to sell or close out a position in an
instrument prior to expiration or maturity depends on the existence of a liquid
secondary market or, in the absence of such a market, the ability and
willingness of the counterparty to enter into a transaction closing out the
position. Therefore, there is no assurance that any derivatives position can
be sold or closed out at a time and price that is favorable to the Fund.
8
<PAGE> 183
(5) LEGAL RISK. Legal risk is the risk of loss caused by the legal
unenforcibility of a party's obligations under the derivative. While a party
seeking price certainty agrees to surrender the potential upside in exchange
for downside protection, the party taking the risk is looking for a positive
payoff. Despite this voluntary assumption of risk, a counterparty that has
lost money in a derivative transaction may try to avoid payment by exploiting
various legal uncertainties about certain derivative products.
(6) SYSTEMIC OR "INTERCONNECTION" RISK. Interconnection risk is the risk
that a disruption in the financial markets will cause difficulties for all
market participants. In other words, a disruption in one market will spill
over into other markets, perhaps creating a chain reaction. Much of the OTC
derivatives market takes place among the OTC dealers themselves, thus creating
a large interconnected web of financial obligations. This interconnectedness
raises the possibility that a default by one large dealer could create losses
at other dealers and destabilize the entire market for OTC derivative
instruments.
GENERAL LIMITATIONS. The use of derivative instruments is subject to
applicable regulations of the Securities and Exchange Commission (the "SEC"),
the several options and futures exchanges upon which they may be traded, the
Commodity Futures Trading Commission ("CFTC"), and various state regulatory
authorities. In addition, the Fund's ability to use derivative instruments may
be limited by certain tax considerations. For a discussion of the federal
income tax treatment of the Fund's derivative instruments, see "Taxes -
Derivative Instruments."
The Fund has filed a notice of eligibility for exclusion from the
definition of the term "commodity pool operator" with the CFTC and the National
Futures Association, which regulate trading in the futures markets. In
accordance with Rule 4.5 of the regulations under the Commodity Exchange Act
(the "CEA"), the notice of eligibility for the Fund includes representations
that the Fund will use futures contracts and related options solely for bona
fide hedging purposes within the meaning of CFTC regulations, provided that the
Fund may hold other positions in futures contracts and related options that do
not qualify as a bona fide hedging position if the aggregate initial margin
deposits and premiums required to establish these positions, less the amount by
which any such futures contracts and related options positions are "in the
money," do not exceed 5% of the Fund's net assets. Adherence to these
guidelines does not limit the Fund's risk to 5% of the Fund's assets.
The SEC has identified certain trading practices involving derivative
instruments that involve the potential for leveraging the Fund's assets in a
manner that raises issues under the 1940 Act. In order to limit the potential
for the leveraging of the Fund's assets, as defined under the 1940 Act, the SEC
has stated that the Fund may use coverage or the segregation of the Fund's
assets. To the extent required by SEC guidelines, the Fund will not enter into
any such transactions unless it owns either: (i) an offsetting ("covered")
position in securities, options, futures, or derivative instruments; or (ii)
cash or liquid or securities positions with a value sufficient at all times to
cover its potential obligations to the extent that the position is not
"covered". The Fund will also set aside cash and/or appropriate liquid assets
in a segregated custodial account if required to do so by the SEC and CFTC
regulations. Assets used as cover or held in a segregated account cannot be
sold while the derivative position is open, unless they are replaced with
similar assets. As a result, the commitment of a large portion of the Fund's
assets to segregated accounts could impede portfolio management or the Fund's
ability to meet redemption requests or other current obligations.
In some cases the Fund may be required to maintain or limit exposure to a
specified percentage of its assets to a particular asset class. In such cases,
when the Fund uses a derivative instrument to increase or decrease exposure to
an asset class and is required by applicable SEC guidelines to set aside liquid
assets in a segregated account to secure its obligations under the derivative
instruments, the Advisor may, where reasonable in light of the circumstances,
measure compliance with the applicable percentage by reference to the nature of
the economic exposure created through the use of the derivative instrument and
not by reference to the nature of the exposure arising from the liquid assets
set aside in the segregated account (unless another interpretation is specified
by applicable regulatory requirements).
OPTIONS. The Fund may use options for any lawful purpose consistent with
the Fund's investment objective such as hedging or managing risk. An option is
a contract in which the "holder" (the buyer) pays a certain amount (the
"premium") to the "writer" (the seller) to obtain the right, but not the
obligation, to buy from the writer (in a "call") or sell to the writer (in a
"put") a specific asset at an agreed upon price "(the "strike price" or
"exercise price") at or before a certain time (the "expiration
9
<PAGE> 184
date"). The holder pays the premium at inception and has no further financial
obligation. The holder of an option will benefit from favorable movements in the
price of the underlying asset but is not exposed to corresponding losses due to
adverse movements in the value of the underlying asset. The writer of an option
will receive fees or premiums but is exposed to losses due to changes in the
value of the underlying asset. The Fund may buy or write (sell) put and call
options on assets, such as securities, currencies, commodities, and indices of
debt and equity securities ("underlying assets") and enter into closing
transactions with respect to such options to terminate an existing position.
Options used by the Fund may include European, American, and Bermuda style
options. If an option is exercisable only at maturity, it is a "European"
option; if it is also exercisable prior to maturity, it is an "American" option.
If it is exercisable only at certain times, it is a "Bermuda" option.
The Fund may purchase (buy) and write (sell) put and call options
underlying assets and enter into closing transactions with respect to such
options to terminate an existing position. The purchase of call options serves
as a long hedge, and the purchase of put options serves as a short hedge.
Writing put or call options can enable the Fund to enhance income by reason of
the premiums paid by the purchaser of such options. Writing call options
serves as a limited short hedge because declines in the value of the hedged
investment would be offset to the extent of the premium received for writing
the option. However, if the security appreciates to a price higher than the
exercise price of the call option, it can be expected that the option will be
exercised and the Fund will be obligated to sell the security at less than its
market value or will be obligated to purchase the security at a price greater
than that at which the security must be sold under the option. All or a
portion of any assets used as cover for OTC options written by the Fund would
be considered illiquid to the extent described under "Investment Policies and
Techniques -- Illiquid Securities." Writing put options serves as a limited
long hedge because increases in the value of the hedged investment would be
offset to the extent of the premium received for writing the option. However,
if the security depreciates to a price lower than the exercise price of the put
option, it can be expected that the put option will be exercised and the Fund
will be obligated to purchase the security at more than its market value.
The value of an option position will reflect, among other things, the
historical price volatility of the underlying investment, the current market
value of the underlying investment, the time remaining until expiration, the
relationship of the exercise price to the market price of the underlying
investment, and general market conditions.
The Fund may effectively terminate its right or obligation under an option
by entering into a closing transaction. For example, the Fund may terminate
its obligation under a call or put option that it had written by purchasing an
identical call or put option; this is known as a closing purchase transaction.
Conversely, the Fund may terminate a position in a put or call option it had
purchased by writing an identical put or call option; this is known as a
closing sale transaction. Closing transactions permit the Fund to realize the
profit or limit the loss on an option position prior to its exercise or
expiration.
The Fund may purchase or write both exchange-traded and OTC options.
Exchange-traded options are issued by a clearing organization affiliated with
the exchange on which the option is listed that, in effect, guarantees
completion of every exchange-traded option transaction. In contrast, OTC
options are contracts between the Fund and the other party to the transaction
("counter party") (usually a securities dealer or a bank) with no clearing
organization guarantee. Thus, when the Fund purchases or writes an OTC option,
it relies on the counter party to make or take delivery of the underlying
investment upon exercise of the option. Failure by the counter party to do so
would result in the loss of any premium paid by the Fund as well as the loss of
any expected benefit of the transaction.
The Fund's ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The Fund intends to
purchase or write only those exchange-traded options for which there appears to
be a liquid secondary market. However, there can be no assurance that such a
market will exist at any particular time. Closing transactions can be made for
OTC options only by negotiating directly with the counter party, or by a
transaction in the secondary market if any such market exists. Although the
Fund will enter into OTC options only with counter parties that are expected to
be capable of entering into closing transactions with the Fund, there is no
assurance that the Fund will in fact be able to close out an OTC option at a
favorable price prior to expiration. In the event of insolvency of the counter
party, the Fund might be unable to close out an OTC option position at any time
prior to its expiration. If the Fund were unable to effect a closing
transaction for an option it had purchased, it would have to exercise the
option to realize any profit.
The Fund may engage in options transactions on indices in much the same
manner as the options on securities discussed above, except the index options
may serve as a hedge against overall fluctuations in the securities market in
general.
10
<PAGE> 185
The writing and purchasing of options is a highly specialized activity
that involves investment techniques and risks different from those associated
with ordinary portfolio securities transactions. Imperfect correlation between
the options and securities markets may detract from the effectiveness of
attempted hedging.
SPREAD TRANSACTIONS. The Fund may use spread transactions for any lawful
purpose consistent with the Fund's investment objective such as hedging or
managing risk. The Fund may purchase covered spread options from securities
dealers. Such covered spread options are not presently exchange-listed or
exchange-traded. The purchase of a spread option gives the Fund the right to
put, or sell, a security that it owns at a fixed dollar spread or fixed yield
spread in relationship to another security that the Fund does not own, but
which is used as a benchmark. The risk to the Fund in purchasing covered
spread options is the cost of the premium paid for the spread option and any
transaction costs. In addition, there is no assurance that closing
transactions will be available. The purchase of spread options will be used to
protect the Fund against adverse changes in prevailing credit quality spreads,
i.e., the yield spread between high quality and lower quality securities. Such
protection is only provided during the life of the spread option.
FUTURES CONTRACTS. The Fund may use futures contracts for any lawful
purpose consistent with the Fund's investment objective such as hedging or
managing risk. The Fund may enter into futures contracts, including interest
rate, index, and currency futures. The Fund may also purchase put and call
options, and write covered put and call options, on futures in which it is
allowed to invest. The purchase of futures or call options thereon can serve
as a long hedge, and the sale of futures or the purchase of put options thereon
can serve as a short hedge. Writing covered call options on futures contracts
can serve as a limited short hedge, and writing covered put options on futures
contracts can serve as a limited long hedge, using a strategy similar to that
used for writing covered options in securities. The Fund's hedging may include
purchases of futures as an offset against the effect of expected increases in
currency exchange rates and securities prices and sales of futures as an offset
against the effect of expected declines in currency exchange rates and
securities prices. The Fund may also write put options on futures contracts
while at the same time purchasing call options on the same futures contracts in
order to create synthetically a long futures contract position. Such options
would have the same strike prices and expiration dates. The Fund will engage
in this strategy only when the Advisor believes it is more advantageous to the
Fund than is purchasing the futures contract.
To the extent required by regulatory authorities, the Fund only enters
into futures contracts that are traded on national futures exchanges and are
standardized as to maturity date and underlying financial instrument. Futures
exchanges and trading are regulated under the CEA by the CFTC. Although
techniques other than sales and purchases of futures contracts could be used to
reduce the Fund's exposure to market, currency, or interest rate fluctuations,
the Fund may be able to hedge its exposure more effectively and perhaps at a
lower cost through using futures contracts.
An interest rate futures contract provides for the future sale by one
party and purchase by another party of a specified amount of a specific
financial instrument (e.g., debt security) or currency for a specified price at
a designated date, time, and place. An index futures contract is an agreement
pursuant to which the parties agree to take or make delivery of an amount of
cash equal to the difference between the value of the index at the close of the
last trading day of the contract and the price at which the index futures
contract was originally written. Transaction costs are incurred when a futures
contract is bought or sold and margin deposits must be maintained. A futures
contract may be satisfied by delivery or purchase, as the case may be, of the
instrument, the currency or by payment of the change in the cash value of the
index. More commonly, futures contracts are closed out prior to delivery by
entering into an offsetting transaction in a matching futures contract.
Although the value of an index might be a function of the value of certain
specified securities, no physical delivery of those securities is made. If the
offsetting purchase price is less than the original sale price, the Fund
realizes a gain; if it is more, the Fund realizes a loss. Conversely, if the
offsetting sale price is more than the original purchase price, the Fund
realizes a gain; if it is less, the Fund realizes a loss. The transaction
costs must also be included in these calculations. There can be no assurance,
however, that the Fund will be able to enter into an offsetting transaction
with respect to a particular futures contract at a particular time. If the
Fund is not able to enter into an offsetting transaction, the Fund will
continue to be required to maintain the margin deposits on the futures
contract.
No price is paid by the Fund upon entering into a futures contract.
Instead, at the inception of a futures contract, the Fund is required to
deposit in a segregated account with its custodian, in the name of the futures
broker through whom the transaction was effected, "initial margin" consisting
of cash and/or other appropriate liquid assets in an amount generally equal to
10% or less of the contract value. Margin must also be deposited when writing
a call or put option on a futures contract, in accordance with applicable
exchange rules. Unlike margin in securities transactions, initial margin on
futures contracts does
11
<PAGE> 186
not represent a borrowing, but rather is in the nature of a performance bond or
good-faith deposit that is returned to the Fund at the termination of the
transaction if all contractual obligations have been satisfied. Under certain
circumstances, such as periods of high volatility, the Fund may be required by
an exchange to increase the level of its initial margin payment, and initial
margin requirements might be increased generally in the future by regulatory
action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of the Fund's obligations to or from a futures
broker. When the Fund purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast, when the Fund purchases
or sells a futures contract or writes a call or put option thereon, it is
subject to daily variation margin calls that could be substantial in the event
of adverse price movements. If the Fund has insufficient cash to meet daily
variation margin requirements, it might need to sell securities at a time when
such sales are disadvantageous. Purchasers and sellers of futures positions
and options on futures can enter into offsetting closing transactions by
selling or purchasing, respectively, an instrument identical to the instrument
held or written. Positions in futures and options on futures may be closed
only on an exchange or board of trade that provides a secondary market. The
Fund intends to enter into futures transactions only on exchanges or boards of
trade where there appears to be a liquid secondary market. However, there can
be no assurance that such a market will exist for a particular contract at a
particular time.
Under certain circumstances, futures exchanges may establish daily limits
on the amount that the price of a future or option on a futures contract can
vary from the previous day's settlement price; once that limit is reached, no
trades may be made that day at a price beyond the limit. Daily price limits do
not limit potential losses because prices could move to the daily limit for
several consecutive days with little or no trading, thereby preventing
liquidation of unfavorable positions.
If the Fund were unable to liquidate a futures or option on a futures
contract position due to the absence of a liquid secondary market or the
imposition of price limits, it could incur substantial losses. The Fund would
continue to be subject to market risk with respect to the position. In
addition, except in the case of purchased options, the Fund would continue to
be required to make daily variation margin payments and might be required to
maintain the position being hedged by the future or option or to maintain cash
or securities in a segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or options on futures contracts
might not correlate perfectly with movements in the prices of the investments
being hedged. For example, all participants in the futures and options on
futures contracts markets are subject to daily variation margin calls and might
be compelled to liquidate futures or options on futures contracts positions
whose prices are moving unfavorably to avoid being subject to further calls.
These liquidations could increase price volatility of the instruments and
distort the normal price relationship between the futures or options and the
investments being hedged. Also, because initial margin deposit requirements in
the futures markets are less onerous than margin requirements in the securities
markets, there might be increased participation by speculators in the future
markets. This participation also might cause temporary price distortions. In
addition, activities of large traders in both the futures and securities
markets involving arbitrage, "program trading" and other investment strategies
might result in temporary price distortions.
FOREIGN CURRENCIES. The Fund may purchase and sell foreign currency on a
spot basis, and may use currency-related derivatives instruments such as
options on foreign currencies, futures on foreign currencies, options on
futures on foreign currencies and forward currency contracts (i.e., an
obligation to purchase or sell a specific currency at a specified future date,
which may be any fixed number of days from the contract date agreed upon by the
parties, at a price set at the time the contract is entered into). The Fund
may use these instruments for hedging or any other lawful purpose consistent
with its investment objective, including transaction hedging, anticipatory
hedging, cross hedging, proxy hedging, and position hedging. The Fund's use of
currency-related derivative instruments will be directly related to the Fund's
current or anticipated portfolio securities, and the Fund may engage in
transactions in currency-related derivative instruments as a means to protect
against some or all of the effects of adverse changes in foreign currency
exchange rates on its portfolio investments. In general, if the currency in
which a portfolio investment is denominated appreciates against the U.S.
dollar, the dollar value of the security will increase. Conversely, a decline
in the exchange rate of the currency would adversely affect the value of the
portfolio investment expressed in U.S. dollars.
12
<PAGE> 187
For example, the Fund might use currency-related derivative instruments to
"lock in" a U.S. dollar price for a portfolio investment, thereby enabling the
Fund to protect itself against a possible loss resulting from an adverse change
in the relationship between the U.S. dollar and the subject foreign currency
during the period between the date the security is purchased or sold and the
date on which payment is made or received. The Fund also might use
currency-related derivative instruments when the Advisor believes that one
currency may experience a substantial movement against another currency,
including the U.S. dollar, and it may use currency-related derivative
instruments to sell or buy the amount of the former foreign currency,
approximating the value of some or all of the Fund's portfolio securities
denominated in such foreign currency. Alternatively, where appropriate, the
Fund may use currency-related derivative instruments to hedge all or part of
its foreign currency exposure through the use of a basket of currencies or a
proxy currency where such currency or currencies act as an effective proxy for
other currencies. The use of this basket hedging technique may be more
efficient and economical than using separate currency-related derivative
instruments for each currency exposure held by the Fund. Furthermore,
currency-related derivative instruments may be used for short hedges - for
example, the Fund may sell a forward currency contract to lock in the U.S.
dollar equivalent of the proceeds from the anticipated sale of a security
denominated in a foreign currency.
In addition, the Fund may use a currency-related derivative instrument to
shift exposure to foreign currency fluctuations from one foreign country to
another foreign country where the Advisor believes that the foreign currency
exposure purchased will appreciate relative to the U.S. dollar and thus better
protect the Fund against the expected decline in the foreign currency exposure
sold. For example, if the Fund owns securities denominated in a foreign
currency and the Advisor believes that currency will decline, it might enter
into a forward contract to sell an appropriate amount of the first foreign
currency, with payment to be made in a second foreign currency that the Advisor
believes would better protect the Fund against the decline in the first
security than would a U.S. dollar exposure. Hedging transactions that use two
foreign currencies are sometimes referred to as "cross hedges." The effective
use of currency-related derivative instruments by the Fund in a cross hedge is
dependent upon a correlation between price movements of the two currency
instruments and the underlying security involved, and the use of two currencies
magnifies the risk that movements in the price of one instrument may not
correlate or may correlate unfavorably with the foreign currency being hedged.
Such a lack of correlation might occur due to factors unrelated to the value of
the currency instruments used or investments being hedged, such as speculative
or other pressures on the markets in which these instruments are traded.
The Fund also might seek to hedge against changes in the value of a
particular currency when no hedging instruments on that currency are available
or such hedging instruments are more expensive than certain other hedging
instruments. In such cases, the Fund may hedge against price movements in that
currency by entering into transactions using currency-related derivative
instruments on another foreign currency or a basket of currencies, the values
of which the Advisor believes will have a high degree of positive correlation
to the value of the currency being hedged. The risk that movements in the
price of the hedging instrument will not correlate perfectly with movements in
the price of the currency being hedged is magnified when this strategy is used.
The use of currency-related derivative instruments by the Fund involves a
number of risks. The value of currency-related derivative instruments depends
on the value of the underlying currency relative to the U.S. dollar. Because
foreign currency transactions occurring in the interbank market might involve
substantially larger amounts than those involved in the use of such derivative
instruments, the Fund could be disadvantaged by having to deal in the 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 (generally consisting of transactions of greater than $1 million).
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis.
Quotation information generally is representative of very large transactions in
the interbank market and thus might not reflect odd-lot transactions where
rates might be less favorable. The interbank market in foreign currencies is a
global, round-the-clock market. To the extent the U.S. options or futures
markets are closed while the markets for the underlying currencies remain open,
significant price and rate movements might take place in the underlying markets
that cannot be reflected in the markets for the derivative instruments until
they re-open.
Settlement of transactions in currency-related derivative instruments
might be required to take place within the country issuing the underlying
currency. Thus, the Fund might be required to accept or make delivery of the
underlying foreign currency in accordance with any U.S. or foreign regulations
regarding the maintenance of foreign banking
13
<PAGE> 188
arrangements by U.S. residents and might be required to pay any fees, taxes
and charges associated with such delivery assessed in the issuing country.
When the Fund engages in a transaction in a currency-related derivative
instrument, it relies on the counterparty to make or take delivery of the
underlying currency at the maturity of the contract or otherwise complete the
contract. In other words, the Fund will be subject to the risk that a loss may
be sustained by the Fund as a result of the failure of the counterparty to
comply with the terms of the transaction. The counterparty risk for
exchange-traded instruments is generally less than for privately-negotiated or
OTC currency instruments, since generally a clearing agency, which is the
issuer or counterparty to each instrument, provides a guarantee of performance.
For privately-negotiated instruments, there is no similar clearing agency
guarantee. In all transactions, the Fund will bear the risk that the
counterparty will default, and this could result in a loss of the expected
benefit of the transaction and possibly other losses to the Fund. The Fund
will enter into transactions in currency-related derivative instruments only
with counterparties that the Advisor reasonably believes are capable of
performing under the contract.
Purchasers and sellers of currency-related derivative instruments may
enter into offsetting closing transactions by selling or purchasing,
respectively, an instrument identical to the instrument purchased or sold.
Secondary markets generally do not exist for forward currency contracts, with
the result that closing transactions generally can be made for forward currency
contracts only by negotiating directly with the counterparty. Thus, there can
be no assurance that the Fund will in fact be able to close out a forward
currency contract (or any other currency-related derivative instrument) at a
time and price favorable to the Fund. In addition, in the event of insolvency
of the counterparty, the Fund might be unable to close out a forward currency
contract at any time prior to maturity. In the case of an exchange-traded
instrument, the Fund will be able to close the position out only on an exchange
which provides a market for the instruments. The ability to establish and
close out positions on an exchange is subject to the maintenance of a liquid
market, and there can be no assurance that a liquid market will exist for any
instrument at any specific time. In the case of a privately-negotiated
instrument, the Fund will be able to realize the value of the instrument only
by entering into a closing transaction with the issuer or finding a third party
buyer for the instrument. While the Fund will enter into privately-negotiated
transactions only with entities who are expected to be capable of entering into
a closing transaction, there can be no assurance that the Fund will in fact be
able to enter into such closing transactions.
The precise matching of currency-related derivative instrument amounts and
the value of the portfolio securities involved generally will not be possible
because the value of such securities, measured in the foreign currency, will
change after the currency-related derivative instrument position has been
established. Thus, the Fund might need to purchase or sell foreign currencies
in the spot (cash) market. The projection of short-term currency market
movements is extremely difficult, and the successful execution of a short-term
hedging strategy is highly uncertain.
Permissible foreign currency options will include options traded primarily
in the OTC market. Although options on foreign currencies are traded primarily
in the OTC market, the Fund will normally purchase or sell OTC options on
foreign currency only when the Advisor reasonably believes a liquid secondary
market will exist for a particular option at any specific time.
There will be a cost to the Fund of engaging in transactions in
currency-related derivative instruments that will vary with factors such as the
contract or currency involved, the length of the contract period and the market
conditions then prevailing. The Fund using these instruments may have to pay a
fee or commission or, in cases where the instruments are entered into on a
principal basis, foreign exchange dealers or other counterparties will realize
a profit based on the difference ("spread") between the prices at which they
are buying and selling various currencies. Thus, for example, a dealer may
offer to sell a foreign currency to the Fund at one rate, while offering a
lesser rate of exchange should the Fund desire to resell that currency to the
dealer.
When required by the SEC guidelines, the Fund will set aside permissible
liquid assets in segregated accounts or otherwise cover its potential
obligations under currency-related derivatives instruments. To the extent the
Fund's assets are so set aside, they cannot be sold while the corresponding
currency position is open, unless they are replaced with similar assets. As a
result, if a large portion of the Fund's assets are so set aside, this could
impede portfolio management or the Fund's ability to meet redemption requests
or other current obligations.
The Advisor's decision to engage in a transaction in a particular
currency-related derivative instrument will reflect the
14
<PAGE> 189
Advisor's judgment that the transaction will provide value to the Fund and its
shareholders and is consistent with the Fund's objectives and policies. In
making such a judgment, the Advisor will analyze the benefits and risks of the
transaction and weigh them in the context of the Fund's entire portfolio and
objectives. The effectiveness of any transaction in a currency-related
derivative instrument is dependent on a variety of factors, including the
Advisor's skill in analyzing and predicting currency values and upon a
correlation between price movements of the currency instrument and the
underlying security. There might be imperfect correlation, or even no
correlation, between price movements of an instrument and price movements of
investments being hedged. Such a lack of correlation might occur due to factors
unrelated to the value of the investments being hedged, such as speculative or
other pressures on the markets in which these instruments are traded. In
addition, the Fund's use of currency-related derivative instruments is always
subject to the risk that the currency in question could be devalued by the
foreign government. In such a case, any long currency positions would decline
in value and could adversely affect any hedging position maintained by the Fund.
The Fund's dealing in currency-related derivative instruments will
generally be limited to the transactions described above. However, the Fund
reserves the right to use currency-related derivatives instruments for
different purposes and under different circumstances. Of course, the Fund is
not required to use currency-related derivatives instruments and will not do so
unless deemed appropriate by the Advisor. It also should be realized that use
of these instruments does not eliminate, or protect against, price movements in
the Fund's securities that are attributable to other (i.e., non-currency
related) causes. Moreover, while the use of currency-related derivatives
instruments may reduce the risk of loss due to a decline in the value of a
hedged currency, at the same time the use of these instruments tends to limit
any potential gain which may result from an increase in the value of that
currency.
SWAP AGREEMENTS. The Fund may enter into interest rate, securities index,
commodity, or security and currency exchange rate swap agreements for any
lawful purpose consistent with the Fund's investment objective, such as for the
purpose of attempting to obtain or preserve a particular desired return or
spread at a lower cost to the Fund than if the Fund had invested directly in an
instrument that yielded that desired return or spread. The Fund also may enter
into swaps in order to protect against an increase in the price of, or the
currency exchange rate applicable to, securities that the Fund anticipates
purchasing at a later date. Swap agreements are two-party contracts entered
into primarily by institutional investors for periods ranging from a few weeks
to several years. In a standard "swap" transaction, two parties agree to
exchange the returns (or differentials in rates of return) earned or realized
on particular predetermined investments or instruments. The gross returns to
be exchanged or "swapped" between the parties are calculated with respect to a
"notional amount," i.e., the return on or increase in value of a particular
dollar amount invested at a particular interest rate, in a particular foreign
currency, or in a "basket" of securities representing a particular index. Swap
agreements may include interest rate caps, under which, in return for a
premium, one party agrees to make payments to the other to the extent that
interest rates exceed a specified rate, or "cap;" interest rate floors, under
which, in return for a premium, one party agrees to make payments to the other
to the extent that interest rates fall below a specified level, or "floor;" and
interest rate collars, under which a party sells a cap and purchases a floor,
or vice versa, in an attempt to protect itself against interest rate movements
exceeding given minimum or maximum levels.
The "notional amount" of the swap agreement is the agreed upon basis for
calculating the obligations that the parties to a swap agreement have agreed to
exchange. Under most swap agreements entered into by the Fund, the obligations
of the parties would be exchanged on a "net basis." Consequently, the Fund's
obligation (or rights) under a swap agreement will generally be equal only to
the net amount to be paid or received under the agreement based on the relative
values of the positions held by each party to the agreement (the "net amount").
The Fund's obligation under a swap agreement will be accrued daily (offset
against amounts owed to the Fund) and any accrued but unpaid net amounts owed
to a swap counterparty will be covered by the maintenance of a segregated
account consisting of cash, or liquid high grade debt obligations.
Whether the Fund's use of swap agreements will be successful in furthering
its investment objective will depend, in part, on the Advisor's ability to
predict correctly whether certain types of investments are likely to produce
greater returns than other investments. Swap agreements may be considered to
be illiquid. Moreover, the Fund bears the risk of loss of the amount expected
to be received under a swap agreement in the event of the default or bankruptcy
of a swap agreement counterparty. Certain restrictions imposed on the Fund by
the Internal Revenue Code may limit the Fund's ability to use swap agreements.
The swaps market is largely unregulated.
The Fund will enter swap agreements only with counterparties that the
Advisor reasonably believes are capable of performing under the swap
agreements. If there is a default by the other party to such a transaction,
the Fund will have to rely
15
<PAGE> 190
on its contractual remedies (which may be limited by bankruptcy, insolvency or
similar laws) pursuant to the agreements related to the transaction.
ADDITIONAL DERIVATIVE INSTRUMENTS AND STRATEGIES. In addition to the
derivative instruments and strategies described above and in the Fund's
Prospectus, the Advisor expects to discover additional derivative instruments
and other hedging or risk management techniques. The Advisor may utilize these
new derivative instruments and techniques to the extent that they are
consistent with the Fund's investment objective and permitted by the Fund's
investment limitations, operating policies, and applicable regulatory
authorities.
FOREIGN INVESTMENT COMPANIES
The Fund may invest, to a limited extent, in foreign investment
companies. Some of the countries in which the Fund invests may not permit
direct investment by outside investors. Investments in such countries may
only be permitted through foreign government-approved or -authorized
investment vehicles, which may include other investment companies. In
addition, it may be less expensive and more expedient for the Fund to invest
in a foreign investment company in a country which permits direct foreign
investment. Investing through such vehicles may involve frequent or layered
fees or expenses and may also be subject to limitation under the 1940 Act.
Under the 1940 Act, the Fund may invest up to 10% of its assets in shares of
other investment companies and up to 5% of its assets in any one investment
company as long as the investment does not represent more than 3% of the
voting stock of the acquired investment company. The Fund does not intend to
invest in such investment companies unless, in the judgment of the Advisor,
the potential benefits of such investments justify the payment of any
associated fees and expenses.
FOREIGN SECURITIES
Investing in foreign securities involves a series of risks not present in
investing in U.S. securities. Many of the foreign securities held by the Fund
will not be registered with the Securities and Exchange Commission (the "SEC"),
nor will the foreign issuers be subject to SEC reporting requirements.
Accordingly, there may be less publicly available information concerning
foreign issuers of securities held by the Fund than is available concerning
U.S. companies. Disclosure and regulatory standards in many respects are less
stringent in emerging market countries than in the U.S. and other major
markets. There also may be a lower level of monitoring and regulation of
emerging markets and the activities of investors in such markets, and
enforcement of existing regulations may be extremely limited. Foreign
companies, and in particular, companies in smaller and emerging capital markets
are not generally subject to uniform accounting, auditing and financial
reporting standards, or to other regulatory requirements comparable to those
applicable to U.S. companies. The Fund's net investment income and capital
gains from its foreign investment activities may be subject to non-U.S.
withholding taxes.
The costs attributable to foreign investing that the Fund must bear
frequently are higher than those attributable to domestic investing; this is
particularly true with respect to emerging capital markets. For example, the
cost of maintaining custody of foreign securities exceeds custodian costs for
domestic securities, and transaction and settlement costs of foreign investing
also frequently are higher than those attributable to domestic investing.
Costs associated with the exchange of currencies also make foreign investing
more expensive than domestic investing. Investment income on certain foreign
securities in which the Fund may invest may be subject to foreign withholding
or other government taxes that could reduce the return of these securities.
Tax treaties between the United States and foreign countries, however, may
reduce or eliminate the amount of foreign tax to which the Fund would be
subject.
Foreign markets also have different clearance and settlement procedures,
and in certain markets there have been times when settlements have failed to
keep pace with the volume of securities transactions, making it difficult to
conduct such transactions. Delays in settlement could result in temporary
periods when assets of the Fund are uninvested and no return is earned thereon.
The inability of the Fund to make intended security purchases due to
settlement problems could cause the Fund to miss investment opportunities.
Inability to dispose of a portfolio security due to settlement problems could
result either in losses to the Fund due to subsequent declines in the value of
such portfolio security or, if the Fund has entered into a contract to sell the
security, could result in possible liability to the purchaser.
16
<PAGE> 191
HIGH-YIELD (HIGH-RISK) SECURITIES
IN GENERAL. The Fund has the authority to invest up to 5% of its net
assets in non-investment grade debt securities. Non-investment grade debt
obligations (hereinafter referred to as "lower-quality securities") include (i)
bonds rated as low as C by Moody's Investors Service, Inc. ("Moody's"),
Standard & Poor's Ratings Group ("S&P"), or Fitch Investors Service, Inc.
("Fitch"), or CCC by Duff & Phelps, Inc. ("D&P"); (ii) commercial paper rated
as low as C by S&P, Not Prime by Moody's, or Fitch 4 by Fitch; and (iii)
unrated debt obligations of comparable quality. Lower-quality securities,
while generally offering higher yields than investment grade securities with
similar maturities, involve greater risks, including the possibility of default
or bankruptcy. They are regarded as predominantly speculative with respect to
the issuer's capacity to pay interest and repay principal. The special risk
considerations in connection with investments in these securities are discussed
below. Refer to the Appendix for a discussion of securities ratings.
EFFECT OF INTEREST RATES AND ECONOMIC CHANGES. The lower-quality and
comparable unrated security market is relatively new and its growth has
paralleled a long economic expansion. As a result, it is not clear how this
market may withstand a prolonged recession or economic downturn. Such
conditions could severely disrupt the market for and adversely affect the value
of such securities.
All interest-bearing securities typically experience appreciation when
interest rates decline and depreciation when interest rates rise. The market
values of lower-quality and comparable unrated securities tend to reflect
individual corporate developments to a greater extent than do higher rated
securities, which react primarily to fluctuations in the general level of
interest rates. Lower-quality and comparable unrated securities also tend to
be more sensitive to economic conditions than are higher-rated securities. As
a result, they generally involve more credit risks than securities in the
higher-rated categories. During an economic downturn or a sustained period of
rising interest rates, highly leveraged issuers of lower-quality and comparable
unrated securities may experience financial stress and may not have sufficient
revenues to meet their payment obligations. The issuer's ability to service
its debt obligations may also be adversely affected by specific corporate
developments, the issuer's inability to meet specific projected business
forecasts or the unavailability of additional financing. The risk of loss due
to default by an issuer of these securities is significantly greater than
issuers of higher-rated securities because such securities are generally
unsecured and are often subordinated to other creditors. Further, if the
issuer of a lower-quality or comparable unrated security defaulted, the Fund
might incur additional expenses to seek recovery. Periods of economic
uncertainty and changes would also generally result in increased volatility in
the market prices of these securities and thus in the Fund's net asset value.
As previously stated, the value of a lower-quality or comparable unrated
security will decrease in a rising interest rate market and accordingly, so
will the Fund's net asset value. If the Fund experiences unexpected net
redemptions in such a market, it may be forced to liquidate a portion of its
portfolio securities without regard to their investment merits. Due to the
limited liquidity of lower-quality and comparable unrated securities (discussed
below), the Fund may be forced to liquidate these securities at a substantial
discount. Any such liquidation would force the Fund to sell the more liquid
portion of its portfolio.
PAYMENT EXPECTATIONS. Lower-quality and comparable unrated securities
typically contain redemption, call or prepayment provisions which permit the
issuer of such securities containing such provisions to, at its discretion,
redeem the securities. During periods of falling interest rates, issuers of
these securities are likely to redeem or prepay the securities and refinance
them with debt securities with a lower interest rate. To the extent an issuer
is able to refinance the securities, or otherwise redeem them, the Fund may
have to replace the securities with a lower yielding security, which would
result in a lower return for the Fund.
CREDIT RATINGS. Credit ratings issued by credit rating agencies are
designed to evaluate the safety of principal and interest payments of rated
securities. They do not, however, evaluate the market value risk of
lower-quality securities and, therefore, may not fully reflect the true risks of
an investment. In addition, credit rating agencies may or may not make timely
changes in a rating to reflect changes in the economy or in the condition of the
issuer that affect the market value of the security. Consequently, credit
ratings are used only as a preliminary indicator of investment quality.
Investments in lower-quality and comparable unrated obligations will be more
dependent on the Advisor's credit analysis than would be the case with
investments in investment-grade debt obligations. The Advisor employs its own
credit research and analysis, which includes a study of existing debt, capital
structure, ability to service debt and to pay dividends, the issuer's
sensitivity to economic
17
<PAGE> 192
conditions, its operating history and the current trend of earnings. The
Advisor continually monitors the investments in the Fund's portfolio and
carefully evaluates whether to dispose of or to retain lower-quality and
comparable unrated securities whose credit ratings or credit quality may have
changed.
LIQUIDITY AND VALUATION. The Fund may have difficulty disposing of
certain lower-quality and comparable unrated securities because there may be a
thin trading market for such securities. Because not all dealers maintain
markets in all lower-quality and comparable unrated securities, there is no
established retail secondary market for many of these securities. The Fund
anticipates that such securities could be sold only to a limited number of
dealers or institutional investors. To the extent a secondary trading market
does exist, it is generally not as liquid as the secondary market for
higher-rated securities. The lack of a liquid secondary market may have an
adverse impact on the market price of the security. As a result, the Fund's
asset value and ability to dispose of particular securities, when necessary to
meet the Fund's liquidity needs or in response to a specific economic event,
may be impacted. The lack of a liquid secondary market for certain securities
may also make it more difficult for the Fund to obtain accurate market
quotations for purposes of valuing the Fund's portfolio. Market quotations are
generally available on many lower-quality and comparable unrated issues only
from a limited number of dealers and may not necessarily represent firm bids of
such dealers or prices for actual sales. During periods of thin trading, the
spread between bid and asked prices is likely to increase significantly. In
addition, adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of lower-quality
and comparable unrated securities, especially in a thinly traded market.
LEGISLATION. Legislation may be adopted, from time to time designed to
limit the use of certain lower-quality and comparable unrated securities by
certain issuers. It is anticipated that if additional legislation is enacted
or proposed, it could have a material affect on the value of these securities
and the existence of a secondary trading market for the securities.
ILLIQUID SECURITIES
The Fund may invest in illiquid securities (i.e., securities that are not
readily marketable). However, the Fund will not acquire illiquid securities
if, as a result, they would comprise more than 15% of the value of the Fund's
net assets (or such other amounts as may be permitted under the 1940 Act).
However, as a matter of internal policy, the Advisor intends to limit the
Fund's investments in illiquid securities to 10% of its net assets.
The Board of Directors of the Fund, or its delegate, has the ultimate
authority to determine, to the extent permissible under the federal securities
laws, which securities are illiquid for purposes of this limitation. Certain
securities exempt from registration or issued in transactions exempt from
registration under the Securities Act of 1933, as amended (the "Securities
Act"), such as securities that may be resold to institutional investors under
Rule 144A under the Securities Act and Section 4(2) commercial paper, may be
considered liquid under guidelines adopted by the Fund's Board of Directors.
The Board of Directors of the Fund has delegated to the Advisor the
day-to-day determination of the liquidity of a security, although it has
retained oversight and ultimate responsibility for such determinations. The
Board of Directors has directed the Advisor to look to such factors as (i) the
frequency of trades or quotes for a security, (ii) the number of dealers
willing to purchase or sell the security and number of potential buyers, (iii)
the willingness of dealers to undertake to make a market in the security, (iv)
the nature of the security and nature of the marketplace trades, such as the
time needed to dispose of the security, the method of soliciting offers, and
the mechanics of transfer, (v) the likelihood that the security's marketability
will be maintained throughout the anticipated holding period, and (vi) any
other relevant factors. The Advisor may determine 4(2) commercial paper to be
liquid if (i) the 4(2) commercial paper is not traded flat or in default as to
principal and interest, (ii) the 4(2) commercial paper is rated in one of the
two highest rating categories by at least two nationally rated statistical
rating organizations ("NRSRO"), or if only one NRSRO rates the security, by
that NRSRO, or is determined by the Advisor to be of equivalent quality, and
(iii) the Advisor considers the trading market for the specific security taking
into account all relevant factors. With respect to the Fund's foreign
holdings, a foreign security may be considered liquid by the Advisor (despite
its restricted nature under the Securities Act) if the security can be freely
traded in a foreign securities market and all the facts and circumstances
support a finding of liquidity.
Restricted securities may be sold only in privately negotiated
transactions or in a public offering with respect to which a registration
statement is in effect under the Securities Act. Where registration is
required, the Fund may be obligated to pay
18
<PAGE> 193
all or part of the registration expenses and a considerable period may elapse
between the time of the decision to sell and the time the Fund may be permitted
to sell a security under an effective registration statement. If, during such a
period, adverse market conditions were to develop, the Fund might obtain a less
favorable price than prevailed when it decided to sell. Restricted securities
will be priced at fair value as determined in good faith by the Board of
Directors of the Fund. If through the appreciation of restricted securities or
the depreciation of unrestricted securities, the Fund should be in a position
where more than 15% of the value of its net assets are invested in illiquid
securities, including restricted securities which are not readily marketable
(except for 144A Securities and 4(2) commercial paper deemed to be liquid by the
Advisor), the Fund will take such steps as is deemed advisable, if any, to
protect liquidity.
The Fund may sell over-the-counter ("OTC") options and, in connection
therewith, segregate assets or cover its obligations with respect to OTC
options written by the Fund. The assets used as cover for OTC options written
by the Fund will be considered illiquid unless the OTC options are sold to
qualified dealers who agree that the Fund may repurchase any OTC option it
writes at a maximum price to be calculated by a formula set forth in the option
agreement. The cover for an OTC option written subject to this procedure would
be considered illiquid only to the extent that the maximum repurchase price
under the formula exceeds the intrinsic value of the option.
LENDING OF PORTFOLIO SECURITIES
The Fund is authorized to lend up to 33 1/3% of the total value of its
portfolio securities to broker-dealers or institutional investors that the
Advisor deems qualified, but only when the borrower maintains with the Fund's
custodian bank collateral either in cash or money market instruments in an
amount at least equal to the market value of the securities loaned, plus
accrued interest and dividends, determined on a daily basis and adjusted
accordingly. Although the Fund is authorized to lend, the Fund does not
presently intend to engage in lending. In determining whether to lend
securities to a particular broker-dealer or institutional investor, the Advisor
will consider, and during the period of the loan will monitor, all relevant
facts and circumstances, including the creditworthiness of the borrower. The
Fund will retain authority to terminate any loans at any time. The Fund may
pay reasonable administrative and custodial fees in connection with a loan and
may pay a negotiated portion of the interest earned on the cash or money market
instruments held as collateral to the borrower or placing broker. The Fund
will receive reasonable interest on the loan or a flat fee from the borrower
and amounts equivalent to any dividends, interest or other distributions on the
securities loaned. The Fund will retain record ownership of loaned securities
to exercise beneficial rights, such as voting and subscription rights and
rights to dividends, interest or other distributions, when retaining such
rights is considered to be in the Fund's interest.
MORTGAGE- AND ASSET-BACKED SECURITIES
Mortgage-backed securities represent direct or indirect participations in,
or are secured by and payable from, mortgage loans secured by real property,
and include single- and multi-class pass-through securities and collateralized
mortgage obligations. Such securities may be issued or guaranteed by U.S.
government agencies or instrumentalities, such as the Government National
Mortgage Association and the Federal National Mortgage Association, or by
private issuers, generally originators and investors in mortgage loans,
including savings associations, mortgage bankers, commercial banks, investment
bankers, and special purpose entities (collectively, "private lenders").
Mortgage-backed securities issued by private lenders may be supported by pools
of mortgage loans or other mortgage-backed securities that are guaranteed,
directly or indirectly, by the U.S. government or one of its agencies or
instrumentalities, or they may be issued without any governmental guarantee of
the underlying mortgage assets but with some form of non-governmental credit
enhancement.
Asset-backed securities have structural characteristics similar to
mortgage-backed securities. Asset-backed debt obligations represent direct or
indirect participation in, or secured by and payable from, assets such as motor
vehicle installment sales contracts, other installment loan contracts, home
equity loans, leases of various types of property, and receivables from credit
card or other revolving credit arrangements. The credit quality of most
asset-backed securities depends primarily on the credit quality of the assets
underlying such securities, how well the entity issuing the security is
insulated from the credit risk of the originator or any other affiliated
entities, and the amount and quality of any credit enhancement of the
securities. Payments or distributions of principal and interest on
asset-backed debt obligations may be supported by non-governmental credit
enhancements including letters of credit, reserve funds, overcollateralization,
and guarantees by third parties. The market for
19
<PAGE> 194
privately issued asset-backed debt obligations is smaller and less liquid than
the market for government sponsored mortgage-backed securities.
The rate of principal payment on mortgage- and asset-backed securities
generally depends on the rate of principal payments received on the underlying
assets which in turn may be affected by a variety of economic and other
factors. As a result, the yield on any mortgage- and asset-backed security is
difficult to predict with precision and actual yield to maturity may be more or
less than the anticipated yield to maturity. The yield characteristics of
mortgage- and asset-backed securities differ from those of traditional debt
securities. Among the principal differences are that interest and principal
payments are made more frequently on mortgage-and asset-backed securities,
usually monthly, and that principal may be prepaid at any time because the
underlying mortgage loans or other assets generally may be prepaid at any time.
As a result, if the Fund purchases these securities at a premium, a prepayment
rate that is faster than expected will reduce yield to maturity, while a
prepayment rate that is slower than expected will have the opposite effect of
increasing the yield to maturity. Conversely, if the Fund purchases these
securities at a discount, a prepayment rate that is faster than expected will
increase yield to maturity, while a prepayment rate that is slower than
expected will reduce yield to maturity. Amounts available for reinvestment by
a Fund are likely to be greater during a period of declining interest rates
and, as a result, are likely to be reinvested at lower interest rates than
during a period of rising interest rates. Accelerated prepayments on
securities purchased by the Fund at a premium also impose a risk of loss of
principal because the premium may not have been fully amortized at the time the
principal is prepaid in full. The market for privately issued mortgage-and
asset-backed securities is smaller and less liquid than the market for
government sponsored mortgage-backed securities.
While many mortgage- and asset-backed securities are issued with only one
class of security, many are issued in more than one class, each with different
payment terms. Multiple class mortgage- and asset-backed securities are issued
for two main reasons. First, multiple classes may be used as a method of
providing credit support. This is accomplished typically through creation of
one or more classes whose right to payments on the security is made subordinate
to the right to such payments of the remaining class or classes. Second,
multiple classes may permit the issuance of securities with payment terms,
interest rates, or other characteristics differing both from those of each
other and from those of the underlying assets. Examples include so-called
"strips" (mortgage - and asset-backed securities entitling the holder to
disproportionate interests with respect to the allocation of interest and
principal of the assets backing the security), and securities with class or
classes having characteristics which mimic the characteristics of non-mortgage-
or asset-backed securities, such as floating interest rates (i.e., interest
rates which adjust as a specified benchmark changes) or scheduled amortization
of principal.
The Fund may invest in stripped mortgage- or asset-backed securities,
which receive differing proportions of the interest and principal payments from
the underlying assets. The market value of such securities generally is more
sensitive to changes in prepayment and interest rates than is the case with
traditional mortgage- and asset-backed securities, and in some cases such
market value may be extremely volatile. With respect to certain stripped
securities, such as interest only and principal only classes, a rate of
prepayment that is faster or slower than anticipated may result in the Fund
failing to recover all or a portion of its investment, even though the
securities are rated investment grade.
Mortgage- and asset-backed securities backed by assets, other than as
described above, or in which the payment streams on the underlying assets are
allocated in a manner different than those described above may be issued in the
future. The Fund may invest in such securities if such investment is otherwise
consistent with its investment objectives and policies and with the investment
restrictions of the Fund.
MORTGAGE DOLLAR ROLLS AND REVERSE REPURCHASE AGREEMENTS
The Fund may engage in reverse repurchase agreements to facilitate
portfolio liquidity, a practice common in the mutual fund industry, or for
arbitrage transactions discussed below. In a reverse repurchase agreement, the
Fund would sell a security and enter into an agreement to repurchase the
security at a specified future date and price. The Fund generally retains the
right to interest and principal payments on the security. Since the Fund
receives cash upon entering into a reverse repurchase agreement, it may be
considered a borrowing. (See "Borrowing".) When required by guidelines of the
SEC, the Fund will set aside permissible liquid assets in a segregated account
to secure its obligations to repurchase the security.
20
<PAGE> 195
The Fund may also enter into mortgage dollar rolls, in which the Fund
would sell mortgage-backed securities for delivery in the current month and
simultaneously contract to purchase substantially similar securities on a
specified future date. While the Fund would forego principal and interest paid
on the mortgage-backed securities during the roll period, the Fund would be
compensated by the difference between the current sales price and the lower
price for the future purchase as well as by any interest earned on the proceeds
of the initial sale. The Fund also could be compensated through the receipt of
fee income equivalent to a lower forward price. At the time the Fund would
enter into a mortgage dollar roll, it would set aside permissible liquid assets
in a segregated account to secure its obligation for the forward commitment to
buy mortgage-backed securities. Mortgage dollar roll transactions may be
considered a borrowing by the Fund. (See "Borrowing".)
The mortgage dollar rolls and reverse repurchase agreements entered into
by the Fund may be used as arbitrage transactions in which the Fund will
maintain an offsetting position in investment grade debt obligations or
repurchase agreements that mature on or before the settlement date on the
related mortgage dollar roll or reverse repurchase agreements. Since the Fund
will receive interest on the securities or repurchase agreements in which it
invests the transaction proceeds, such transactions may involve leverage.
However, since such securities or repurchase agreements will be high quality
and will mature on or before the settlement date of the mortgage dollar roll or
reverse repurchase agreement, the Advisor believes that such arbitrage
transactions do not present the risks to the Fund that are associated with
other types of leverage.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with certain banks or
non-bank dealers. In a repurchase agreement, the Fund buys a security at one
price, and at the time of sale, the seller agrees to repurchase the obligation
at a mutually agreed upon time and price (usually within seven days). The
repurchase agreement, thereby, determines the yield during the purchaser's
holding period, while the seller's obligation to repurchase is secured by the
value of the underlying security. The Advisor will monitor, on an ongoing
basis, the value of the underlying securities to ensure that the value always
equals or exceeds the repurchase price plus accrued interest. Repurchase
agreements could involve certain risks in the event of a default or insolvency
of the other party to the agreement, including possible delays or restrictions
upon the Fund's ability to dispose of the underlying securities. Although no
definitive creditworthiness criteria are used, the Advisor reviews the
creditworthiness of the banks and non-bank dealers with which the Fund enters
into repurchase agreements to evaluate those risks. The Fund may, under
certain circumstances, deem repurchase agreements collateralized by U.S.
government securities to be investments in U.S. government securities.
SHORT SALES AGAINST THE BOX
The Fund may sell securities short against the box to hedge unrealized
gains on portfolio securities. Selling securities short against the box
involves selling a security that the Fund owns or has the right to acquire, for
delivery at a specified date in the future. If the Fund sells securities short
against the box, it may protect unrealized gains, but will lose the opportunity
to profit on such securities if the price rises.
SMALL AND MEDIUM COMPANIES
The Fund may invest a substantial portion of its assets in small and
medium companies. While small and medium companies generally have the
potential for rapid growth, investments in small and medium companies often
involve greater risks than investments in larger, more established companies
because small and medium companies may lack the management experience,
financial resources, product diversification, and competitive strengths of
larger companies. In addition, in many instances the securities of smaller
and medium companies are traded only over-the-counter or on a regional
securities exchange, and the frequency and volume of their trading is
substantially less than is typical of larger companies. Therefore, the
securities of small and medium companies may be subject to greater and more
abrupt price fluctuations. When making large sales, the Fund may have to sell
portfolio holdings at discounts from quoted prices or may have to make a
series of small sales over an extended period of time due to the trading
volume of small and medium company securities. Investors should be aware
that, based on the foregoing factors, an investment in the Fund may be subject
to greater price fluctuations than an investment in a fund that invests
primarily in larger, more established companies. The
21
<PAGE> 196
Advisor's research efforts may also play a greater role in selecting securities
for the Fund than in a fund that invests in larger, more established companies.
TEMPORARY DEFENSIVE POSITION
When the Advisor determines that market conditions warrant a temporary
defensive position, the Fund may invest without limitation in cash (U.S.
dollars, foreign currencies, or multi-currency units) and short-term fixed
income securities, including U.S. government securities, commercial paper,
banker's acceptances, certificates of deposit, and time deposits.
WARRANTS
The Fund may acquire warrants. Warrants are securities giving the holder
the right, but not the obligation, to buy the stock of an issuer at a given
price (generally higher than the value of the stock at the time of issuance)
during a specified period or perpetually. Warrants may be acquired separately
or in connection with the acquisition of securities. Warrants do not carry
with them the right to dividends or voting rights with respect to the
securities that they entitle their holder to purchase, and they do not
represent any rights in the assets of the issuer. As a result, warrants may be
considered to have more speculative characteristics than certain other types of
investments. In addition, the value of a warrant does not necessarily change
with the value of the underlying securities, and a warrant ceases to have value
if it is not exercised prior to its expiration date.
WHEN-ISSUED SECURITIES
The Fund may purchase securities on a "when-issued" basis. The price of
debt obligations purchased on a when-issued basis, which may be expressed in
yield terms, generally is fixed at the time the commitment to purchase is made,
but delivery and payment for the securities take place at a later date.
Normally, the settlement date occurs within 45 days of the purchase although in
some cases settlement may take longer. During the period between the purchase
and settlement, no payment is made by the Fund to the issuer and no interest on
the debt obligations accrues to the Fund. Forward commitments 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 value of
the Fund's other assets. While when-issued securities may be sold prior to the
settlement date, the Fund intends to purchase such securities with the purpose
of actually acquiring them unless a sale appears desirable for investment
reasons. At the time the Fund makes the commitment to purchase a security on a
when-issued basis, it will record the transaction and reflect the value of the
security in determining its net asset value. The Fund does not believe that
its net asset value will be adversely affected by purchases of securities on a
when-issued basis.
To the extent required by the SEC, the Fund will maintain cash and
marketable securities equal in value to commitments for when-issued securities.
Such segregated securities either will mature or, if necessary, be sold on or
before the settlement date. When the time comes to pay for when-issued
securities, the Fund will meet its obligations from then-available cash flow,
sale of the securities held in the separate account, described above, sale of
other securities or, although it would not normally expect to do so, from the
sale of the when-issued securities themselves (which may have a market value
greater or less than the Fund's payment obligation).
ZERO-COUPON, STEP-COUPON AND PAY-IN-KIND SECURITIES
The Fund may invest in zero-coupon, step-coupon, and pay-in-kind
securities. These securities are debt securities that do not make regular cash
interest payments. Zero-coupon and step-coupon securities are sold at a deep
discount to their face value. Pay-in-kind securities pay interest through the
issuance of additional securities. Because such securities do not pay current
cash income, the price of these securities can be volatile when interest rates
fluctuate. While these securities do not pay current cash income, federal
income tax law requires the holders of zero-coupon, step-coupon, and
pay-in-kind securities to include in income each year the portion of the
original issue discount (or deemed discount) and other non-cash income on such
securities accruing that year. In order to continue to qualify as a "regulated
investment company" under the Internal Revenue Code and avoid a certain excise
tax, the Fund may be required to distribute a portion of such discount and
income and may be required to dispose of other portfolio securities, which may
occur in periods of adverse market prices, in order to generate cash to meet
these distribution requirements.
22
<PAGE> 197
DIRECTORS AND OFFICERS OF THE CORPORATION
Directors and officers of the Corporation, together with information as to
their principal business occupations during the last five years, and other
information are shown below. Each director who is deemed an "interested
person," as defined in the 1940 Act, is indicated by an asterisk (*). Each
officer and director holds the same position with the 25 registered open-end
management investment companies consisting of 38 mutual funds, which are
managed by the Advisor (the "Strong Funds"). The Strong Funds, in the
aggregate, pays each Director who is not a director, officer, or employee of
the Advisor, or any affiliated company (a "disinterested director") an annual
fee of $50,000, plus $100 per Board meeting for each Strong Fund. In addition,
each disinterested director is reimbursed by the Strong Funds for travel and
other expenses incurred in connection with attendance at such meetings. Other
officers and directors of the Strong Funds receive no compensation or expense
reimbursement from the Strong Funds.
*RICHARD S. STRONG (DOB 5/12/42), Chairman of the Board and Director of the
Corporation.
Prior to August 1985, Mr. Strong was Chief Executive Officer of the
Advisor, which he founded in 1974. Since August 1985, Mr. Strong has been a
Security Analyst and Portfolio Manager of the Advisor. In October 1991, Mr.
Strong also became the Chairman of the Advisor. Strong is a director of the
Advisor. Mr. Strong has been in the investment management business since 1967.
Mr. Strong has served the Corporation as a director since December 1990 and
Chairman of the Board since January 1992.
MARVIN E. NEVINS (DOB 7/9/18), Director of the Corporation.
Private Investor. From 1945 to 1980, Mr. Nevins was Chairman of Wisconsin
Centrifugal Inc.; a foundry. From July 1983 to December 1986, he was Chairman
of General Casting Corp., Waukesha, Wisconsin, a foundry. Mr. Nevins is a
former Chairman of the Wisconsin Association of Manufacturers & Commerce. He
was also a regent of the Milwaukee School of Engineering and a member of the
Board of Trustees of the Medical College of Wisconsin. Mr. Nevins has served
the Corporation as a director since December 1990.
WILLIE D. DAVIS (DOB 7/24/34), Director of the Corporation.
Mr. Davis has been director of Alliance Bank Since 1980, Sara Lee
Corporation (a food/consumer products company) since 1983, KMart Corporation (a
discount consumer products company) since 1985, YMCA Metropolitan - Los Angeles
since 1985, Dow Chemical Company since 1988, MGM Grand, Inc. (an
entertainment/hotel company) since 1990, WICOR, Inc. (a utility company) since
1990, Johnson Controls, Inc. (an industrial company) since 1992, L.A. Gear (a
footwear/sportswear company) since 1992, and Rally's Hamburger, Inc. since
1994. Mr. Davis has been a trustee of the University of Chicago since 1980,
Marquette University since 1988, and Occidental College since 1990. Since
1977, Mr. Davis has been President and Chief Executive Officer of All Pro
Broadcasting, Inc. Mr. Davis was a director of the Fireman's Fund (an
insurance company) from 1975 until 1990. Mr. Davis has served the Corporation
as a director since July 1994.
*JOHN DRAGISIC (DOB 11/26/40), President and Director of the Corporation.
Mr. Dragisic has been President of the Advisor since October 1995, and a
director of the Advisor since July 1994. Mr. Dragisic served as Vice Chairman
of the Advisor from July 1994 until October 1995. Mr. Dragisic was the
President and Chief Executive Officer of Grunau Company, Inc. (a mechanical
contracting and engineering firm), Milwaukee, Wisconsin from 1987 until July
1994. From 1981 to 1987, he was an Executive Vice President with Grunau
Company, Inc. From 1969 until 1973, Mr. Dragisic worked for the InterAmerican
Development Bank. Mr. Dragisic received his Ph.D. in Economics in 1971 from
the University of Wisconsin - Madison and his B.A. degree in Economics in 1962
from Lake Forest College. Mr. Dragisic has served the Corporation as Vice
Chairman from July 1994 through October 1995; as President since October 1995;
and as a director from July 1991 until July 1994, and since April 1995.
STANLEY KRITZIK (DOB 1/9/30), Director of the Corporation.
23
<PAGE> 198
Mr. Kritzik has been a Partner of Metropolitan Associates since 1962, a
Director of Aurora Health Care since 1987, and Health Network Ventures, Inc.
since 1992. Mr. Kritzik has served the Corporation as a director since April
1995.
WILLIAM F. VOGT (DOB 7/19/47), Director of the Corporation.
Mr. Vogt has been the President of Vogt Management Consulting, Inc. since
1990. From 1982 until 1990, he served as Executive Director of University
Physicians of the University of Colorado. Mr. Vogt is the Past President of
the Medical Group Management Association and a Fellow of the American College
of Medical Practice Executives. Mr. Vogt has served the Corporation as a
director since April 1995.
LAWRENCE A. TOTSKY (DOB 5/6/59), C.P.A., Vice President of the Corporation.
Mr. Totsky has been Senior Vice President of the Advisor since December
1994. Mr. Totsky acted as the Advisor's Manager of Shareholder Accounting and
Compliance from June 1987 to June 1991 when he was named Director of Mutual
Fund Administration. Mr. Totsky has served the Corporation as a Vice President
since May 1993.
THOMAS P. LEMKE (DOB 7/30/54), Vice President of the Corporation.
Mr. Lemke has been Senior Vice President, Secretary, and General Counsel
of the Advisor since September 1994. For two years prior to joining the
Advisor, Mr. Lemke acted as Resident Counsel for Funds Management at J.P.
Morgan & Co., Inc. From February 1989 until April 1992, Mr. Lemke acted as
Associate General Counsel to Sanford C. Bernstein Co., Inc. For two years
prior to that, Mr. Lemke was Of Counsel at the Washington, D.C. law firm of Tew
Jorden & Schulte, a successor of Finley, Kumble & Wagner. From August 1979
until December 1986, Mr. Lemke worked at the Securities and Exchange
Commission, most notably as the Chief Counsel to the Division of Investment
Management (November 1984 - December 1986), and as Special Counsel to the
Office of Insurance Products, Division of Investment Management (April 1982 -
October 1984). Mr. Lemke has served the Corporation as a Vice President since
October 1994.
STEPHEN J. SHENKENBERG (DOB 6/14/58), Vice President and Secretary of the
Corporation.
Mr. Shenkenberg has been Deputy General Counsel to the Advisor since
November 1996. From December 1992 until November 1996, Mr. Shenkenberg acted
as Associate Counsel to the Advisor. From June 1987 until December 1992, Mr.
Shenkenberg was an attorney for Godfrey & Kahn, S.C., a Milwaukee law firm.
Mr. Shenkenberg has served the Corporation as a Vice President since April 1996
and as Secretary since October 1996.
JOHN S. WEITZER (DOB 10/31/67), Vice President of the Corporation.
Mr. Weitzer has been an Associate Counsel to the Advisor since July 1993.
Mr. Weitzer has served the Corporation as a Vice President since January 1996.
Except for Messrs. Nevins, Davis, Kritzik and Vogt, the address of all of
the above persons is P.O. Box 2936, Milwaukee, Wisconsin 53201. Mr. Nevins'
address is 6075 Pelican Bay Boulevard, Naples, Florida 34108. Mr. Davis'
address is 161 North La Brea, Inglewood, California 90301. Mr. Kritzik's
address is 1123 North Astor Street, P.O. Box 92547, Milwaukee, Wisconsin
53202-0547. Mr. Vogt's address is 2830 East Third Avenue, Denver, Colorado
80206.
In addition to the positions listed above, the following individuals also
hold the following positions with Strong Holdings, Inc. ("Holdings"), a
Wisconsin corporation and subsidiary of the Advisor; Strong Funds Distributors,
Inc., the Fund's underwriter ("Distributors"), Heritage Reserve Development
Corporation ("Heritage"), and Strong Service Corporation ("SSC"), each of which
is a Wisconsin corporation and subsidiary of Holdings; Fussville Real Estate
Holdings L.L.C. ("Real Estate Holdings") and Sherwood Development L.L.C.
("Sherwood"), each of which is a Wisconsin Limited
24
<PAGE> 199
Liability Company and subsidiary of the Advisor and Heritage; and Fussville
Development L.L.C. ("Fussville Development"), a Wisconsin Limited Liability
Company and subsidiary of the Advisor and Real Estate Holdings:
25
<PAGE> 200
RICHARD S. STRONG:
CHAIRMAN AND A DIRECTOR - Holdings and Distributors (since October 1993);
Heritage (since January 1994); and SSC (since November 1995).
CHAIRMAN AND A MEMBER OF THE MANAGING BOARD - Real Estate Holdings and
Fussville Development (since December 1995 and February 1994,
respectively); and Sherwood (since October 1994).
JOHN DRAGISIC:
PRESIDENT AND A DIRECTOR - Holdings (since December 1995 and July 1994,
respectively); Distributors (since September 1996 and July 1994,
respectively); Heritage (since May 1994 and August 1994, respectively);
and SSC (since November 1995).
VICE CHAIRMAN AND A MEMBER OF THE MANAGING BOARD - Real Estate and
Fussville Development (since December 1995 and August 1994,
respectively); and Sherwood (since October 1994).
THOMAS P. LEMKE:
VICE PRESIDENT - Holdings, Heritage, Real Estate Holdings, and Fussville
Development (since December 1995); Distributors (since October 1996);
Sherwood (since October 1994); and SSC (since November 1995).
STEPHEN J. SHENKENBERG:
VICE PRESIDENT AND SECRETARY - Distributors (since December 1995).
SECRETARY - Holdings, Heritage, Fussville Development, Real Estate
Holdings, and Sherwood (since December 1995); and SSC (since November
1995).
As of March 31, 1997, the officers and directors of the Corporation did
not own any of the Fund's outstanding shares.
PRINCIPAL SHAREHOLDERS
Except for the organizational shares of the Fund, the Fund's shares are
held of record by an insurance company separate account. As of March 31, 1997,
the following persons owned of record or is known by the Fund to own of record
or beneficially more than 5% of the Fund's outstanding shares:
<TABLE>
Name and Address Shares Percent of Class
---------------- ------ ----------------
<S> <C> <C>
Nationwide Insurance 6,821,505 97.03%
P.O. Box 182029
Columbus, OH 43218
</TABLE>
A shareholder owning more than 25% of the Fund's shares may be considered
a "controlling person" of the Fund. Accordingly, its vote could have a more
significant effect on matters presented to shareholders for approval than the
vote of other Fund shareholders.
26
<PAGE> 201
INVESTMENT ADVISOR AND DISTRIBUTOR
The Advisor to the Fund is Strong Capital Management, Inc. Mr. Richard S.
Strong controls the Advisor. Mr. Strong is the Chairman and a director of the
Advisor, Mr. Dragisic is the President and a director of the Advisor, Mr.
Totsky is a Senior Vice President of the Advisor, Mr. Lemke is a Senior Vice
President, Secretary, and General Counsel of the Advisor, Mr. Shenkenberg is
Vice President, Assistant Secretary, and Deputy General Counsel of the Advisor,
and Mr. Weitzer is an Associate Counsel of the Advisor. A brief description of
the Fund's investment advisory agreement ("Advisory Agreement") is set forth in
the Prospectus under "Management."
The Fund's Advisory Agreement is dated July 10, 1995, and will remain in
effect as to the Fund for a period of two years. The Advisory Agreement was
approved by the Fund's initial shareholder on its first day of operations.
Thereafter, the Advisory Agreement is required to be approved annually by the
Board of Directors of the Corporation or by vote of a majority of the Fund's
outstanding voting securities (as defined in the 1940 Act). In either case,
each annual renewal must also be approved by the vote of a majority of the
Corporation's directors who are not parties to the Advisory Agreement or
interested persons of any such party, cast in person at a meeting called for
the purpose of voting on such approval. The Advisory Agreement is terminable,
without penalty, on 60 days' written notice by the Board of Directors of the
Corporation, by vote of a majority of the Fund's outstanding voting securities,
or by the Advisor. In addition, the Advisory Agreement will terminate
automatically in the event of its assignment.
Under the terms of the Advisory Agreement, the Advisor manages the Fund's
investments subject to the supervision of the Corporation's Board of Directors.
The Advisor is responsible for investment decisions and supplies investment
research and portfolio management. At its expense, the Advisor provides office
space and all necessary office facilities, equipment, and personnel for
servicing the investments of the Fund. The Advisor places all orders for the
purchase and sale of the Fund's securities at its expense.
Except for expenses assumed by the Advisor, as set forth above, or by the
Distributor, as described below with respect to the distribution of the Fund's
shares, the Fund is responsible for all its other expenses, including, without
limitation, interest charges, taxes, brokerage commissions, and similar
expenses; organizational expenses; expenses of issue, sale, repurchase, or
redemption of shares; expenses of registering or qualifying shares for sale
with the states and the SEC; expenses for printing and distributing
Prospectuses and quarterly financial statements to existing shareholders;
charges of custodians, transfer agent fees (including the printing and mailing
of reports and notices to shareholders), registrars, auditing and legal
services, clerical services related to recordkeeping and shareholder relations,
and printing of stock certificates; and fees for directors who are not
"interested persons" of the Advisor; and its allocable share of the
Corporation's expenses.
As compensation for its services, the Fund pays to the Advisor a monthly
management fee at the annual rate of 1.00% of the Fund's average daily net
asset value. (See "Additional Information - Calculation of Net Asset Value" in
the Prospectus.) From time to time, the Advisor may voluntarily waive all or a
portion of its management fee for the Fund. In 1995 and 1996, the Fund paid
the Advisor $2,075 and 476,498, respectively, in management fees.
The Advisory Agreement requires the Advisor to reimburse the Fund in the
event that the expenses and charges payable by the Fund in any fiscal year,
including the management fee but excluding taxes, interest, brokerage
commissions, and similar fees and to the extent permitted extraordinary
expenses, exceed two percent (2%) of the average net asset value of the Fund
for such year, as determined by valuations made as of the close of each
business day of the year. Reimbursement of expenses in excess of the
applicable limitation will be made on a monthly basis and will be paid to the
Fund by reduction of the Advisor's fee, subject to later adjustment month by
month for the remainder of the Fund's fiscal year. The Advisor may from time
to time absorb expenses for the Fund in addition to the reimbursement of
expenses in excess of applicable limitations.
On July 12, 1994, the Securities and Exchange Commission (the "SEC") filed
an administrative action (the "Order") against the Advisor, Mr. Strong, and
another employee of the Advisor in connection with conduct that occurred
between 1987 and early 1990. In re Strong/Corneliuson Capital Management,
Inc.; et al. Admin. Proc. File No. 3-8411. The proceeding was settled by
consent without admitting or denying the allegations in the Order. The Order
found that the Advisor and Mr. Strong aided and abetted violations of Section
17(a) of the 1940 Act by effecting trades between mutual funds, and between
mutual
27
<PAGE> 202
funds and Harbour Investments Ltd. ("Harbour"), without complying with the
exemptive provisions of SEC Rule 17a-7 or otherwise obtaining an exemption. It
further found that the Advisor violated, and Mr. Strong aided and abetted
violations of, the disclosure provisions of the 1940 Act and the Investment
Advisers Act of 1940 by misrepresenting the Advisor's policy on personal
trading and by failing to disclose trading by Harbour, an entity in which
principals of the Advisor owned between 18 and 25 percent of the voting stock.
As part of the settlement, the respondents agreed to a censure and a cease and
desist order and the Advisor agreed to various undertakings, including adoption
of certain procedures and a limitation for six months on accepting certain
types of new advisory clients.
On June 6, 1996, the Department of Labor (the "DOL") filed an action
against the Advisor for equitable relief alleging violations of the Employee
Retirement Income Security Act of 1974 ("ERISA") in connection with cross
trades that occurred between 1987 and late 1989 involving certain pension
accounts managed by the Advisor. Contemporaneous with this filing, the
Advisor, without admitting or denying the DOL's allegations, agreed to the
entry of a consent judgment resolving all matters relating to the allegations.
Reich v. Strong Capital Management, Inc., (U.S.D.C. E.D. WI) the Consent
Judgment"). Under the terms of the Consent Judgment, the Advisor agreed to
reimburse the affected accounts a total of $5.9 million. The settlement did
not have any material impact on the Advisor's financial position or operations.
The Fund and the Advisor have adopted a Code of Ethics (the "Code") which
governs the personal trading activities of all "Access Persons" of the Advisor.
Access Persons include every director and officer of the Advisor and the
investment companies managed by the Advisor, including the Fund, as well as
certain employees of the Advisor who have access to information relating to the
purchase or sale of securities by the Advisor on behalf of accounts managed by
it. The Code is based upon the principal that such Access Persons have a
fiduciary duty to place the interests of the Fund and the Advisor's other
clients ahead of their own.
The Code requires Access Persons (other than Access Persons who are
independent directors of the investment companies managed by the Advisor,
including the Fund) to, among other things, preclear their securities
transactions (with limited exceptions, such as transactions in shares of mutual
funds, direct obligations of the U.S. government, and certain options on
broad-based securities market indexes) and to execute such transactions through
the Advisor's trading department. The Code, which applies to all Access Persons
(other than Access Persons who are independent directors of the investment
companies managed by the Advisor, including the Fund), includes a ban on
acquiring any securities in an initial public offering, other than a new
offering of a registered open-end investment company, and a prohibition from
profiting on short-term trading in securities. In addition, no Access Person
may purchase or sell any security which is contemporaneously being purchased or
sold, or to the knowledge of the Access Person, is being considered for
purchase or sale, by the Advisor on behalf of any mutual fund or other account
managed by it. Finally, the Code provides for trading "black out" periods or
seven calendar days during which time Access Persons who are portfolio managers
may not trade in securities which have been purchased or sold by any mutual
fund or other account managed by the portfolio manager.
From time to time the Advisor votes the shares owned by the Fund according
to its Statement of General Proxy Voting Policy ("Proxy Voting Policy"). The
general principal of the Proxy Voting Policy is to vote any beneficial interest
in an equity security prudently and solely in the best long-term economic
interest of the Fund and its beneficiaries considering all relevant factors and
without undue influence from individuals or groups who may have an economic
interest in the outcome of a proxy vote. Shareholders may obtain a copy of the
Proxy Voting Policy upon request from the Advisor.
The Advisor provides investment advisory services for multiple clients and
may give advice and take action, with respect to any client, that may differ
from the advice given, or the timing or nature of action taken, with respect to
any one account. However, the Advisor will allocate over a period of time, to
the extent practical, investment opportunities to each account on a fair and
equitable basis relative to other similarly-situated client accounts. The
Advisor, its principals and associates (to the extent not prohibited by the
Code), and other clients of the Advisory may have, acquire, increase, decrease,
or dispose of securities or interests therein at or about the same time that
the Advisor is purchasing or selling securities or interests therein for an
account that are or may be deemed to be inconsistent with the actions taken by
such persons.
Under a Distribution Agreement dated July 10, 1995 with the Corporation
(the "Distribution Agreement"), Strong Funds Distributors, Inc. ("Distributor"),
a subsidiary of the Advisor, acts as underwriter of the Fund's shares. The
Distribution Agreement provides that the Distributor will use its best efforts
to distribute the Fund's shares. Shares are only offered and sold to the
separate accounts of certain insurance companies. Since the Fund is a "no-load"
fund, no sales commissions are charged
28
<PAGE> 203
on the purchase of Fund shares. Certain sales charges may apply to the
variable annuity or life insurance contract, which should be described in the
prospectus of the insurance company's separate account. The Distribution
Agreement further provides that the Distributor will bear the additional costs
of printing prospectuses and shareholder reports which are used for selling
purposes, as well as advertising and other costs attributable to the
distribution of the Fund's shares. The Distributor is an indirect subsidiary
of the Advisor and controlled by the Advisor and Richard S. Strong. The
Distribution Agreement is subject to the same termination and renewal
provisions as are described above with respect to the Advisory Agreement.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Advisor is responsible for decisions to buy and sell securities for
the Fund and for the placement of the Fund's investment business and the
negotiation of the commissions to be paid on such transactions. It is the
policy of the Advisor to seek the best execution at the best security price
available with respect to each transaction, in light of the overall quality of
brokerage and research services provided to the Advisor or the Fund. In
over-the-counter transactions, orders are placed directly with a principal
market maker unless it is believed that a better price and execution can be
obtained using a broker. The best price to the Fund means the best net price
without regard to the mix between purchase or sale price and commission, if
any. In selecting broker-dealers and in negotiating commissions, the Advisor
considers a variety of factors, including best price and execution, the full
range of brokerage services provided by the broker, as well as its capital
strength and stability, and the quality of the research and research services
provided by the broker. Brokerage will not be allocated based on the sale of
any shares of the Strong Funds.
The Advisor has adopted procedures that provide generally for the Advisor
to seek to bunch orders for the purchase or sale of the same security for the
Fund, other mutual funds managed by the Advisor, and other advisory clients
(collectively, the "client accounts"). The Advisor will bunch orders when it
deems it to be appropriate and in the best interest of the client accounts.
When a bunched order is filled in its entirety, each participating client
account will participate at the average share price for the bunched order on
the same business day, and transaction costs shall be shared pro rata based on
each client's participation in the bunched order. When a bunched order is only
partially filled, the securities purchased will be allocated on a pro rata
basis to each client account participating in the bunched order based upon the
initial amount requested for the account, subject to certain exceptions, and
each participating account will participate at the average share price for the
bunched order on the same business day.
Section 28(e) of the Securities Exchange Act of 1934 ("Section 28(e)")
permits an investment advisor, under certain circumstances, to cause an account
to pay a broker or dealer a commission for effecting a transaction in excess of
the amount of commission another broker or dealer would have charged for
effecting the transaction in recognition of the value of the brokerage and
research services provided by the broker or dealer. Brokerage and research
services include (a) furnishing advice as to the value of securities, the
advisability of investing in, purchasing or selling securities, and the
availability of securities or purchasers or sellers of securities; (b)
furnishing analyses and reports concerning issuers, industries, securities,
economic factors and trends, portfolio strategy, and the performance of
accounts; and (c) effecting securities transactions and performing functions
incidental thereto (such as clearance, settlement, and custody).
In carrying out the provisions of the Advisory Agreement, the Advisor may
cause the Fund to pay a broker, which provides brokerage and research services
to the Advisor, a commission for effecting a securities transaction in excess
of the amount another broker would have charged for effecting the transaction.
The Advisor believes it is important to its investment decision-making process
to have access to independent research. The Advisory Agreement provides that
such higher commissions will not be paid by the Fund unless (a) the Advisor
determines in good faith that the amount is reasonable in relation to the
services in terms of the particular transaction or in terms of the Advisor's
overall responsibilities with respect to the accounts as to which it exercises
investment discretion; (b) such payment is made in compliance with the
provisions of Section 28(e), other applicable state and federal laws, and the
Advisory Agreement; and (c) in the opinion of the Advisor, the total
commissions paid by the Fund will be reasonable in relation to the benefits to
the Fund over the long term. The investment management fee paid by the Fund
under the Advisory Agreement is not reduced as a result of the Advisor's
receipt of research services.
29
<PAGE> 204
Generally, research services provided by brokers may include information
on the economy, industries, groups of securities, individual companies,
statistical information, accounting and tax law interpretations, political
developments, legal developments affecting portfolio securities, technical
market action, pricing and appraisal services, credit analysis, risk
measurement analysis, performance analysis, and analysis of corporate
responsibility issues. Such research services are received primarily in the
form of written reports, telephone contacts, and personal meetings with
security analysts. In addition, such research services may be provided in the
form of access to various computer-generated data, computer hardware and
software, and meetings arranged with corporate and industry spokespersons,
economists, academicians, and government representatives. In some cases,
research services are generated by third parties but are provided to the
Advisor by or through brokers. Such brokers may pay for all or a portion of
computer hardware and software costs relating to the pricing of securities.
Where the Advisor itself receives both administrative benefits and
research and brokerage services from the services provided by brokers, it makes
a good faith allocation between the administrative benefits and the research
and brokerage services, and will pay for any administrative benefits with cash.
In making good faith allocations of costs between administrative benefits and
research and brokerage services, a conflict of interest may exist by reason of
the Advisor's allocation of the costs of such benefits and services between
those that primarily benefit the Advisor and those that primarily benefit the
Fund and other advisory clients.
From time to time, the Advisor may purchase new issues of securities for
the Fund in a fixed price offering. In these situations, the seller may be a
member of the selling group that will, in addition to selling the securities to
the Fund and other advisory clients, provide the Advisor with research. The
National Association of Securities Dealers has adopted rules expressly
permitting these types of arrangements under certain circumstances. Generally,
the seller will provide research "credits" in these situations at a rate that
is higher than that which is available for typical secondary market
transactions. These arrangements may not fall within the safe harbor of Section
28(e).
Each year, the Advisor considers the amount and nature of research and
research services provided by brokers, as well as the extent to which such
services are relied upon, and attempts to allocate a portion of the brokerage
business of the Fund and other advisory clients on the basis of that
consideration. In addition, brokers may suggest a level of business they would
like to receive in order to continue to provide such services. The actual
brokerage business received by a broker may be more or less than the suggested
allocations, depending upon the Advisor's evaluation of all applicable
considerations.
The Advisor has informal arrangements with various brokers whereby, in
consideration for providing research services and subject to Section 28(e), the
Advisor allocates brokerage to those firms, provided that their brokerage and
research services are satisfactory to the Advisor and their execution
capabilities were compatible with the Advisor's policy of seeking best
execution at the best security price available, as discussed above. In no case
will the Advisor make binding commitments as to the level of brokerage
commissions it will allocate to a broker, nor will it commit to pay cash if any
informal targets are not met. The Advisor anticipates it will continue to
enter into such brokerage arrangements.
The Advisor may direct the purchase of securities on behalf of the Fund
and other advisory clients in secondary market transactions, in public
offerings directly from an underwriter, or in privately negotiated transactions
with an issuer. When the Advisor believes the circumstances so warrant,
securities purchased in public offerings may be resold shortly after
acquisition in the immediate aftermarket for the security in order to take
advantage of price appreciation from the public offering price or for other
reasons. Short-term trading of securities acquired in public offerings, or
otherwise, may result in higher portfolio turnover and associated brokerage
expenses.
The Advisor is responsible for selecting brokers in connection with
foreign securities transactions. The fixed commissions paid in connection with
most foreign stock transactions are usually higher than negotiated commissions
on U.S. stock transactions. Foreign stock exchanges and brokers are subject to
less government supervision and regulation as compared with the U.S. exchanges
and brokers. In addition, foreign security settlements may in some instances
be subject to delays and related administrative uncertainties.
The Advisor places portfolio transactions for other advisory accounts,
including other mutual funds managed by the Advisor. Research services
furnished by firms through which the Fund effects its securities transactions
may be used by the Advisor in servicing all of its accounts; not all of such
services may be used by the Advisor in connection with the Fund. In the
30
<PAGE> 205
opinion of the Advisor, it is not possible to measure separately the benefits
from research services to each of the accounts (including the Fund) managed by
the Advisor. Because the volume and nature of the trading activities of the
accounts are not uniform, the amount of commissions in excess of those charged
by another broker paid by each account for brokerage and research services will
vary. However, in the opinion of the Advisor, such costs to the Fund will not
be disproportionate to the benefits received by the Fund on a continuing basis.
The Advisor seeks to allocate portfolio transactions equitably whenever
concurrent decisions are made to purchase or sell securities by the Fund and
another advisory account. In some cases, this procedure could have an adverse
effect on the price or the amount of securities available to the Fund. In
making such allocations between the Fund and other advisory accounts, the main
factors considered by the Advisor are the respective investment objectives, the
relative size of portfolio holdings of the same or comparable securities, the
availability of cash for investment, the size of investment commitments
generally held, and the opinions of the persons responsible for recommending
the investment.
Where consistent with a client's investment objectives, investment
restrictions, and risk tolerance, the Advisor may purchase securities sold in
underwritten public offerings for client accounts, commonly referred to as
"deal" securities. The Advisor has adopted deal allocation procedures (the
"procedures"), summarized below, that reflect the Advisor's overriding policy
that deal securities must be allocated among participating client accounts in a
fair and equitable manner and that deal securities may not be allocated in a
manner that unfairly discriminates in favor of certain clients or types of
clients.
The procedures provide that, in determining which client accounts a
portfolio manager team will seek to have purchase deal securities, the team
will consider all relevant factors including, but not limited to, the nature,
size, and expected allocation to the Advisor of deal securities; the size of
the account(s); the accounts' investment objectives and restrictions; the risk
tolerance of the client; the client's tolerance for possibly higher portfolio
turnover; the amount of commissions generated by the account during the past
year; and the number of other deals the client has participated in during the
past year.
Where more than one of the Advisor's portfolio manager team seeks to have
client accounts participate in a deal and the amount of deal securities
allocated to the Advisor by the underwriting syndicate is less than the
aggregate amount ordered by the Advisor (a "reduced allocation"), the deal
securities will be allocated among the portfolio manager teams based on all
relevant factors. The primary factor shall be assets under management,
although other factors that may be considered in the allocation decision
include, but are not limited to, the nature, size, and expected allocation of
the deal; the amount of brokerage commissions or other amounts generated by the
respective participating portfolio manager teams; and which portfolio manager
team is primarily responsible for the Advisor receiving securities in the deal.
Based on the relevant factors, the Advisor has established general allocation
percentages for its portfolio manager teams, and these percentages are reviewed
on a regular basis to determine whether asset growth or other factors make it
appropriate to use different general allocation percentages for reduced
allocations.
When a portfolio manager team receives a reduced allocation of deal
securities, the portfolio manager team will allocate the reduced allocation
among client accounts in accordance with the allocation percentages set forth
in the team's initial allocation instructions for the deal securities, except
where this would result in a de minimis allocation to any client account. On a
regular basis, the Advisor reviews the allocation of deal securities to ensure
that they have been allocated in a fair and equitable manner that does not
unfairly discriminate in favor of certain clients or types of clients.
During 1995 and 1996, the Fund paid $7,627 and 639,406 respectively, in
brokerage commissions.
CUSTODIAN
As custodian of the Fund's assets, Brown Brothers Harriman & Co., 40 Water
Street, Boston, Massachusetts 02109, has custody of all securities and cash of
the Fund, delivers and receives payment for securities sold, receives and pays
for securities purchased, collects income from investments, and performs other
duties, all as directed by officers of the Corporation. In addition, with the
approval of the Corporation's Board of Directors and subject to the rules of
the SEC, the Fund will have sub-custodians in those foreign countries in which
their respective assets may be invested. The custodian and, if applicable, the
sub-custodian are in no way responsible for any of the investment policies or
decisions of the Fund.
31
<PAGE> 206
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT
The Advisor acts as transfer agent and dividend-disbursing agent for the
Fund at no cost.
ADMINISTRATIVE SERVICES
From time to time the Fund and/or the Advisor may enter into arrangements
under which certain administrative services may be performed by the insurance
companies that purchase shares in the Fund. These administrative services may
include, among other things, responding to ministerial inquiries concerning the
Fund's investment objective, investment program, policies and performance,
transmitting, on behalf of the Fund, proxy statements, annual reports, updated
prospectuses, and other communications regarding the Fund, and providing only
related services as the Fund or its shareholders may reasonably request.
Depending on the arrangements, the Fund and/or Advisor may compensate such
insurance companies or their agents directly or indirectly for the
administrative services. To the extent the Fund compensates the insurance
company for these services, the Fund will pay the insurance company an annual
fee that will vary depending upon the number of contract holders that utilize
the Fund as the funding medium for their contracts. The insurance company may
impose other account or service charges. See the prospectus for the separate
account of the insurance company for additional information regarding such
charges.
TAXES
GENERAL
As indicated under "Additional Information - Distributions and Taxes" in
the Prospectus, the Fund intends to continue to qualify annually for treatment
as a regulated investment company ("RIC") under the Internal Revenue Code of
1986, as amended (the "Code"). This qualification does not involve government
supervision of the Fund's management practices or policies.
In order to qualify for treatment as a RIC under the Code, the Fund must
distribute to its shareholders for each taxable year at least 90% of its
investment company taxable income (consisting generally of net investment
income, net short-term capital gain, and net gains from certain foreign
currency transactions) ("Distribution Requirement") and must meet several
additional requirements. Among these requirements are the following: (1) the
Fund must derive at least 90% of its gross income each taxable year from
dividends, interest, payments with respect to securities loans, and gains from
the sale or other disposition of securities or foreign currencies, or other
income (including gains from options, futures, or forward contracts) derived
with respect to its business of investing in securities or those currencies
("Income Requirement"); (2) the Fund must derive less than 30% of its gross
income each taxable year from the sale or other disposition of securities, or
any of the following, that were held for less than three months - options or
futures (other than those on foreign currencies), or foreign currencies (or
options, futures, or forward contracts thereon) that are not directly related
to the Fund's principal business or investing in securities (or options and
futures with respect to securities) ("30% Limitation"); (3) at the close of
each quarter of the Fund's taxable year, at least 50% of the value of its total
assets must be represented by cash and cash items, U.S. government securities,
securities of other RICs, and other securities, with these other securities
limited, in respect of any one issuer, to an amount that does not exceed 5% of
the value of the Fund's total assets and that does not represent more than 10%
of the issuer's outstanding voting securities; and (4) at the close of each
quarter of the Fund's taxable year, not more than 25% of the value of its total
assets may be invested in securities (other than U.S. government securities or
the securities of other RICs) of any one issuer. From time to time the Advisor
may find it necessary to make certain types of investments for the purpose of
ensuring that the Fund continues to qualify for treatment as a RIC under the
Code.
If Fund shares are sold at a loss after being held for six months or less,
the loss will be treated as long-term, instead of short-term, capital loss to
the extent of any capital gain distributions received on those shares.
In addition, the Fund must satisfy the diversification requirements of
Section 817(h) of the Code. In general, for the Fund to meet these investment
diversification requirements, Treasury regulations require that no more than
55% of the total value of the assets of the Fund may be represented by any one
investment, no more than 70% by two investments, no more
32
<PAGE> 207
than 80% by three investments and no more than 90% by four investments.
Generally, for purposes of the regulations, all securities of the same issuer
are treated as a single investment. With respect to the United States
Government securities (including any security that is issued, guaranteed or
insured by the United States or an instrumentality of the United States), each
governmental agency or instrumentality is treated as a separate issuer.
Compliance with the regulations is tested on the last day of each calendar year
quarter. There is a 30-day period after the end of each calendar year quarter
in which to cure any non-compliance with these requirements.
FOREIGN TRANSACTIONS
Interest and dividends received by the Fund may be subject to income,
withholding, or other taxes imposed by foreign countries and U.S. possessions
that would reduce the yield on its securities. Tax conventions between certain
countries and the United States may reduce or eliminate these foreign taxes,
however, and many foreign countries do not impose taxes on capital gains in
respect of investments by foreign investors.
The Fund maintains its accounts and calculates its income in U.S. dollars.
In general, gain or loss (1) from the disposition of foreign currencies and
forward currency contracts, (2) from the disposition of
foreign-currency-denominated debt securities that are attributable to
fluctuations in exchange rates between the date the securities are acquired and
their disposition date, and (3) attributable to fluctuations in exchange rates
between the time the Fund accrues interest or other receivables or expenses or
other liabilities denominated in a foreign currency and the time the Fund
actually collects those receivables or pays those liabilities, will be treated
as ordinary income or loss. A foreign-currency-denominated debt security
acquired by the Fund may bear interest at a high normal rate that takes into
account expected decreases in the value of the principal amount of the security
due to anticipated currency devaluations; in that case, the Fund would be
required to include the interest in income as it accrues but generally would
realize a currency loss with respect to the principal only when the principal
was received (through disposition or upon maturity).
The Fund may invest in the stock of "passive foreign investment companies"
("PFICs"). A PFIC is a foreign corporation that, in general, meets either of
the following tests: (1) at least 75% of its gross income is passive or (2) an
average of at least 50% of its assets produce, or are held for the production
of, passive income. Under certain circumstances, the Fund will be subject to
federal income tax on a portion of any "excess distribution" received on the
stock or of any gain on disposition of the stock (collectively, "PFIC income"),
plus interest thereon, even if the Fund distributes the PFIC income to its
shareholders. The balance of the PFIC income will be included in the Fund's
investment company taxable income and, accordingly, will not be taxable to it
to the extent that income is distributed to its shareholders. If the Fund
invests in a PFIC and elects to treat the PFIC as a "qualified electing fund,"
then in lieu of the foregoing tax and interest obligation, the Fund will be
required to include in income each year its pro rata share of the qualified
electing fund's annual ordinary earnings and net capital gain (the excess of
net long-term capital gain over net short-term capital loss) -- which probably
would have to be distributed to its shareholders to satisfy the Distribution
Requirement -- even if those earnings and gain were not received by the Fund.
In most instances it will be very difficult, if not impossible, to make this
election because of certain requirements thereof.
DERIVATIVE INSTRUMENTS
The use of derivatives strategies, such as purchasing and selling
(writing) options and futures and entering into forward currency contracts,
involves complex rules that will determine for income tax purposes the
character and timing of recognition of the gains and losses the Fund realizes
in connection therewith. Gains from the disposition of foreign currencies
(except certain gains therefrom that may be excluded by future regulations),
and income from transactions in options, futures, and forward currency
contracts derived by the Fund with respect to its business of investing in
securities or foreign currencies, will qualify as permissible income under the
Income Requirement. However, income from the disposition of options and
futures (other than those on foreign currencies) will be subject to the 30%
Limitation if they are held for less than three months. Income from the
disposition of foreign currencies, and options, futures, and forward contracts
on foreign currencies, that are not directly related to the Fund's principal
business of investing in securities (or options and futures with respect to
securities) also will be subject to the 30% Limitation if they are held for
less than three months.
If the Fund satisfies certain requirements, any increase in value of a
position that is part of a "designated hedge" will be offset by any decrease in
value (whether realized or not) of the offsetting hedging position during the
period of the hedge for purposes of determining whether the Fund satisfies the
30% Limitation. Thus, only the net gain (if any) from the designated
33
<PAGE> 208
hedge will be included in gross income for purposes of that limitation. The
Fund intends that, when it engages in hedging strategies, the hedging
transactions will qualify for this treatment, but at the present time it is not
clear whether this treatment will be available for all of the Fund's hedging
transactions. To the extent this treatment is not available or is not elected
by the Fund, it may be forced to defer the closing out of certain options,
futures, or forward currency contracts beyond the time when it otherwise would
be advantageous to do so, in order for the Fund to continue to qualify as a
RIC.
For federal income tax purposes, the Fund is required to recognize as
income for each taxable year its net unrealized gains and losses on options,
futures, and forward currency contracts that are subject to section 1256 of the
Code ("Section 1256 Contracts") and are held by the Fund as of the end of the
year, as well as gains and losses on Section 1256 Contracts actually realized
during the year. Except for Section 1256 Contracts that are part of a "mixed
straddle" and with respect to which the Fund makes a certain election, any gain
or loss recognized with respect to Section 1256 Contracts is considered to be
60% long-term capital gain or loss and 40% short-term capital gain or loss,
without regard to the holding period of the Section 1256 Contract. Unrealized
gains on Section 1256 Contracts that have been held by the Fund for less than
three months as of the end of its taxable year, and that are recognized for
federal income tax purposes as described above, will not be considered gains on
investments held for less than three months for purposes of the 30% Limitation.
ZERO-COUPON, STEP-COUPON, AND PAY-IN-KIND SECURITIES
The Fund may acquire zero-coupon, step-coupon, or other securities issued
with original issue discount. As a holder of those securities, the Fund must
include in its income the original issue discount that accrues on the
securities during the taxable year, even if the Fund receives no corresponding
payment on the securities during the year. Similarly, the Fund must include in
its income securities it receives as "interest" on pay-in-kind securities.
Because the Fund annually must distribute substantially all of its investment
company taxable income, including any original issue discount and other
non-cash income, to satisfy the Distribution Requirement, it may be required in
a particular year to distribute as a dividend an amount that is greater than
the total amount of cash it actually receives. Those distributions may be made
from the proceeds on sales of portfolio securities, if necessary. The Fund may
realize capital gains or losses from those sales, which would increase or
decrease its investment company taxable income or net capital gain, or both.
In addition, any such gains may be realized on the disposition of securities
held for less than three months. Because of the 30% Limitation, any such gains
would reduce the Fund's ability to sell other securities, or certain options,
futures, or forward currency contracts, held for less that three months that
it might wish to sell in the ordinary course of its portfolio management.
The foregoing federal tax discussion as well as the tax discussion
contained within the Prospectus under "Additional Information - Distributions
and Taxes" is intended to provide you with an overview of the impact of federal
income tax provisions on the Fund or its shareholders. These tax provisions
are subject to change by legislative or administrative action at the federal,
state, or local level, and any changes may be applied retroactively. Any such
action that limits or restricts the Fund's current ability to pass-through
earnings without taxation at the Fund level, or otherwise materially changes
the Fund's tax treatment, could adversely affect the value of a shareholder's
investment in the Fund. Because the Fund's taxes are a complex matter, you
should consult your tax adviser for more detailed information concerning the
taxation of the Fund and the federal, state, and local tax consequences to
shareholders of an investment in the Fund.
DETERMINATION OF NET ASSET VALUE
A more complete discussion of the Fund's determination of net asset value
is contained in the Prospectus. Generally, the net asset value of the Fund
will be determined as of the close of trading on each day the New York Stock
Exchange (the "NYSE") is open for trading. The NYSE is open for trading Monday
through Friday except New Year's Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
Additionally, if any of the aforementioned holidays falls on a Saturday, the
NYSE will not be open for trading on the preceding Friday, and when any such
holiday falls on a Sunday, the NYSE will not be open for trading on the
succeeding Monday, unless unusual business conditions exist, such as the ending
of a monthly or the yearly accounting period.
Debt securities are valued by a pricing service that utilizes electronic
data processing techniques to determine values for normal institutional-sized
trading units of debt securities without regard to sale or bid prices when
such values are believed to more accurately reflect the fair market value for
such securities. Otherwise, sale or bid prices are used. Any securities or
34
<PAGE> 209
other assets for which market quotations are not readily available are valued
at fair value as determined in good faith by the Board of Directors of each
Corporation. Debt securities having remaining maturities of 60 days are valued
by the amortized cost method when the Corporation's Board of Directors
determines that the fair value of such securities is their amortized cost.
Under this method of valuation, a security is initially valued at its
acquisition cost, and thereafter, amortization of any discount or premium is
assumed each day, regardless of the impact of the fluctuating rates on the
market value of the instrument.
ADDITIONAL SHAREHOLDER INFORMATION
The Fund has elected to be governed by Rule 18f-1 under the 1940 Act,
which obligates it to redeem shares in cash, with respect to any one
shareholder during any 90-day period, up to the lesser of $250,000 or 1% of the
assets of the Fund. If the Advisor determines that existing conditions make
cash payments undesirable, redemption payments may be made in whole or in part
in securities or other financial assets, valued for this purpose as they are
valued in computing the NAV for the Fund's shares (a "redemption-in-kind").
Shareholders receiving securities or other financial assets in a
redemption-in-kind may realize a gain or loss for tax purposes, and will incur
any costs of sale, as well as the associated inconveniences. If you expect to
make a redemption in excess of the lesser of $250,000 or 1% of the Fund's
assets during any 90-day period and would like to avoid any possibility of
being paid with securities in-kind, you may do so by providing Strong Funds
with an unconditional instruction to redeem at least 15 calendar days prior to
the date on which the redemption transaction is to occur, specifying the dollar
amount or number of shares to be redeemed and the date of the transaction
(please call 1-800-368-3863). This will provide the Fund with sufficient time
to raise the cash in an orderly manner to pay the redemption and thereby
minimize the effect of the redemption on the interests of the Fund's remaining
shareholders. Redemption checks in excess of the lesser of $250,000 or 1% of
the Fund's assets during any 90-day period may not be honored by the Fund if
the Advisor determines that existing conditions make cash payments undesirable.
FUND ORGANIZATION
The Fund is a series of common stock of Strong Variable Insurance Funds,
Inc., a Wisconsin corporation (the "Corporation"). The Corporation (formerly
known as Strong Discovery Fund II, Inc., formerly known as Strong D Fund, Inc.)
was organized on December 28, 1990 and is authorized to issue an indefinite
number of shares of common stock and series and classes of series of shares of
common stock, with a par value of $.00001 per share. The Corporation is
authorized to issue an indefinite number of shares of common stock of the Fund.
Each share of the Corporation has one vote, and all shares of a series
participate equally in dividends and other capital gains distributions and in
the residual assets of that Fund in the event of liquidation. Fractional shares
have the same rights proportionately as do full shares. Shares of the
Corporation have no preemptive, conversion, or subscription rights. The
Corporation currently has seven series of common stock outstanding. The assets
belonging to each series of shares is held separately by the custodian, and in
effect each series is a separate fund. All holders of shares of the
Corporation would vote on each matter presented to shareholders for action
except with respect to any matter which affects only one or more series or
classes, in which case only the shares of the affected series or class shall be
entitled to vote. Because of current federal securities law requirements the
Corporation expects that its shareholders will offer to owners of variable
annuity and variable life insurance contracts the opportunity to instruct them
as to how shares allocable to their contracts will be voted with respect to
certain matters, such as approval of changes to the investment advisory
agreement.
PERFORMANCE INFORMATION
As described under "Additional Information - Performance Information" in
the Prospectus, the Fund's historical performance or return may be shown in the
form of "average annual total return," "total return," and "cumulative total
return." From time to time, the Advisor may voluntarily waive all or a portion
of its management fee and/or absorb certain expenses for the Fund. Total
returns contained in advertisements include the effect of deducting the Fund's
expenses, but may not include charges and expenses attributable to any
particular insurance product. Since shares may only be purchased by the
separate accounts of certain insurance companies, contracts owners should
carefully review the prospectus of the separate account for
35
<PAGE> 210
information on fees and expenses. Excluding such fees and expenses from the
Fund's total return quotations has the effect of increasing the performance
quoted.
AVERAGE ANNUAL TOTAL RETURN
The Fund's average annual total return quotation is computed in accordance
with a standardized method prescribed by rules of the SEC. The average annual
total return for the Fund for a specific period is found by first taking a
hypothetical $10,000 investment ("initial investment") in the Fund's shares on
the first day of the period and computing the "redeemable value" of that
investment at the end of the period. The redeemable value is then divided by
the initial investment, and this quotient is taken to the Nth root (N
representing the number of years in the period) and one is subtracted from the
result, which is then expressed as a percentage. The calculation assumes that
all income and capital gains dividends paid by the Fund have been reinvested at
net asset value on the reinvestment dates during the period.
TOTAL RETURN
Calculation of the Fund's total return is not subject to a standardized
formula. Total return performance for a specific period is calculated by first
taking an investment (assumed below to be $10,000) ("initial investment") in
the Fund's shares on the first day of the period and computing the "ending
value" of that investment at the end of the period. The total return
percentage is then determined by subtracting the initial investment from the
ending value and dividing the remainder by the initial investment and
expressing the result as a percentage. The calculation assumes that all income
and capital gains dividends paid by the Fund have been reinvested at net asset
value on the reinvestment dates during the period. Total return may also be
shown as the increased dollar value of the hypothetical investment over the
period.
CUMULATIVE TOTAL RETURN
Calculation of the Fund's cumulative total return is not subject to a
standardized formula and represents the simple change in value of an investment
over a stated period and may be quoted as a percentage or as a dollar amount.
Total returns and cumulative total returns may be broken down into their
components of income and capital (including capital gains and changes in share
price) in order to illustrate the relationship between these factors and their
contributions to total return.
The Fund's performance figures are based upon historical results and do
not represent future performance. The Fund's shares are sold at net asset
value per share. The Fund's returns and net asset value will fluctuate and
shares are redeemable at the then current net asset value of the Fund, which
may be more or less than original cost. Factors affecting the Fund's
performance include general market conditions, operating expenses, and
investment management. Any additional fees charged by an insurance company or
other financial services firm would reduce the returns described in this
section.
The table below shows performance information for various periods ended
December 31, 1996. Securities prices fluctuated during these periods.
INTERNATIONAL STOCK FUND II
<TABLE>
<CAPTION>
Average
Total Return Annual Total Return
------------------- -------------------
Initial $10,000 Ending Value Percentage Increase Percentage
Investment December 31, 1996 Increase
---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Life of Fund* $10,000 $11,327 13.27% 10.97%
One Year $10,000 $11,038 10.38% 10.38%
</TABLE>
* Commenced operations on October 20, 1995.
The Fund's total return for the three months ending March 31, 1997, was
2.65%.
36
<PAGE> 211
COMPARISONS
(1) U.S. TREASURY BILLS, NOTES, OR BONDS
Investors may also wish to compare the performance of the Fund to that of
United States Treasury bills, notes, or bonds, which are issued by the U.S.
government, because such instruments represent alternative income producing
products. Treasury obligations are issued in selected denominations. Rates of
Treasury obligations are fixed at the time of issuance and payment of principal
and interest is backed by the full faith and credit of the United States
Treasury. The market value of such instruments will generally fluctuate
inversely with interest rates prior to maturity and will equal par value at
maturity.
(2) CERTIFICATES OF DEPOSIT
Investors may wish to compare the Fund's performance to that of
certificates of deposit offered by banks and other depositary institutions.
Certificates of deposit represent an alternative income producing product.
Certificates of deposit may offer fixed or variable interest rates and
principal is guaranteed and may be insured. Withdrawal of the deposits prior to
maturity normally will be subject to a penalty. Rates offered by banks and
other depositary institutions are subject to change at any time specified by
the issuing institution.
(3) MONEY MARKET FUNDS
Investors may also want to compare performance of the Fund to that of
money market funds. Money market fund yields will fluctuate and an investment
in money market fund shares is neither insured nor guaranteed by the U.S.
government, but share values usually remain stable.
(4) LIPPER ANALYTICAL SERVICES, INC. ("LIPPER") AND OTHER INDEPENDENT RANKING
ORGANIZATIONS
From time to time, in marketing and other fund literature, the Fund's
performance may be compared to the performance of other mutual funds in general
or to the performance of particular types of mutual funds, with similar
investment goals, as tracked by independent organizations. Among these
organizations, Lipper, a widely used independent research firm which ranks
mutual funds by overall performance, investment objectives, and assets, may be
cited. Lipper performance figures are based on changes in net asset value,
with all income and capital gain dividends reinvested. Such calculations do
not include the effect of any sales charges imposed by other funds. The Fund
will be compared to Lipper's appropriate fund category, that is, by fund
objective and portfolio holdings.
(5) MORNINGSTAR, INC.
The Fund's performance may also be compared to the performance of other
mutual funds by Morningstar, Inc. which rates funds on the basis of historical
risk and total return. Morningstar's ratings range from five stars (highest)
to one star (lowest) and represent Morningstar's assessment of the historical
risk level and total return of the Fund as a weighted average for 3, 5, and 10
year periods. Ratings are not absolute and do not represent future results.
(6) VARDS REPORT
The Fund's performance may also be compared to the performance of other
variable annuity products in general or to the performance of particular types
of variable annuity products, with similar investment goals, as tracked by the
VARDS Report (Variable Annuity Research and Data Service Report) produced by
Financial Planning Resources, Inc. The VARDS Report is a monthly performance
analysis of the variable annuity industry.
(7) INDEPENDENT SOURCES
Evaluations of Fund performance made by independent sources may also be
used in advertisements concerning the Fund, including reprints of, or
selections from, editorials or articles about the Fund, especially those with
similar objectives. Sources for Fund performance information and articles
about the Fund may include publications such as Money, Forbes, Kiplinger's,
Smart Money, Morningstar, Inc., Financial World, Business Week, U.S. News and
World Report, The Wall Street Journal, Barron's, and a variety of investment
newsletters.
37
<PAGE> 212
(8) INDICES
The Fund may compare its performance to a wide variety of indices
including the following:
(a) Consumer Price Index
(b) Dow Jones Average of 30 Industrials
(c) NASDAQ Over-the-Counter Composite Index
(d) Standard & Poor's 500 Stock Index
(e) Standard & Poor's 400 Mid-Cap Stock Index
(f) Standard & Poor's 600 Small-Cap Index
(g) Wilshire 4500 Index
(h) Wilshire 5000 Index
(i) Wilshire Small Cap Index
(j) Wilshire Small Cap Growth Index
(k) Wilshire Small Cap Value Index
(l) Wilshire Midcap 750 Index
(m) Wilshire Midcap Growth Index
(n) Wilshire Midcap Value Index
(o) Wilshire Large Cap Growth Index
(p) Russell 1000 Index
(q) Russell 1000 Growth Index
(r) Russell 2000 Index
(s) Russell 2000 Small Stock Index
(t) Russell 2000 Growth Index
(u) Russell 2000 Value Index
(v) Russell 2500 Index
(w) Russell 3000 Stock Index
(x) Russell MidCap Index
(y) Russell MidCap Growth Index
(z) Russell MidCap Value Index
(aa) Value Line Index
(bb) Morgan Stanley Capital International EAFE(R) Index (Net
Dividend, Gross Dividend, and Price-Only). In addition, the Fund may
compare its performance to certain other indices that measure stock
market performance in geographic areas in which the Fund may invest.
The market prices and yields of the stocks in these indexes will
fluctuate. The Fund may also compare its portfolio weighting to the
EAFE Index weighting, which represents the relative capitalization
of the major overseas markets on a dollar-adjusted basis
(cc) Morgan Stanley Capital International World Index
There are differences and similarities between the investments that the
Fund may purchase for its portfolio and the investments measured by these
indices.
(9) HISTORICAL INFORMATION
Because the Fund's investments primarily are denominated in foreign
currencies, the strength or weakness of the U.S. dollar as against these
currencies may account for part of the Fund's investment performance.
Historical information regarding the value of the dollar versus foreign
currencies may be used from time to time in advertisements concerning the Fund.
Such historical information is not indicative of future fluctuations in the
value of the U.S. dollar against these currencies. Marketing materials may
cite country and economic statistics and historical stock market performance
for any of the countries in which the Fund invests, including, but not limited
to, the following: population growth, gross domestic product, inflation rate,
average stock market price earnings ratios and the total value of stock
markets. Sources for such statistics may include official publications of
various foreign governments, exchanges, or investment research firms. In
addition, marketing materials may cite the portfolio manager's views or
interpretations of such statistical data or historical performance.
38
<PAGE> 213
(10) HISTORICAL ASSET CLASS RETURNS
From time to time, marketing materials may portray the historical returns
of various asset classes. Such presentations will typically compare the
average annual rates of return of inflation, U.S. Treasury bills, bonds, common
stocks, and small stocks. There are important differences between each of these
investments that should be considered in viewing any such comparison. The
market value of stocks will fluctuate with market conditions, and small-stock
prices generally will fluctuate more than large-stock prices. Stocks are
generally more volatile than bonds. In return for this volatility, stocks have
generally performed better than bonds or cash over time. Bond prices generally
will fluctuate inversely with interest rates and other market conditions, and
the prices of bonds with longer maturities generally will fluctuate more than
those of shorter-maturity bonds. Interest rates for bonds may be fixed at the
time of issuance, and payment of principal and interest may be guaranteed by
the issuer and, in the case of U.S. Treasury obligations, backed by the full
faith and credit of the U.S. Treasury.
(11) STRONG VARIABLE INSURANCE FUNDS
The Strong Variable Insurance Funds offer a range of investment options.
All of the members of the Strong Variable Insurance Funds and their investment
objectives are listed below. The Funds are listed in ascending order of risk
and return, as determined by the Funds' Advisor.
FUND NAME INVESTMENT OBJECTIVE
<TABLE>
<CAPTION>
FUND NAME INVESTMENT OBJECTIVE
<S> <C>
- ------------------------------------------------------------------------------------------------------------
Strong Advantage Fund II Current income with a very low degree of share-price fluctuation.
- ------------------------------------------------------------------------------------------------------------
Strong Government Securities Fund II Total return by investing for a high level of current income with a
moderate degree of share-price fluctuation.
- ------------------------------------------------------------------------------------------------------------
Strong Asset Allocation Fund II High total return consistent with reasonable risk over the long term.
- ------------------------------------------------------------------------------------------------------------
Strong Special Fund II Capital growth.
- ------------------------------------------------------------------------------------------------------------
Strong Growth Fund II Capital growth.
- ------------------------------------------------------------------------------------------------------------
Strong Discovery Fund II Capital growth.
- ------------------------------------------------------------------------------------------------------------
Strong International Stock Fund II Capital growth.
- ------------------------------------------------------------------------------------------------------------
</TABLE>
Each Fund may from time to time be compared to the other Funds in the
Strong Variable Insurance Funds based on a risk/reward spectrum. In general,
the amount of risk associated with any investment product is commensurate with
that product's potential level of reward. The Strong Variable Insurance Funds'
risk/reward continuum or any Fund's position on the continuum may be described
or diagrammed in marketing materials. The Strong Variable Insurance Funds'
risk/reward continuum positions the risk and reward potential of each Fund
relative to the other Strong Variable Insurance Funds, but is not intended to
position any Fund relative to other mutual funds or investment products.
Marketing materials may also discuss the relationship between risk and reward
as it relates to an individual investor's portfolio. Financial goals vary from
person to person. You may choose one or more of the Strong Variable Insurance
Funds to help you reach your financial goals.
The Advisor also serves as advisor to the Strong Family of Funds, which is
a retail fund complex composed of 26 open-end management investment companies.
ADDITIONAL FUND INFORMATION
(1) PORTFOLIO CHARACTERISTICS
In order to present a more complete picture of the Fund's portfolio,
marketing materials may include various actual or estimated portfolio
characteristics, including but not limited to median market capitalizations,
earnings per share, alphas, betas, price/earnings ratios, returns on equity,
dividend yields, capitalization ranges, growth rates, price/book ratios, top
holdings, sector breakdowns, asset allocations, quality breakdowns, and
breakdowns by geographic region.
(2) MEASURES OF VOLATILITY AND RELATIVE PERFORMANCE
Occasionally statistics may be used to specify Fund volatility or risk.
The general premise is that greater volatility connotes greater risk undertaken
in achieving performance. Measures of volatility or risk are generally used to
compare the Fund's net asset value or performance relative to a market index.
One measure of volatility is beta. Beta is the volatility of a fund relative
to the total market as represented by the Standard & Poor's 500 Stock Index. A
beta of more than 1.00 indicates
39
<PAGE> 214
volatility greater than the market, and a beta of less than 1.00 indicates
volatility less than the market. Another measure of volatility or risk is
standard deviation. Standard deviation is a statistical tool that measures the
degree to which a fund's performance has varied from its average performance
during a particular time period.
Standard deviation is calculated using the following formula:
2
Standard deviation = the square root of E(x - x )
i m
------------
n-1
where E = "the sum of",
x = each individual return during the time period,
i
x = the average return over the time period, and
m
n = the number of individual returns during the time period.
Statistics may also be used to discuss the Fund's relative performance.
One such measure is alpha. Alpha measures the actual return of a fund compared
to the expected return of a fund given its risk (as measured by beta). The
expected return is based on how the market as a whole performed, and how the
particular fund has historically performed against the market. Specifically,
alpha is the actual return less the expected return. The expected return is
computed by multiplying the advance or decline in a market representation by
the fund's beta. A positive alpha quantifies the value that the fund manager
has added, and a negative alpha quantifies the value that the fund manager has
lost.
Other measures of volatility and relative performance may be used as
appropriate. However, all such measures will fluctuate and do not represent
future results.
GENERAL INFORMATION
BUSINESS PHILOSOPHY
The Advisor is an independent, Midwestern-based investment advisor, owned
by professionals active in its management. Recognizing that investors are the
focus of its business, the Advisor strives for excellence both in investment
management and in the service provided to investors. This commitment affects
many aspects of the business, including professional staffing, product
development, investment management, and service delivery.
The increasing complexity of the capital markets requires specialized
skills and processes for each asset class and style. Therefore, the Advisor
believes that active management should produce greater returns than a passively
managed index. The Advisor has brought together a group of top-flight
investment professionals with diverse product expertise, and each concentrates
on their investment specialty. The Advisor believes that people are the firm's
most important asset. For this reason, continuity of professionals is critical
to the firm's long-term success.
INVESTMENT ENVIRONMENT
Discussions of economic, social, and political conditions and their impact
on the Fund may be used in advertisements and sales materials. Such factors
that may impact the Fund include, but are not limited to, changes in interest
rates, political developments, the competitive environment, consumer behavior,
industry trends, technological advances, macroeconomic trends, and the supply
and demand of various financial instruments. In addition, marketing materials
may cite the portfolio management's views or interpretations of such factors.
EIGHT BASIC PRINCIPLES FOR SUCCESSFUL MUTUAL FUND INVESTING
These common sense rules are followed by many successful investors. They
make sense for beginners, too. If you have a question on these principles, or
would like to discuss them with us, please contact us at 1-800-368-3863.
1. Have a plan - even a simple plan can help you take control of your
financial future. Review your plan once a year, or if your circumstances
change.
40
<PAGE> 215
2. Start investing as soon as possible. Make time a valuable ally. Let it
put the power of compounding to work for you, while helping to reduce your
potential investment risk.
3. Diversify your portfolio. By investing in different asset classes -
stocks, bonds, and cash - you help protect against poor performance in one
type of investment while including investments most likely to help you
achieve your important goals.
4. Invest regularly. Investing is a process, not a one-time event. By
investing regularly over the long term, you reduce the impact of
short-term market gyrations, and you attend to your long-term plan before
you're tempted to spend those assets on short-term needs.
5. Maintain a long-term perspective. For most individuals, the best
discipline is staying invested as market conditions change. Reactive,
emotional investment decisions are all too often a source of regret - and
principal loss.
6. Consider stocks to help achieve major long-term goals. Over time, stocks
have provided the more powerful returns needed to help the value of your
investments stay well ahead of inflation.
7. Keep a comfortable amount of cash in your portfolio. To meet current
needs, including emergencies, use a money market fund or a bank account -
not your long-term investment assets.
8. Know what you're buying. Make sure you understand the potential risks and
rewards associated with each of your investments. Ask questions... request
information...make up your own mind. And choose a fund company that helps
you make informed investment decisions.
PORTFOLIO MANAGEMENT
The portfolio manager works with a team of analysts, traders, and
administrative personnel. From time to time, marketing materials may discuss
various members of the team, including their education, investment experience,
and other credentials.
The Advisor's investment philosophy is that (i) active management with
focused security and country selection can generate superior returns over
passive benchmarks; (ii) local knowledge and local contacts are essential for
effective international investing; (iii) application of U.S. and non-U.S.
financial analysis techniques can be used to value certain international
securities; (iv) attractive investment opportunities exist in all areas -
established and developing markets, large and small companies; (v) seeking out
under-researched and undervalued companies is as valid in international
investing as in domestic investing; and (vi) risk can be reduced by
underweighting the least attractive markets, not overweighting volatile
markets, and making bold allocations to attractive markets and securities.
The Advisor's investment process includes (i) global market analysis to
determine which countries/currencies to emphasize and avoid; (ii) combining
U.S. and non-U.S. fundamental research techniques where possible; (iii)
utilizing local knowledge and local contacts to closely monitor companies and
unearth new candidates for investment opportunities; (iv) focusing on stock
selection in moderately attractive markets; (v) focusing on sector/industry
weightings in the most attractive markets; (vi) emphasizing growth companies in
smaller and emerging markets; (vii) emphasizing value plays and turnaround
situations in more mature equity markets; and (viii) utilizing hedging of
foreign currency risk on an opportunistic basis.
The Advisor considers selling a stock when there is a high price/cash flow
or price/earnings multiple relative to the country and/or industry,
deterioration in country policies towards investors, or deterioration in
company fundamentals and management.
41
<PAGE> 216
INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P., 411 East Wisconsin Avenue, Milwaukee, Wisconsin
53202, have been selected as the independent accountants for the Fund,
providing audit services and assistance and consultation with respect to the
preparation of filings with the SEC.
LEGAL COUNSEL
Godfrey & Kahn, S.C., 780 North Water Street, Milwaukee, Wisconsin 53202,
acts as outside legal counsel for the Fund.
FINANCIAL STATEMENTS
The Annual Report for the year ended December 31, 1996 that is attached
hereto contains the following financial information for the Fund:
(a) Schedule of Investments in Securities.
(b) Statement of Operations.
(c) Statement of Assets and Liabilities.
(d) Statement of Changes in Net Assets.
(e) Notes to Financial Statements.
(f) Financial Highlights.
(g) Report of Independent Accountants.
42
<PAGE> 217
APPENDIX
BOND RATINGS
STANDARD & POOR'S DEBT RATINGS
A Standard & Poor's corporate or municipal debt rating is a current
assessment of the creditworthiness of an obligor with respect to a specific
obligation. This assessment may take into consideration obligors such as
guarantors, insurers, or lessees.
The debt rating is not a recommendation to purchase, sell, or hold a
security, inasmuch as it does not comment as to market price or suitability for
a particular investor.
The ratings are based on current information furnished by the issuer or
obtained by S&P from other sources it considers reliable. S&P does not perform
an audit in connection with any rating and may, on occasion, rely on unaudited
financial information. The ratings may be changed, suspended, or withdrawn as
a result of changes in, or unavailability of, such information, or based on
other circumstances.
The ratings are based, in varying degrees, on the following
considerations:
1. Likelihood of default capacity and willingness of
the obligor as to the timely payment of interest and repayment
of principal in accordance with the terms of the obligation.
2. Nature of and provisions of the obligation.
3. Protection afforded by, and relative position of,
the obligation in the event of bankruptcy, reorganization, or
other arrangement under the laws of bankruptcy and other laws
affecting creditors' rights.
INVESTMENT GRADE
AAA Debt rated 'AAA' has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA Debt rated 'AA' has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree.
A Debt rated 'A' has a strong capacity to pay interest and repay
principal, although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher-rated
categories.
BBB Debt rated 'BBB' is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
SPECULATIVE GRADE
Debt rated 'BB', 'B', 'CCC', 'CC' and 'C' is regarded as having
predominantly speculative characteristics with respect to capacity to pay
interest and repay principal. 'BB' indicates the least degree of speculation
and 'C' the highest. While such debt will likely have some quality and
protective characteristics, these are outweighed by large uncertainties or
major exposures to adverse conditions.
BB Debt rated 'BB' has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The 'BB'
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied 'BBB-' rating.
B Debt rated 'B' has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial, or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The 'B' rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied 'BB' or 'BB-' rating.
A-1
<PAGE> 218
CCC Debt rated 'CCC' has a currently identifiable vulnerability to
default, and is dependent upon favorable business, financial, and economic
conditions to meet timely payment of interest and repayment of principal. In
the event of adverse business, financial, or economic conditions, it is not
likely to have the capacity to pay interest and repay principal. The 'CCC'
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied 'B' or 'B-' rating.
CC Debt rated 'CC' typically is applied to debt subordinated to senior
debt that is assigned an actual or implied 'CCC' rating.
C Debt rated 'C' typically is applied to debt subordinated to senior debt
which is assigned an actual or implied 'CCC-' rating. The 'C' rating may be
used to cover a situation where a bankruptcy petition has been filed, but debt
service payments are continued.
CI The rating 'CI' is reserved for income bonds on which no interest is
being paid.
D Debt rated 'D' is in payment default. The 'D' rating category is used
when interest payments or principal payments are not made on the date due, even
if the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grade period. The 'D' rating also will be
used upon the filing of a bankruptcy petition if debt service payments are
jeopardized.
MOODY'S LONG-TERM DEBT RATINGS
Aaa - Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edged". Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa - Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risk appear somewhat larger than in Aaa
securities.
A - Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper-medium grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may be
present which suggest a susceptibility to impairment some time in the future.
Baa - Bonds which are rated Baa are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest
payments and principal security appear adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable over
any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba - Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate, and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
maintenance of other terms of the contract over any long period of time may be
small.
Caa - Bonds which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to principal
or interest.
Ca - Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other marked
shortcomings.
C - Bonds which are rated C are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
A-2
<PAGE> 219
FITCH INVESTORS SERVICE, INC. BOND RATINGS
Fitch investment grade bond and preferred stock ratings provide a guide to
investors in determining the credit risk associated with a particular security.
The ratings represent Fitch's assessment of the issuer's ability to meet the
obligations of a specific debt or preferred issue in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the
issuer's future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided
by insurance policies or financial guaranties unless otherwise indicated.
Bonds and preferred stock carrying the same rating are of similar but not
necessarily identical credit quality since the rating categories do not fully
reflect small differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for other reasons.
AAA Bonds and preferred stock considered to be investment grade
and of the highest credit quality. The obligor has an exceptionally
strong ability to pay interest and/or dividends and repay principal,
which is unlikely to be affected by reasonably foreseeable events.
AA Bonds and preferred stock considered to be investment grade
and of very high credit quality. The obligor's ability to pay
interest and/or dividends and repay principal is very strong,
although not quite as strong as bonds rated 'AAA'. Because bonds
and preferred stock rated in the 'AAA' and 'AA' categories are not
significantly vulnerable to foreseeable future developments,
short-term debt of the issuers is generally rated 'F-1+'.
A Bonds and preferred stock considered to be investment grade
and of high credit quality. The obligor's ability to pay interest
and/or dividends and repay principal is considered to be strong,
but may be more vulnerable to adverse changes in economic
conditions and circumstances than debt or preferred securities with
higher ratings.
BBB Bonds and preferred stock considered to be investment grade
and of satisfactory credit quality. The obligor's ability to pay
interest or dividends and repay principal is considered to be
adequate. Adverse changes in economic conditions and circumstances,
however, are more likely to have adverse impact on these securities
and, therefore, impair timely payment. The likelihood that the
ratings of these bonds or preferred will fall below investment grade
is higher than for securities with higher ratings.
Fitch speculative grade bond or preferred stock ratings provide a guide to
investors in determining the credit risk associated with a particular security.
The ratings ('BB' to 'C') represent Fitch's assessment of the likelihood of
timely payment of principal and interest or dividends in accordance with the
terms of obligation for issues not in default. For defaulted bonds or
preferred stock, the rating ('DDD' to 'D') is an assessment of the ultimate
recovery value through reorganization or liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer or possible recovery value in
bankruptcy, the current and prospective financial condition and operating
performance of the issuer and any guarantor, as well as the economic and
political environment that might affect the issuer's future financial strength.
Bonds or preferred stock that have the same rating are of similar but not
necessarily identical credit quality since the rating categories cannot fully
reflect the differences in the degrees of credit risk.
A-3
<PAGE> 220
BB Bonds or preferred stock are considered speculative. The
obligor's ability to pay interest or dividends and repay principal
may be affected over time by adverse economic changes. However,
business and financial alternatives can be identified, which could
assist the obligor in satisfying its debt service requirements.
B Bonds or preferred stock are considered highly speculative.
While bonds in this class are currently meeting debt service
requirements or paying dividends, the probability of continued
timely payment of principal and interest reflects the obligor's
limited margin of safety and the need for reasonable business and
economic activity throughout the life of the issue.
CCC Bonds or preferred stock have certain identifiable
characteristics that, if not remedied, may lead to default. The
ability to meet obligations requires an advantageous business and
economic environment.
CC Bonds or preferred stock are minimally protected. Default
in payment of interest and/or principal seems probable over time.
C Bonds are in imminent default in payment of interest or
principal or suspension of preferred stock dividends is imminent.
DDD, DD,
and D Bonds are in default on interest and/or principal payments
or preferred stock dividends are suspended. Such securities are
extremely speculative and should be valued on the basis of their
ultimate recovery value in liquidation or reorganization of the
obligor. 'DDD' represents the highest potential for recovery of
these securities, and 'D' represents the lowest potential for
recovery.
DUFF & PHELPS, INC. LONG-TERM DEBT RATINGS
These ratings represent a summary opinion of the issuer's long-term
fundamental quality. Rating determination is based on qualitative and
quantitative factors which may vary according to the basic economic and
financial characteristics of each industry and each issuer. Important
considerations are vulnerability to economic cycles as well as risks related to
such factors as competition, government action, regulation, technological
obsolescence, demand shifts, cost structure, and management depth and
expertise. The projected viability of the obligor at the trough of the cycle
is a critical determination.
Each rating also takes into account the legal form of the security, (e.g.,
first mortgage bonds, subordinated debt, preferred stock, etc.). The extent of
rating dispersion among the various classes of securities is determined by
several factors including relative weightings of the different security classes
in the capital structure, the overall credit strength of the issuer, and the
nature of covenant protection. Review of indenture restrictions is important
to the analysis of a company's operating and financial constraints. From time
to time, Duff & Phelps Credit Rating Co. places issuers or security classes on
Rating Watch. The Rating Watch Status results from a need to notify investors
and the issuer that there are conditions present leading us to re-evaluate the
current rating(s). A listing on Rating Watch, however, does not mean a rating
change is inevitable. The Rating Watch Status can either be resolved quickly
or over a longer period of time, depending on the reasons surrounding the
placement on Rating Watch. The "up" designation means a rating may be
upgraded; the "down" designation means a rating may be downgraded, and the
uncertain designation means a rating may be raised or lowered.
The Credit Rating Committee formally reviews all ratings once per quarter
(more frequently, if necessary). Ratings of 'BBB-' and higher fall within the
definition of investment grade securities, as defined by bank and insurance
supervisory authorities. Structured finance issues, including real estate,
asset-backed and mortgage-backed financings, use this same rating scale with
minor modification in the definitions. Thus, an investor can compare the
credit quality of investment alternatives across industries and structural
types. A "Cash Flow Rating" (as noted for specific ratings) addresses the
likelihood that aggregate principal and interest will equal or exceed the rated
amount under appropriate stress conditions.
<TABLE>
<CAPTION>
RATING SCALE DEFINITION
- ---------------------------------------------------------------------------------------------------
<S> <C>
AAA Highest credit quality. The risk factors are negligible, being only slightly more
than for risk-free U.S. Treasury debt.
- ---------------------------------------------------------------------------------------------------
AA+ High credit quality. Protection factors are strong. Risk is modest, but may
AA vary slightly from time to time because of economic conditions.
AA-
</TABLE>
A-4
<PAGE> 221
<TABLE>
<S> <C>
- --------------------------------------------------------------------------------------------
A+ Protection factors are average but adequate. However, risk factors are more
A variable and greater in periods of economic stress.
A-
- --------------------------------------------------------------------------------------------
BBB+ Below-average protection factors but still considered sufficient for prudent
BBB investment. Considerable variability in risk during economic cycles.
BBB-
- --------------------------------------------------------------------------------------------
BB+ Below investment grade but deemed likely to meet obligations when due.
BB Present or prospective financial protection factors fluctuate according to
BB- industry conditions or company fortunes. Overall quality may move up or
down frequently within this category.
- --------------------------------------------------------------------------------------------
B+ Below investment grade and possessing risk that obligations will not be met
B when due. Financial protection factors will fluctuate widely according to
B- economic cycles, industry conditions and/or company fortunes. Potential
exists for frequent changes in the rating within this category or into a higher
or lower rating grade.
- --------------------------------------------------------------------------------------------
CCC Well below investment grade securities. Considerable uncertainty exists as to
timely payment of principal, interest or preferred dividends.
Protection factors are narrow and risk can be substantial with unfavorable
economic/industry conditions, and/or with unfavorable company developments.
- --------------------------------------------------------------------------------------------
DD Defaulted debt obligations. Issuer failed to meet scheduled principal and/or
interest payments.
DP Preferred stock with dividend arrearages.
- --------------------------------------------------------------------------------------------
</TABLE>
IBCA LONG-TERM DEBT RATINGS
AAA - Obligations for which there is the lowest expectation of investment
risk. Capacity for timely repayment of principal and interest is substantial,
such that adverse changes in business, economic or financial conditions are
unlikely to increase investment risk substantially.
AA - Obligations for which there is a very low expectation of investment
risk. Capacity for timely repayment of principal and interest is substantial.
Adverse changes in business, economic or financial conditions may increase
investment risk, albeit not very significantly.
A - Obligations for which there is a low expectation of investment risk.
Capacity for timely repayment of principal and interest is strong, although
adverse changes in business, economic or financial conditions may lead to
increased investment risk.
BBB - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial
conditions are more likely to lead to increased investment risk than for
obligations in other categories.
BB - Obligations for which there is a possibility of investment risk
developing. Capacity for timely repayment of principal and interest exists,
but is susceptible over time to adverse changes in business, economic or
financial conditions.
B - Obligations for which investment risk exists. Timely repayment of
principal and interest is not sufficiently protected against adverse changes in
business, economic or financial conditions.
A-5
<PAGE> 222
CCC - Obligations for which there is a current perceived possibility of
default. Timely repayment of principal and interest is dependent on favorable
business, economic or financial conditions.
CC - Obligations which are highly speculative or which have a high risk of
default.
C - Obligations which are currently in default.
NOTES: "+" or "-" may be appended to a rating below AAA to denote relative
status within major rating categories. Ratings of BB and below are assigned
where it is considered that speculative characteristics are present.
THOMSON BANKWATCH LONG-TERM DEBT RATINGS
Long-Term Debt Ratings assigned by Thomson BankWatch also weigh heavily
government ownership and support. The quality of both the company's management
and franchise are of even greater importance in the Long-Term Debt Rating
decisions. Long-Term Debt Ratings look out over a cycle and are not adjusted
frequently for what we believe are short-term performance aberrations.
Long-Term Debt Ratings can be restricted to local currency debt - ratings
will be identified by the designation LC. In addition, Long-Term Debt Ratings
may include a plus (+) or minus (-) to indicate where within the category the
issue is placed. BankWatch Long-Term Debt Ratings are based on the following
scale:
Investment Grade
AAA (LC-AAA) - Indicates that the ability to repay principal and interest
on a timely basis is extremely high.
AA (LC-AA) - Indicates a very strong ability to repay principal and
interest on a timely basis, with limited incremental risk compared to issues
rated in the highest category.
A (LC-A) - Indicates the ability to repay principal and interest is
strong. Issues rated A could be more vulnerable to adverse developments (both
internal and external) than obligations with higher ratings.
BBB (LC-BBB) - The lowest investment-grade category; indicates an
acceptable capacity to repay principal and interest. BBB issues are more
vulnerable to adverse developments (both internal and external) than
obligations with higher ratings.
Non-Investment Grade - may be speculative in the likelihood of timely repayment
of principal and interest
BB (LC-BB) - While not investment grade, the BB rating suggests that the
likelihood of default is considerably less than for lower-rated issues.
However, there are significant uncertainties that could affect the ability to
adequately service debt obligations.
B (LC-B) - Issues rated B show higher degree of uncertainty and therefore
greater likelihood of default than higher-rated issues. Adverse developments
could negatively affect the payment of interest and principal on a timely
basis.
CCC (LC-CCC) - Issues rated CCC clearly have a high likelihood of default,
with little capacity to address further adverse changes in financial
circumstances.
CC (LC-CC) - CC is applied to issues that are subordinate to other
obligations rated CCC and are afforded less protection in the event of
bankruptcy or reorganization.
D (LC-D) - Default.
SHORT-TERM RATINGS
STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt considered short-term in the relevant
market.
A-6
<PAGE> 223
Ratings are graded into several categories, ranging from 'A-1' for the
highest quality obligations to 'D' for the lowest. These categories are as
follows:
A-1 This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus sign (+) designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated 'A-1'.
A-3 Issues carrying this designation have adequate capacity for timely
payment. They are, however, more vulnerable to the adverse effects of changes
in circumstances than obligations carrying the higher designations.
B Issues rated 'B' are regarded as having only speculative capacity for
timely payment.
C This rating is assigned to short-term debt obligations with doubtful
capacity for payment.
D Debt rated 'D' is in payment default. The 'D' rating category is used
when interest payments or principal payments are not made on the date due, even
if the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grace period.
STANDARD & POOR'S NOTE RATINGS
An S&P note rating reflects the liquidity factors and market-access risks
unique to notes. Notes maturing in three years or less will likely receive a
note rating. Notes maturing beyond three years will most likely receive a
long-term debt rating.
The following criteria will be used in making the assessment:
- Amortization schedule - the larger the final maturity
relative to other maturities, the more likely the issue is to be
treated as a note.
- Source of payment - the more the issue depends on the market
for its refinancing, the more likely it is to be treated as a note.
Note rating symbols and definitions are as follows:
SP-1 Strong capacity to pay principal and interest. Issues determined to
possess very strong characteristics are given a plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term of the
notes.
SP-3 Speculative capacity to pay principal and interest.
MOODY'S SHORT-TERM RATINGS
Moody's short-term debt ratings are opinions of the ability of issuers to
repay punctually senior debt obligations. These obligations have an original
maturity not exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment ability of rated issuers:
Issuers rated Prime-1 (or supporting institutions) have a superior ability
for repayment of senior short-term debt obligations. Prime-1 repayment ability
will often be evidenced by many of the following characteristics: (i) leading
market positions in well-established industries, (ii) high rates of return on
funds employed, (iii) conservative capitalization structure with moderate
reliance on debt and ample asset protection, (iv) broad margins in earnings
coverage of fixed financial charges and high internal cash generation, and (v)
well established access to a range of financial markets and assured sources of
alternate liquidity.
A-7
<PAGE> 224
Issuers rated Prime-2 (or supporting institutions) have a strong ability
for repayment of senior short-term debt obligations. This will normally be
evidenced by many of the characteristics cited above, but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be
more affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The effect of industry
characteristics and market compositions may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt
protection measurements and may require relatively high financial leverage.
Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
FITCH INVESTORS SERVICE, INC. SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes.
The short-term rating places greater emphasis than a long-term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
F-1+ Exceptionally Strong Credit Quality. Issues assigned this
rating are regarded as having the strongest degree of assurance for
timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating
reflect an assurance of timely payment only slightly less in degree
than issues rated 'F-1+'.
F-2 Good Credit Quality. Issues assigned this rating have a
satisfactory degree of assurance for timely payment but the margin
of safety is not as great as for issues assigned 'F-1+' and 'F-1'
ratings.
F-3 Fair Credit Quality. Issues assigned this rating have
characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause
these securities to be rated below investment grade.
F-S Weak Credit Quality. Issues assigned this rating have
characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial
and economic conditions.
D Default. Issues assigned this rating are in actual or
imminent payment default.
LOC The symbol LOC indicates that the rating is based on a letter
of credit issued by a commercial bank.
DUFF & PHELPS, INC. SHORT-TERM DEBT RATINGS
Duff & Phelps' short-term ratings are consistent with the rating criteria
used by money market participants. The ratings apply to all obligations with
maturities of under one year, including commercial paper, the uninsured portion
of certificates of deposit, unsecured bank loans, master notes, bankers
acceptances, irrevocable letters of credit, and current maturities of long-term
debt. Asset-backed commercial paper is also rated according to this scale.
Emphasis is placed on liquidity which is defined as not only cash from
operations, but also access to alternative sources of funds including trade
credit, bank lines, and the capital markets. An important consideration is the
level of an obligor's reliance on short-term funds on an ongoing basis.
The distinguishing feature of Duff & Phelps' short-term ratings is the
refinement of the traditional '1' category. The majority of short-term debt
issuers carry the highest rating, yet quality differences exist within that
tier. As a consequence, Duff & Phelps has incorporated gradations of '1+' (one
plus) and '1-' (one minus) to assist investors in recognizing those
differences.
A-8
<PAGE> 225
From time to time, Duff & Phelps places issuers or security classes on
Rating Watch. The Rating Watch status results from a need to notify investors
and the issuer that there are conditions present leading us to re-evaluate the
current rating(s). A listing on Rating Watch, however, does not mean a rating
change is inevitable.
The Rating Watch status can either be resolved quickly or over a longer
period of time, depending on the reasons surrounding the placement on Rating
Watch. The "up" designation means a rating may be upgraded; the "down"
designation means a rating may be downgraded, and the "uncertain" designation
means a rating may be raised or lowered.
<TABLE>
<CAPTION>
Rating Scale: Definition
------------- ----------
<S> <C>
High Grade
D-1+ Highest certainty of timely payment. Short-Term liquidity,
including internal operating factors and/or access to alternative
sources of funds, is outstanding, and safety is just below risk-free
U.S. Treasury short-term obligations.
D-1 Very high certainty of timely payment. Liquidity factors are
excellent and supported by good fundamental protection factors.
Risk factors are minor.
D-1- High certainty of timely payment. Liquidity factors are
strong and supported by good fundamental protection factors. Risk
factors are very small.
Good Grade
D-2 Good certainty of timely payment. Liquidity factors and
company fundamentals are sound. Although ongoing funding needs may
enlarge total financing requirements, access to capital markets is
good. Risk factors are small.
Satisfactory Grade
D-3 Satisfactory liquidity and other protection factors qualify
issues as to investment grade. Risk factors are larger and subject
to more variation. Nevertheless, timely payment is expected.
Non-Investment Grade
D-4 Speculative investment characteristics. Liquidity is not
sufficient to insure against disruption in debt service. Operating
factors and market access may be subject to a high degree of
variation.
Default
D-5 Issuer failed to meet scheduled principal and/or interest payments.
</TABLE>
THOMSON BANKWATCH (TBW) SHORT-TERM RATINGS
The TBW Short-Term Ratings apply, unless otherwise noted, to specific debt
instruments of the rated entities with a maturity of one year or less. TBW
Short-Term Ratings are intended to assess the likelihood of an untimely or
incomplete payments of principal or interest.
TBW-1 The highest category; indicates a very high likelihood that
principal and interest will be paid on a timely basis.
TBW-2 The second highest category; while the degree of safety regarding
timely repayment of principal and interest is strong, the relative degree of
safety is not as high as for issues rated "TBW-1".
TBW-3 The lowest investment-grade category; indicates that while the
obligation is more susceptible to adverse developments (both internal and
external) than those with higher ratings, the capacity to service principal and
interest in a timely fashion is considered adequate.
A-9
<PAGE> 226
TBW-4 The lowest rating category; this rating is regarded as
non-investment grade and therefore speculative.
IBCA SHORT-TERM RATINGS
IBCA Short-Term Ratings assess the borrowing characteristics of banks and
corporations, and the capacity for timely repayment of debt obligations. The
Short-Term Ratings relate to debt which has a maturity of less than one year.
A1 Obligations supported by the highest capacity for timely repayment.
Where issues possess a particularly strong credit feature, a rating of
A1+ is assigned.
A2 Obligations supported by a good capacity for timely repayment.
A3 Obligations supported by a satisfactory capacity for timely repayment.
B Obligations for which there is an uncertainty as to the capacity to
ensure timely repayment.
C Obligations for which there is a high risk of default or which are
currently in default.
A-10
<PAGE> 227
STRONG ADVANTAGE FUND II
Strong Advantage Fund II (the "Fund") is a diversified series of the Strong
Variable Insurance Funds, Inc. (the "Corporation"), an open-end management
investment company, commonly called a mutual fund. The Fund seeks current income
with a very low degree of share-price fluctuation. The Fund invests primarily in
ultra short-term, investment-grade debt obligations, and its average effective
portfolio maturity will normally be one year or less.
Shares of the Fund are only offered and sold to the separate accounts of
certain insurance companies for the purpose of funding variable annuity and
variable life insurance contracts. This Prospectus should be read together with
the prospectus of the separate account of the specific insurance product which
preceded or accompanies this Prospectus.
This Prospectus contains information that you should consider before you
invest. Please read it carefully and keep it for future reference. A Statement
of Additional Information for the Fund, dated May 1, 1997, which contains
further information, is incorporated by reference into this Prospectus, and has
been filed with the Securities and Exchange Commission ("SEC"). This Statement,
which may be revised from time to time, is available upon request and without
charge by writing to the Fund at P.O. Box 2936, Milwaukee, Wisconsin 53201 or by
calling 1-800-368-1683.
============================================================================
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
- ----------------------------------------------------------------------------
May 1, 1997
-------------------
PROSPECTUS PAGE 1
<PAGE> 228
TABLE OF CONTENTS
<TABLE>
<S> <C>
THE FUND........................................ 2
FINANCIAL HIGHLIGHTS............................ 3
INVESTMENT OBJECTIVE AND POLICIES............... 4
FUNDAMENTALS OF FIXED INCOME INVESTING.......... 5
IMPLEMENTATION OF POLICIES AND RISKS............ 8
SPECIAL CONSIDERATIONS.......................... 17
MANAGEMENT...................................... 18
ADDITIONAL INFORMATION.......................... 19
APPENDIX........................................ A-1
</TABLE>
No person has been authorized to give any information or to make any
representations other than those contained in this Prospectus and the Statement
of Additional Information and, if given or made, such information or
representations may not be relied upon as having been authorized by the Fund.
This Prospectus does not constitute an offer to sell securities to any person in
any state or jurisdiction in which such offering may not lawfully be made.
THE FUND
The Fund is a diversified series of the Corporation, which is an open-end
management investment company. The Fund offers and sells its shares only to
separate accounts of insurance companies for the purpose of funding variable
annuity and variable life insurance contracts. The Fund does not impose any
sales or redemption charges. Strong Capital Management, Inc. (the "Advisor") is
the investment advisor for the Fund.
-------------------
PROSPECTUS PAGE 2
<PAGE> 229
FINANCIAL HIGHLIGHTS
The following annual Financial Highlights for the Fund have been audited by
Coopers & Lybrand L.L.P., independent certified public accountants. Their report
for the fiscal year ended December 31, 1996 is included in the Fund's Annual
Report that is contained in the Fund's Statement of Additional Information. The
Financial Highlights should be read in conjunction with the Financial Statements
and related notes included in the Fund's Annual Report. Additional information
about the performance of the Fund is contained in the Fund's Annual Report,
which may be obtained without charge by calling or writing Strong Funds. Please
note that the total return shown in the Financial Highlights does not reflect
expenses that apply to the separate account or the related insurance policies.
Inclusion of these charges would reduce the total return for the periods shown.
The following presents information relating to a share of common stock
outstanding for the entire period ended as indicated.
<TABLE>
<CAPTION>
12-31-96 12-31-95(1)
-------- -----------
<S> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $10.03 $10.00
INCOME FROM INVESTMENT OPERATIONS:
Net Investment Income 0.44 0.05
Net Realized and Unrealized Gains
on Investments 0.04 0.03
------ ------
Total from Investment Operations 0.48 0.08
LESS DISTRIBUTIONS:
From Net Investment Income (0.44) (0.05)
From Net Realized Gains (0.04) --
------ ------
Total Distributions (0.48) (0.05)
------ ------
NET ASSET VALUE, END OF PERIOD $10.03 $10.03
====== ======
TOTAL RETURN +4.9% +0.8%
RATIOS AND SUPPLEMENTAL DATA
Net Assets, End of Period (In Thousands) $ 588 $ 501
Ratio of Expenses to Average Net Assets 2.0% 1.0%*
Ratio of Net Investment Income to
Average Net Assets 4.3% 5.2%*
Portfolio Turnover Rate 72.2% 0.0%
</TABLE>
* Calculated on an annualized basis.
(1) Inception date is November 30, 1995. Total return and portfolio turnover
rate are not annualized.
-------------------
PROSPECTUS PAGE 3
<PAGE> 230
INVESTMENT OBJECTIVE AND POLICIES
The Fund has adopted certain fundamental investment restrictions that are set
forth in the Fund's Statement of Additional Information ("SAI"). Those
restrictions, the Fund's investment objective and any other investment policies
identified as "fundamental" cannot be changed without shareholder approval. To
further guide investment activities, the Fund has also instituted a number of
non-fundamental operating policies, which are described throughout this
Prospectus and in the SAI. Although these additional policies may be changed by
the Corporation's Board of Directors without shareholder approval, the Fund will
promptly notify shareholders of any material change in operating policies.
The Fund seeks current income with a very low degree of share-price
fluctuation. The Fund invests primarily in ultra short-term investment-grade
debt obligations.
The Fund is designed for investors who seek higher yields than money market
funds generally offer and who are willing to accept some modest principal
fluctuation in order to achieve that objective. BECAUSE ITS SHARE PRICE WILL
VARY, THE FUND IS NOT AN APPROPRIATE INVESTMENT FOR THOSE WHOSE PRIMARY
OBJECTIVE IS ABSOLUTE PRINCIPAL STABILITY. The Fund's investments include a
combination of high-quality money market instruments, as well as securities with
longer maturities and debt obligations of lower quality. Under normal market
conditions, it is anticipated that the Fund will maintain an average effective
portfolio maturity of one year or less. There is no maturity limit on any
individual bond in the Fund's portfolio. When the Advisor determines market
conditions warrant a temporary defensive position, the Fund may invest without
limitation in cash and short-term fixed income securities.
Under normal market conditions, at least 75% of the Fund's net assets will be
invested in investment-grade debt obligations, which generally include a range
of obligations from those in the highest rating category to those rated in the
fourth-highest rating category (e.g., BBB or higher by Standard & Poor's Ratings
Group or "S&P"). The Fund may also invest up to 25% of its net assets in
non-investment-grade debt obligations that are rated in the fifth highest rating
category (e.g., BB by S&P) or unrated securities of comparable quality. In
general, non-investment-grade securities are regarded as predominantly
speculative with respect to the capacity of the issuer to pay interest and repay
principal. However, because these securities compose the tier immediately below
investment grade, they are considered the least speculative non-investment-grade
securities. (See "Fundamentals of Fixed Income Investing - Credit Quality.")
-------------------
PROSPECTUS PAGE 4
<PAGE> 231
FUNDAMENTALS OF
FIXED INCOME INVESTING
The Fund may invest in a wide variety of debt obligations and other
securities. See "Implementation of Policies and Risks - Debt Obligations."
Issuers of debt obligations have a contractual obligation to pay interest at
a specified rate ("coupon rate") on specified dates and to repay principal
("face value" or "par value") on a specified maturity date. Certain debt
obligations (usually intermediate- and long-term obligations) have provisions
that allow the issuer to redeem or "call" the obligation before its maturity.
Issuers are most likely to call such debt obligations during periods of falling
interest rates. As a result, the Fund may be required to invest the
unanticipated proceeds of the called obligations at lower interest rates, which
may cause the Fund's income to decline.
Although the net asset value of the Fund is expected to fluctuate, the
Advisor actively manages the Fund's portfolio and adjusts its average portfolio
maturity according to the Advisor's interest rate outlook while seeking to avoid
or reduce, to the extent possible, any negative changes in net asset value.
PRICE VOLATILITY
The market value of debt obligations is affected by changes in prevailing
interest rates. The market value of a debt obligation generally reacts inversely
to interest-rate changes, meaning, when prevailing interest rates decline, an
obligation's price usually rises, and when prevailing interest rates rise, an
obligation's price usually declines. A fund portfolio consisting primarily of
debt obligations will react similarly to changes in interest rates.
MATURITY
In general, the longer the maturity of a debt obligation, the higher its
yield and the greater its sensitivity to changes in interest rates. Conversely,
the shorter the maturity, the lower the yield but the greater the price
stability. Commercial paper is generally considered the shortest form of debt
obligation. Notes, whose original maturities are two years or less, are
considered short-term obligations. The term "bond" generally refers to
securities with maturities longer than two years. Bonds with maturities of three
years or less are considered short term, bonds with maturities between three and
seven years are considered intermediate term, and bonds with maturities greater
than seven years are considered long term.
The Fund's average portfolio maturity represents an average based on the
actual stated maturity dates of the debt securities in the Fund's portfolio,
except that (i) variable-rate securities are deemed to mature at the next
interest-rate adjustment date, (ii) debt securities with put features are deemed
-------------------
PROSPECTUS PAGE 5
<PAGE> 232
to mature at the next put-exercise date, (iii) the maturity of mortgage-backed
securities is determined on an "expected life" basis, and (iv) securities being
hedged with futures contracts may be deemed to have a longer maturity, in the
case of purchases of futures contracts, and a shorter maturity, in the case of
sales of futures contracts, than they would otherwise be deemed to have.
The Fund's average "effective portfolio maturity" will be calculated in
nearly the same manner as average portfolio maturity, which is explained above.
However, for the purpose of calculating average effective portfolio maturity, a
security that is subject to redemption at the option of the issuer on a
particular date (the "call date") which is prior to the security's stated
maturity may be deemed to mature on the call date rather than on its stated
maturity date. The call date of a security will be used to calculate average
effective portfolio maturity when the Advisor reasonably anticipates, based upon
information available to it, that the issuer will exercise its right to redeem
the security. The Advisor may base its conclusion on such factors as the
interest rate paid on the security compared to prevailing market rates, the
amount of cash available to the issuer of the security, events affecting the
issuer of the security, and other factors that may compel or make it
advantageous for the issuer to redeem a security prior to its stated maturity.
CREDIT QUALITY
The values of debt obligations may also be affected by changes in the credit
rating or financial condition of their issuers. Generally, the lower the quality
rating of an obligation, the higher the degree of risk as to the payment of
interest and return of principal. To compensate investors for taking on such
increased risk, those issuers deemed to be less creditworthy generally must
offer their investors higher interest rates than do issuers with better credit
ratings.
In conducting its credit research and analysis, the Advisor considers both
qualitative and quantitative factors to evaluate the creditworthiness of
individual issuers. The Advisor also relies, in part, on credit ratings compiled
by a number of nationally recognized statistical rating organizations, which
include Standard & Poor's Ratings Group ("S&P"), Moody's Investors Service,
Inc., Fitch Investors Service, Inc., Duff & Phelps Rating Co., Thomson
BankWatch, Inc., and IBCA, Inc. (the "NRSROs"). "Appendix - Ratings of Debt
Obligations" presents a summary of the ratings of these organizations. Please
refer to the Appendix in the Fund's SAI for a detailed description of the
ratings of the NRSROs.
INVESTMENT-GRADE DEBT OBLIGATIONS. Debt obligations rated in the highest-
through the medium-quality categories are commonly referred to as
"investment-grade" debt obligations and include the following:
- - U.S. government securities (See "Implementation of Policies and Risks - Debt
Obligations" below);
-------------------
PROSPECTUS PAGE 6
<PAGE> 233
- - bonds or bank obligations rated in one of the four highest rating categories
(e.g., BBB or higher by S&P);
- - short-term notes rated in one of the two highest rating categories (e.g., SP-2
or higher by S&P);
- - short-term bank obligations rated in one of the three highest rating
categories (e.g., A-3 or higher by S&P), with respect to obligations maturing
in one year or less;
- - commercial paper rated in one of the three highest rating categories (e.g.,
A-3 or higher by S&P);
- - unrated debt obligations determined by the Advisor to be of comparable
quality; and
- - repurchase agreements involving investment-grade debt obligations.
Investment-grade debt obligations are generally believed to have relatively
low degrees of credit risk. All ratings are determined at the time of
investment. Any subsequent rating downgrade of a debt obligation will be
monitored by the Advisor to consider what action, if any, the Fund should take
consistent with its investment objective. For purposes of determining whether a
security is investment grade, the Advisor may use the highest rating assigned to
that security by any NRSRO.
HIGH-YIELD (HIGH-RISK) SECURITIES. High-yield (high-risk) securities, also
referred to as "junk bonds," are those securities that are rated lower than
investment grade and unrated securities of comparable quality. Although these
securities generally offer higher yields than investment-grade securities with
similar maturities, lower-quality securities involve greater risks, including
the possibility of default or bankruptcy. In general, they are regarded to be
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal. Other potential risks associated with investing in high-
yield securities include:
- - substantial market-price volatility resulting from changes in interest rates,
changes in or uncertainty about economic conditions, and changes in the actual
or perceived ability of the issuer to meet its obligations;
- - greater sensitivity of highly-leveraged issuers to adverse economic changes
and individual-issuer developments;
- - subordination to the prior claims of other creditors;
- - additional Congressional attempts to restrict the use or limit the tax and
other advantages of these securities; and
- - adverse publicity and changing investor perceptions about these securities.
As with any other asset in the Fund's portfolio, any reduction in the value
of such securities as a result of the factors listed above would be reflected in
the net asset value of the Fund. In addition, a fund that invests in
lower-quality securities may incur additional expenses to the extent it is
required to seek
-------------------
PROSPECTUS PAGE 7
<PAGE> 234
recovery upon a default in the payment of principal and interest on its
holdings. As a result of the associated risks, successful investments in
high-yield, high-risk securities will be more dependent on the Advisor's credit
analysis than generally would be the case with investments in investment-grade
securities.
It is uncertain how the high-yield market will perform during a prolonged
period of rising interest rates. A prolonged economic downturn or a prolonged
period of rising interest rates could adversely affect the market for these
securities, increase their volatility, and reduce their value and liquidity. In
addition, lower-quality securities tend to be less liquid than higher-quality
debt securities because the market for them is not as broad or active. If market
quotations are not available, these securities will be valued in accordance with
procedures established by the Corporation's Board of Directors. Judgment may,
therefore, play a greater role in valuing these securities. The lack of a liquid
secondary market may have an adverse effect on market price and the Fund's
ability to sell particular securities.
See the Appendix for information concerning the credit quality of the Fund's
investments for the fiscal period ended December 31, 1996.
IMPLEMENTATION OF POLICIES AND RISKS
In addition to the Fund's investment policies described above (and subject to
certain restrictions described herein), the Fund may invest in some or all of
the following securities and employ some or all of the following investment
techniques, some of which may present special risks as described below. A more
complete discussion of these securities and investment techniques and their
associated risks is contained in the Fund's SAI.
DEBT OBLIGATIONS
The Fund may invest in any debt obligations. The Fund's authority to invest
in certain types of debt obligations may be restricted or subject to objective
investment criteria. For additional information on these restrictions, see
"Investment Objective and Policies."
TYPES OF OBLIGATIONS. Debt obligations include (i) corporate debt securities,
including bonds, debentures, and notes; (ii) bank obligations, such as
certificates of deposit, banker's acceptances, and time deposits of domestic and
foreign banks and their subsidiaries and branches, and domestic savings and loan
associations (in amounts in excess of the insurance coverage (currently $100,000
per account) provided by the Federal Deposit Insurance Corporation); (iii)
commercial paper (including variable-amount master demand notes); (iv)
repurchase agreements; (v) loan interests; (vi) foreign debt obligations issued
by foreign issuers traded either in foreign markets or in domestic markets
through depositary receipts; (vii) convertible securities - debt obligations of
corporations convertible into or exchangeable for equity securities or
-------------------
PROSPECTUS PAGE 8
<PAGE> 235
debt obligations that carry with them the right to acquire equity securities, as
evidenced by warrants attached to such securities, or acquired as part of units
of the securities; (viii) preferred stocks - securities that represent an
ownership interest in a corporation and that give the owner a prior claim over
common stock on the company's earnings or assets; (ix) trust preferred
securities - certain obligations which have characteristics of both debt and
preferred stock; (x) U.S. government securities; (xi) mortgage-backed
securities, collateralized mortgage obligations, and similar securities; and
(xii) municipal obligations.
GOVERNMENT SECURITIES
U.S. government securities are issued or guaranteed by the U.S. government or
its agencies or instrumentalities. Securities issued by the government include
U.S. Treasury obligations, such as Treasury bills, notes, and bonds. Securities
issued or guaranteed by government agencies or instrumentalities include the
following:
- - the Federal Housing Administration, Farmers Home Administration, Export-Import
Bank of the United States, Small Business Administration, and the Government
National Mortgage Association, including GNMA pass-through certificates, whose
securities are supported by the full faith and credit of the United States;
- - the Federal Home Loan Banks, Federal Intermediate Credit Banks, and the
Tennessee Valley Authority, whose securities are supported by the right of the
agency to borrow from the U.S. Treasury;
- - the Federal National Mortgage Association, whose securities are supported by
the discretionary authority of the U.S. government to purchase certain
obligations of the agency or instrumentality; and
- - the Student Loan Marketing Association, the Interamerican Development Bank,
and International Bank for Reconstruction and Development, whose securities
are supported only by the credit of such agencies.
Although the U.S. government provides financial support to such U.S.
government-sponsored agencies or instrumentalities, no assurance can be given
that it will always do so. The U.S. government and its agencies and
instrumentalities do not guarantee the market value of their securities;
consequently, the value of such securities will fluctuate.
MORTGAGE- AND ASSET-BACKED SECURITIES
Mortgage-backed securities represent direct or indirect participation in, or
are secured by and payable from, mortgage loans secured by real property, and
include single- and multi-class pass-through securities and collateralized
mortgage obligations. Such securities may be issued or guaranteed by U.S.
-------------------
PROSPECTUS PAGE 9
<PAGE> 236
government agencies or instrumentalities or by private issuers, generally
originators in mortgage loans, including savings associations, mortgage bankers,
commercial banks, investment bankers, and special purpose entities
(collectively, "private lenders"). Mortgage-backed securities issued by private
lenders may be supported by pools of mortgage loans or other mortgage-backed
securities that are guaranteed, directly or indirectly, by the U.S. government
or one of its agencies or instrumentalities, or they may be issued without any
governmental guarantee of the underlying mortgage assets but with some form of
non-governmental credit enhancement.
Asset-backed securities have structural characteristics similar to mortgage-
backed securities. However, the underlying assets are not first-lien mortgage
loans or interests therein; rather they include assets such as motor vehicle
installment sales contracts, other installment loan contracts, home equity
loans, leases of various types of property and receivables from credit card or
other revolving credit arrangements. Payments or distributions of principal and
interest on asset-backed securities may be supported by non-governmental credit
enhancements similar to those utilized in connection with mortgage-backed
securities.
The yield characteristics of mortgage- and asset-backed securities differ
from those of traditional debt obligations. Among the principal differences are
that interest and principal payments are made more frequently on mortgage-and
asset-backed securities, usually monthly, and that principal may be prepaid at
any time because the underlying mortgage loans or other assets generally may be
prepaid at any time. As a result, if the Fund purchases these securities at a
premium, a prepayment rate that is faster than expected will reduce yield to
maturity, while a prepayment rate that is slower than expected will have the
opposite effect of increasing the yield to maturity. Conversely, if the Fund
purchases these securities at a discount, a prepayment rate that is faster than
expected will increase yield to maturity, while a prepayment rate that is slower
than expected will reduce yield to maturity. Accelerated prepayments on
securities purchased by the Fund at a premium also impose a risk of loss of
principal because the premium may not have been fully amortized at the time the
principal is prepaid in full. The market for privately issued mortgage- and
asset-backed securities is smaller and less liquid than the market for
government sponsored mortgage-backed securities.
The Fund may invest in stripped mortgage- or asset-backed securities, which
receive differing proportions of the interest and principal payments from the
underlying assets. The market value of such securities generally is more
sensitive to changes in prepayment and interest rates than is the case with
traditional mortgage- and asset-backed securities, and in some cases the market
value may be extremely volatile. With respect to certain stripped securities,
such as interest-only ("IO") and principal-only ("PO") classes, a rate of
prepayment that is faster or slower than anticipated may result in the Fund
failing to recover all or a portion of its investment, even though the
securities are rated investment grade.
---------------------
PROSPECTUS PAGE 10
<PAGE> 237
LOAN INTERESTS
The Fund may invest a portion of its assets in loan interests, which are
interests in amounts owed by a corporate, governmental or other borrower to
lenders or lending syndicates. Loan interests purchased by the Fund may have a
maturity of any number of days or years, and may be secured or unsecured. Loan
interests, which may take the form of participation interests in, assignments
of, or novations of a loan, may be acquired from U.S. and foreign banks,
insurance companies, finance companies or other financial institutions that have
made loans or are members of a lending syndicate or from the holders of loan
interests. Loan interests involve the risk of loss in case of default or
bankruptcy of the borrower and, in the case of participation interests, involve
a risk of insolvency of the agent lending bank or other financial intermediary.
Loan interests are not rated by any nationally recognized statistical rating
organization ("NRSRO") and are, at present, not readily marketable and may be
subject to contractual restrictions on resale.
FOREIGN SECURITIES AND CURRENCIES
The Fund may invest up to 25% of its net assets directly or indirectly in
foreign securities. The Fund may invest in U.S. securities enhanced as to credit
quality or liquidity by foreign issuers without regard to this limit. Foreign
investments involve special risks, including:
- - expropriation, confiscatory taxation, and withholding taxes on dividends and
interest;
- - less extensive regulation of foreign brokers, securities markets, and issuers;
- - less publicly available information and different accounting standards;
- - costs incurred in conversions between currencies, possible delays in
settlement in foreign securities markets, limitations on the use or transfer
of assets (including suspension of the ability to transfer currency from a
given country), and difficulty of enforcing obligations in other countries;
and
- - diplomatic developments and political or social instability.
Foreign economies may differ favorably or unfavorably from the U.S. economy
in various respects, including growth of gross domestic product, rates of
inflation, currency depreciation, capital reinvestment, resource
self-sufficiency, and balance-of-payments positions. Many foreign securities may
be less liquid and their prices more volatile than comparable U.S. securities.
Although the Fund generally invests only in securities that are regularly traded
on recognized exchanges or in over-the-counter markets, from time to time
foreign securities may be difficult to liquidate rapidly without adverse price
effects. Certain costs attributable to foreign investing, such as custody
charges and brokerage costs, may be higher than those attributable to domestic
investing.
---------------------
PROSPECTUS PAGE 11
<PAGE> 238
Because most foreign securities are denominated in non-U.S. currencies, the
investment performance of the Fund could be affected by changes in foreign
currency exchange rates to some extent. The value of the Fund's assets
denominated in foreign currencies will increase or decrease in response to
fluctuations in the value of those foreign currencies relative to the U.S.
dollar. Currency exchange rates can be volatile at times in response to supply
and demand in the currency exchange markets, international balances of payments,
governmental intervention, speculation, and other political and economic
conditions.
The Fund may purchase and sell foreign currency on a spot basis and may
engage in forward currency contracts, currency options, and futures transactions
for hedging or any other lawful purpose. (See "Derivative Instruments.")
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with certain banks and non-bank
dealers. In a repurchase agreement, the Fund buys a security at one price, and
at the time of sale, the seller agrees to repurchase the obligation at a
mutually agreed upon time and price (usually within seven days). The repurchase
agreement determines the yield during the purchaser's holding period, while the
seller's obligation to repurchase is secured by the value of the underlying
security. The Fund may enter into repurchase agreements with respect to any
security in which it may invest. The Advisor will monitor, on an ongoing basis,
the value of the underlying securities to ensure that the value always equals or
exceeds the repurchase price plus accrued interest. Repurchase agreements could
involve certain risks in the event of a default or insolvency of the other party
to the agreement, including possible delays or restrictions upon the Fund's
ability to dispose of the underlying securities. Although no definitive
creditworthiness criteria are used, the Advisor reviews the creditworthiness of
the banks and non-bank dealers with which the Funds enter into repurchase
agreements to evaluate those risks. The Fund may, under certain circumstances,
deem repurchase agreements collateralized by U.S. government securities to be
investments in U.S. government securities.
DERIVATIVE INSTRUMENTS
The Fund may use derivative instruments for any lawful purpose consistent
with the Fund's investment objective such as hedging or managing risk.
Derivative instruments are commonly defined to include securities or contracts
whose values depend on (or "derive" from) the value of one or more other assets,
such as securities, currencies, or commodities. These "other assets" are
commonly referred to as "underlying assets."
A derivative instrument generally consists of, is based upon, or exhibits
characteristics similar to options or forward contracts. Options and forward
contracts are considered to be the basic "building blocks" of derivatives. For
---------------------
PROSPECTUS PAGE 12
<PAGE> 239
example, forward-based derivatives include forward contracts, swap contracts, as
well as exchange-traded futures. Option-based derivatives include privately
negotiated, over-the-counter (OTC) options (including caps, floors, collars, and
options on forward and swap contracts) and exchange-traded options on futures.
Diverse types of derivatives may be created by combining options or forward
contracts in different ways, and by applying these structures to a wide range of
underlying assets.
An option is a contract in which the "holder" (the buyer) pays a certain
amount (the "premium") to the "writer" (the seller) to obtain the right, but not
the obligation, to buy from the writer (in a "call") or sell to the writer (in a
"put") a specific asset at an agreed upon price at or before a certain time. The
holder pays the premium at inception and has no further financial obligation.
The holder of an option-based derivative generally will benefit from favorable
movements in the price of the underlying asset but is not exposed to
corresponding losses due to adverse movements in the value of the underlying
asset. The writer of an option-based derivative generally will receive fees or
premiums but generally is exposed to losses due to changes in the value of the
underlying asset.
A forward is a sales contract between a buyer (holding the "long" position)
and a seller (holding the "short" position) for an asset with delivery deferred
until a future date. The buyer agrees to pay a fixed price at the agreed future
date and the seller agrees to deliver the asset. The seller hopes that the
market price on the delivery date is less than the agreed upon price, while the
buyer hopes for the contrary. The change in value of a forward-based derivative
generally is roughly proportional to the change in value of the underlying
asset.
Derivative instruments may include (i) options; (ii) futures; (iii) options
on futures; (iv) short sales against the box, in which the Fund sells a security
it owns for delivery at a future date; (v) swaps, in which two parties agree to
exchange a series of cash flows in the future, such as interest-rate payments;
(vi) interest-rate caps, under which, in return for a premium, one party agrees
to make payments to the other to the extent that interest rates exceed a
specified rate, or "cap"; (vii) interest-rate floors, under which, in return for
a premium, one party agrees to make payments to the other to the extent that
interest rates fall below a specified level, or "floor"; (viii) forward currency
contracts and foreign currency exchange-related securities; and (ix) structured
instruments which combine the foregoing in different ways.
Derivatives may be exchange-traded or traded in OTC transactions between
private parties. OTC transactions are subject to additional risks, such as the
credit risk of the counterparty to the instrument and are less liquid than
exchange-traded derivatives since they often can only be closed out with the
other party to the transaction. Derivative instruments may include elements of
leverage and, accordingly, the fluctuation of the value of the derivative
instrument in relation to the underlying asset may be magnified. When required
by SEC guidelines, the Fund will set aside permissible liquid assets in a
segregated account to secure its obligations under the derivative.
---------------------
PROSPECTUS PAGE 13
<PAGE> 240
The successful use of derivatives by the Fund is dependent upon a variety of
factors, particularly the Advisor's ability to correctly anticipate trends in
the underlying asset. In a hedging transaction, if the Advisor incorrectly
anticipates trends in the underlying asset, the Fund may be in a worse position
than if no hedging had occurred. In addition, there may be imperfect correlation
between the Fund's derivative transactions and the instruments being hedged. To
the extent that the Fund is engaging in derivative transactions for risk
management, the Fund's successful use of such transactions is more dependent
upon the Advisor's ability to correctly anticipate such trends, since losses in
these transactions may not be offset in gains in the Fund's portfolio or in
lower purchase prices for assets it intends to acquire. The Advisor's prediction
of trends in underlying assets may prove to be inaccurate, which could result in
substantial losses to the Fund.
In addition to the derivative instruments and strategies described above, the
Advisor expects to discover additional derivative instruments and other trading
techniques. The Advisor may utilize these new derivative instruments and
techniques to the extent that they are consistent with the Fund's investment
objective and permitted by the Fund's investment limitations, operating
policies, and applicable regulatory authorities.
WHEN-ISSUED SECURITIES
The Fund may invest without limitation in securities purchased on a when-
issued or delayed-delivery basis. Although the payment and interest terms of
these securities are established at the time the purchaser enters into the
commitment, these securities may be delivered and paid for at a future date,
generally within 45 days. Purchasing when-issued securities allows the Fund to
lock in a fixed price or yield on a security it intends to purchase. However,
when the Fund purchases a when-issued security, it immediately assumes the risk
of ownership, including the risk of price fluctuation.
The greater the Fund's outstanding commitments for these securities, the
greater the exposure to potential fluctuations in the net asset value of the
Fund. Purchasing when-issued securities may involve the additional risk that the
yield available in the market when the delivery occurs may be higher or the
market price lower than that obtained at the time of commitment. Although the
Fund may be able to sell these securities prior to the delivery date, it will
purchase when-issued securities for the purpose of actually acquiring the
securities, unless, after entering into the commitment, a sale appears desirable
for investment reasons. When required by SEC guidelines, the Fund will set aside
permissible liquid assets in a segregated account to secure its outstanding
commitments for when-issued securities.
---------------------
PROSPECTUS PAGE 14
<PAGE> 241
ILLIQUID SECURITIES
The Fund may invest up to 15% of its net assets in illiquid securities.
Illiquid securities are those securities that are not readily marketable,
including restricted securities and repurchase obligations maturing in more than
seven days. Certain restricted securities which may be resold to institutional
investors under Rule 144A under the Securities Act of 1933 and Section 4(2)
commercial paper may be determined to be liquid under guidelines adopted by the
Corporation's Board of Directors.
ZERO-COUPON, STEP-COUPON, AND PAY-IN-KIND SECURITIES
The Fund may invest in zero-coupon, step-coupon, and pay-in-kind securities.
These securities are debt securities that do not make regular cash interest
payments. Zero-coupon and step-coupon securities are sold at a deep discount to
their face value. Pay-in-kind securities pay interest through the issuance of
additional securities. Because such securities do not pay current cash income,
the price of these securities can be volatile when interest rates fluctuate.
While these securities do not pay current cash income, federal income tax law
requires the holders of zero-coupon, step-coupon, and pay-in-kind securities to
include in income each year the portion of the original issue discount (or
deemed discount) and other non-cash income on such securities accrued during
that year.
MORTGAGE DOLLAR ROLLS AND
REVERSE REPURCHASE AGREEMENTS
The Fund may engage in reverse repurchase agreements to facilitate portfolio
liquidity, a practice common in the mutual fund industry, or for arbitrage
transactions discussed below. In a reverse repurchase agreement, the Fund would
sell a security and enter into an agreement to repurchase the security at a
specified future date and price. The Fund generally retains the right to
interest and principal payments on the security. Since the Fund receives cash
upon entering into a reverse repurchase agreement, it may be considered a
borrowing. When required by SEC guidelines, the Fund will set aside permissible
liquid assets in a segregated account to secure its obligation to repurchase the
security.
The Fund may also enter into mortgage dollar rolls, in which the Fund would
sell mortgage-backed securities for delivery in the current month and
simultaneously contract to purchase substantially similar securities on a
specified future date. While the Fund would forego principal and interest paid
on the mortgage-backed securities during the roll period, the Fund would be
compensated by the difference between the current sale price and the lower price
for the future purchase as well as by any interest earned on the proceeds of the
initial sale. The Fund also could be compensated through the receipt of
---------------------
PROSPECTUS PAGE 15
<PAGE> 242
fee income equivalent to a lower forward price. When required by SEC guidelines,
the Fund would set aside permissible liquid assets in a segregated account to
secure its obligation for the forward commitment to buy mortgage-backed
securities. Mortgage dollar roll transactions may be considered a borrowing by
the Fund.
The mortgage dollar rolls and reverse repurchase agreements entered into by
the Fund may be used as arbitrage transactions in which the Fund will maintain
an offsetting position in investment-grade debt obligations or repurchase
agreements that mature on or before the settlement date of the related mortgage
dollar roll or reverse repurchase agreement. Since the Fund will receive
interest on the securities or repurchase agreements in which it invests the
transaction proceeds, such transactions may involve leverage. However, since
such securities or repurchase agreements will be high quality and will mature on
or before the settlement date of the mortgage dollar roll or reverse repurchase
agreement, the Advisor believes that such arbitrage transactions do not present
the risks to the Fund that are associated with other types of leverage.
CASH MANAGEMENT
The Fund may invest directly in cash and short-term fixed income securities,
including, for this purpose, shares of one or more money market funds managed by
the Advisor (collectively, the "Strong Money Funds"). The Strong Money Funds
seek current income, a stable share price of $1.00, and daily liquidity. All
money market instruments can change in value when interest rates or an issuer's
creditworthiness change dramatically. The Strong Money Funds cannot guarantee
that they will always be able to maintain a stable net asset value of $1.00 per
share.
PORTFOLIO TURNOVER
The Fund's historical portfolio turnover rate is listed under "Financial
Highlights." The annual portfolio turnover rate indicates changes in the Fund's
portfolio. The turnover rate may vary from year to year, as well as within a
year. It may also be affected by sales of portfolio securities necessary to meet
cash requirements for redemption of shares. High portfolio turnover in any year
will result in the payment by the Fund of above-average amounts of transaction
costs. The annual portfolio turnover rate for the Fund is expected to be between
200% and 300%. However, the Fund's portfolio turnover rate may exceed 300% when
the Advisor believes the anticipated benefits of short-term investments outweigh
any increase in transaction costs or increase in capital gains. This rate should
not be considered as a limiting factor.
---------------------
PROSPECTUS PAGE 16
<PAGE> 243
SPECIAL CONSIDERATIONS
The Fund is designed as an investment vehicle for variable annuity and
variable life insurance contracts funded by separate accounts of certain
insurance companies. Section 817(h) of the Internal Revenue Code of 1986, as
amended (the "Code") and the regulations thereunder impose certain
diversification standards on the investments underlying variable annuity and
variable life insurance contracts in order for such contracts to be treated for
tax purposes as annuities or life insurance. Section 817(h) of the Code provides
that a variable annuity and variable life insurance contract based on a separate
account shall not be treated as an annuity or life insurance contract for any
period (and any subsequent period) for which the account's investments are not
adequately diversified. These diversification requirements are in addition to
the diversification requirements applicable to the Fund under Subchapter M of
the Code and the Investment Company Act of 1940 (the "1940 Act") and may affect
the composition of the Fund's investments.
Since the shares of the Fund are currently sold to segregated asset accounts
underlying such variable annuity and variable life insurance contracts, the Fund
intends to comply with the diversification requirements as set forth in the
regulations. The Secretary of the Treasury may in the future issue additional
regulations or revenue rulings that may prescribe the circumstances in which a
contract owner's control of the investments of a separate account may cause the
contract owner, rather than the insurance company, to be treated as the owner of
assets of the separate account. Failure to comply with Section 817(h) of the
Code or any regulation thereunder, or with any future regulations or revenue
rulings on contract owner control, would cause earnings regarding a contract
owner's interest in an insurance company's separate account to be includible in
the contract owner's gross income in the year earned. Such standards may apply
only prospectively, although retroactive application is possible. In the event
that any such regulations or revenue rulings are adopted, the Fund may not be
able to continue to operate as currently described in this prospectus, or
maintain its investment program.
The Fund will be managed in such a manner as to comply with the requirements
of Subchapter L of the Code. It is possible that in order to comply with such
requirements, less desirable investment decisions may be made which would affect
the investment performance of the Fund.
The Fund may sell its shares to the separate accounts of various insurance
companies, which are not affiliated with each other, for the purpose of funding
variable annuity and variable life insurance contracts. The Fund currently does
not foresee any disadvantages to contract owners arising out of the fact that it
offers its shares to separate accounts of various insurance companies, which are
not affiliated with each other, to serve as an investment medium for their
variable products. However, it is theoretically possible that the interests of
owners of various contracts participating in the Fund through the separate
---------------------
PROSPECTUS PAGE 17
<PAGE> 244
accounts might at some time be in conflict. The Board of Directors of the
Corporation, however, will monitor events in order to identify any material
irreconcilable conflicts which may possibly arise and to determine what action,
if any, should be taken in response to such conflicts. If such a conflict were
to occur, one or more insurance companies' separate accounts might be required
to withdraw its investments in the Fund, and shares of another Fund may be
substituted. This might force the Fund to sell securities at disadvantageous
prices. In addition, the Board of Directors may refuse to sell Fund shares to
any separate account or may suspend or terminate the offering of Fund shares if
such action is required by law or regulatory authority or is in the best
interest of the shareholders of the Fund.
Except for the organizational shares of the Fund, the Fund's shares may be
held of record only by insurance company separate accounts. As of March 31,
1997, Fortis Benefits Insurance Co. owned approximately 51% of the Fund. As of
March 31, 1997, the Advisor owned approximately 30% of the Fund. The Advisor's
share ownership represents the organizational shares of the Fund. Their
ownership of greater than 25% of the Fund's shares may result in them being
deemed to be controlling entities of the Fund. They may continue to be deemed as
such until insurance companies, if any, selling significant numbers of variable
annuity and variable life insurance contracts, make substantial investments in
the Fund's shares.
MANAGEMENT
The Board of Directors of the Corporation is responsible for managing the
Fund's business and affairs. The Fund has entered into an investment advisory
agreement (an "Advisory Agreement") with the Advisor. Under the terms of the
Advisory Agreement, the Advisor manages the Fund's investments and business
affairs, subject to the supervision of the Board of Directors.
The Advisor began conducting business in 1974. Since then, its principal
business has been providing continuous investment supervision for individuals
and institutional accounts, such as pension funds and profit-sharing plans as
well as mutual funds, several of which are funding vehicles for variable
insurance products. As of March 31, 1997, the Advisor had over $23 billion under
management. The Advisor's principal mailing address is P.O. Box 2936, Milwaukee,
Wisconsin 53201. Mr. Richard S. Strong, the Chairman of the Board of the
Corporation, is the controlling shareholder of the Advisor.
As compensation for its services, the Fund pays the Advisor a monthly
management fee. The annual fee is .60% of the average daily net asset value of
the Fund. Under the terms of the Advisory Agreement, the Advisor provides office
space and all necessary office facilities, equipment, and personnel for
servicing the investments of the Fund. From time to time, the Advisor may
voluntarily waive all or a portion of its management fee and/or absorb certain
expenses for the Fund without further notification of the commencement or
termination of any such waiver or absorption. Any such waiver or absorption
---------------------
PROSPECTUS PAGE 18
<PAGE> 245
will have the effect of lowering the overall expense ratio of the Fund and
increasing the Fund's return to investors at the time such amounts were waived
and/or absorbed.
Except for expenses assumed by the Advisor or Strong Funds Distributors,
Inc., the Fund is responsible for all its other expenses, including, without
limitation, interest charges, taxes, brokerage commissions and similar expenses;
expenses of issue, sale, repurchase, or redemption of shares; expenses of
registering or qualifying shares for sale with the states and the SEC; expenses
of printing and distribution of prospectuses to existing shareholders; charges
of custodians (including fees as custodian for keeping books and similar
services for the Fund), transfer agents (including the printing and mailing of
reports and notices to shareholders), registrars, auditing and legal services,
and clerical services related to recordkeeping and shareholder relations;
printing of stock certificates; fees for directors who are not "interested
persons" of the Advisor; expenses of indemnification; extraordinary expenses;
and costs of shareholder and director meetings.
The Advisor permits portfolio managers and other persons who may have access
to information about the purchase or sale of securities in the Fund's portfolio
("access persons") to purchase and sell securities for their own accounts,
subject to the Advisor's policy governing personal investing. The policy
requires access persons to conduct their personal investment activities in a
manner that the Advisor believes is not detrimental to the Fund or to the
Advisor's other advisory clients. Among other things, the policy requires access
persons to obtain preclearance before executing personal trades and prohibits
access persons from keeping profits derived from the purchase or sale of the
same security within 60 calendar days. See the SAI for more information.
PORTFOLIO MANAGER. Mr. Jeffrey A. Koch joined the Advisor as a portfolio
manager and securities analyst in June 1989. For a brief period prior to that,
he was a market-maker clerk at Fossett Corporation, a clearing firm. Mr. Koch
earned his M.B.A. in Finance at Washington University in St. Louis, Missouri in
1989. His undergraduate degree, awarded in 1987, is from the University of
Minnesota-Morris. Mr. Koch is also a Chartered Financial Analyst. Mr. Koch has
managed the Fund since its inception in June 1995.
ADDITIONAL INFORMATION
HOW TO INVEST. Investments in the Fund may only be made by separate accounts
established and maintained by insurance companies for purposes of funding
variable annuity and variable life insurance contracts. For instructions on how
to direct a separate account to purchase shares in the Fund, please refer to the
prospectus of the insurance company's separate account. The Fund does not impose
any sales charge or 12b-1 fee. Certain sales charges may
---------------------
PROSPECTUS PAGE 19
<PAGE> 246
apply to the variable annuity or variable life insurance contract, which should
be described in the prospectus of the insurance company's separate account. The
Fund may decline to accept a purchase order upon receipt when, in the judgment
of the Advisor, it would not be in the best interest of the existing
shareholders to accept the order. Shares of the Fund will be sold at the net
asset value next determined after receipt by the Fund of a purchase order in
proper form placed by an insurance company investing in the Fund. Certificates
for shares in the Fund will not be issued.
CALCULATION OF NET ASSET VALUE. The net asset value ("NAV") per share for the
Fund is determined as of the close of trading on the New York Stock Exchange
(the "Exchange"), currently 3:00 p.m. Central Time, on days the Exchange is open
for business. The NAV will not be determined for the Fund on days during which
the Fund receives no orders to purchase shares and no shares are tendered for
redemption. The Fund's NAV is calculated by taking the fair value of the Fund's
total assets, subtracting all its liabilities, and dividing by the total number
of shares outstanding. Expenses are accrued and applied daily when determining
the NAV.
Debt securities are valued by a pricing service that utilizes electronic data
processing techniques to determine values for normal institutional size trading
units of debt securities without regard to the existence of sale or bid prices
when such values are believed to more accurately reflect the fair market value
of such securities. Otherwise, sale or bid prices are used. Any securities or
other assets for which market quotations are not readily available are valued at
fair value as determined in good faith by the Board of Directors. Debt
securities having remaining maturities of 60 days or less are valued by the
amortized cost method when the Board of Directors determines that the fair value
of such securities is their amortized cost.
HOW TO REDEEM SHARES. Shares of the Fund may be redeemed on any business day.
The price received upon redemption will be the net asset value next determined
after the redemption request in proper form is received by the Fund. (See
"Calculation of Net Asset Value.") Contract owners should refer to the
withdrawal or surrender instructions in the prospectus of the separate account
for instructions on how to redeem shares. Once the redemption request is
received in proper form, the Fund will ordinarily forward payment to the
separate account no later than seven days after receipt.
The right of redemption may be suspended during any period in which: (i)
trading on the Exchange is restricted, as determined by the SEC, or the Exchange
is closed for other than weekends and holidays; (ii) the SEC has permitted such
suspension by order; or (iii) an emergency, as determined by the SEC, exists
which makes disposal of portfolio securities or valuation of net assets of the
Fund not reasonably practicable.
---------------------
PROSPECTUS PAGE 20
<PAGE> 247
DISTRIBUTIONS AND TAXES. The policy of the Fund is to pay dividends to the
insurance company's separate accounts from net investment income monthly and to
distribute substantially all net realized capital gains, after using any
available capital loss carryovers, annually. All dividends and capital gain
distributions paid to the insurance company's separate accounts will be
automatically reinvested in additional Fund shares.
The Fund intends to continue to qualify for treatment as a Regulated
Investment Company or "RIC" under Subchapter M of the Code and, if so qualified,
will not be liable for federal income tax on earnings and gains distributed to
its shareholders in a timely manner. If the Fund does not so qualify, however,
it would be treated for tax purposes as an ordinary corporation and would
receive no tax deduction for distributions made to its shareholders. For more
information regarding tax implications for owners of variable annuity or
variable life insurance contracts investing in the Fund, please refer to the
prospectus of your insurance company's separate account. See "Special
Considerations" for a discussion of special tax considerations relating to the
Fund's compliance with Subchapter L of the Code, as an investment vehicle for
variable annuity and variable life insurance contracts of certain insurance
companies.
This section is not intended to be a full discussion of present or proposed
federal income tax law and its effect on the Fund and investors. (See the SAI
for a further discussion.) Investors are urged to consult their own tax adviser.
ORGANIZATION. The Fund is a series of common stock of the Corporation, which
is a Wisconsin corporation. The Corporation is authorized to issue an indefinite
number of shares of common stock and series and classes of series of shares of
common stock. All holders of shares of the Corporation would vote on each matter
presented to shareholders for action except with respect to any matter which
affects only one or more series or classes, in which case only the shares of the
affected series or class shall be entitled to vote.
All shares participate equally in dividends and other capital gains
distributions by the Fund and in the residual assets of the Fund in the event of
liquidation. Generally, the Corporation will not hold an annual meeting of
shareholders unless required by the 1940 Act.
The insurance company separate accounts, as the record shareholders in the
Fund, have the right to vote on matters submitted for a shareholder vote. Under
current interpretations of the 1940 Act, these insurance companies must solicit
voting instructions from contract owners and vote Fund shares in accordance with
the instructions received or, for Fund shares for which no voting instructions
were received, in the same proportion as those Fund shares for which
instructions were received. Contract owners should refer to the prospectus of
the insurance company's separate account for a complete description of their
voting rights.
TRANSFER AGENT, DIVIDEND-DISBURSING AGENT, AND DISTRIBUTOR. The Advisor, P.O.
Box 2936, Milwaukee, Wisconsin 53201, acts as transfer agent and
---------------------
PROSPECTUS PAGE 21
<PAGE> 248
dividend-disbursing agent for the Fund. Strong Funds Distributors, Inc., P.O.
Box 2936, Milwaukee, Wisconsin 53201, an indirect subsidiary of the Advisor,
acts as distributor of the shares of the Fund.
PERFORMANCE INFORMATION. The Fund may advertise a variety of types of
performance information, including "yield," "average annual total return,"
"total return," and "cumulative total return." Each of these figures is based
upon historical results and does not represent the future performance of the
Fund.
Yield is an annualized figure, which means that it is assumed that the Fund
generates the same level of net investment income over a one-year period. The
Fund's yield is a measure of the net investment income per share earned by the
Fund over a specific 30-day period and is shown as a percentage of the net asset
value of the Fund's shares at the end of the period.
Average annual total return and total return figures measure both the net
investment income generated by, and the effect of any realized and unrealized
appreciation or depreciation of, the underlying investments in the Fund assuming
the reinvestment of all dividends and distributions. Total return figures are
not annualized and simply represent the aggregate change of the Fund's
investments over a specified period of time.
The Fund's shares are sold at the net asset value per share of the Fund.
Returns and net asset value will fluctuate. Shares of the Fund are redeemable by
the separate accounts of insurance companies at the then current net asset value
per share for the Fund, which may be more or less than the original cost. TOTAL
RETURNS CONTAINED IN ADVERTISEMENTS INCLUDE THE EFFECT OF DEDUCTING THE FUND'S
EXPENSES, BUT MAY NOT INCLUDE CHARGES AND EXPENSES ATTRIBUTABLE TO ANY
PARTICULAR INSURANCE PRODUCT. SINCE SHARES MAY ONLY BE PURCHASED BY THE SEPARATE
ACCOUNTS OF CERTAIN INSURANCE COMPANIES, CONTRACT OWNERS SHOULD CAREFULLY REVIEW
THE PROSPECTUS OF THE SEPARATE ACCOUNT FOR INFORMATION ON FEES AND EXPENSES.
Excluding such fees and expenses from the Fund's total return quotations has the
effect of increasing the performance quoted. The Fund will not use information
concerning its investment performance in advertisements or sales materials
unless appropriate information concerning the relevant separate account is also
included. Additional information concerning the Fund's performance appears in
the SAI.
---------------------
PROSPECTUS PAGE 22
<PAGE> 249
APPENDIX
RATINGS OF DEBT OBLIGATIONS
<TABLE>
<CAPTION>
Standard & Poor's
Ratings Moody's Investor Fitch Investors Duff & Phelps Thomsons
Definition Group Services, Inc. Service, Inc. Rating Co. IBCA, Inc. BankWatch, Inc.
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Highest quality AAA Aaa AAA AAA AAA AAA
High quality AA Aa AA AA AA AA
Upper medium grade A A A A A A
Medium grade BBB Baa BBB BBB BBB BBB
Low grade BB Ba BB BB BB BB
Speculative B B B B B B
Submarginal CCC, CC, C Caa, Ca CCC, CC, C CCC CCC, CC CCC, CC
Probably in
default D C DDD, DD, D DD C D
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
----------------------
PROSPECTUS PAGE A-1
<PAGE> 250
ASSET COMPOSITION
For the fiscal year ended December 31, 1996, the following Fund's assets were
invested in the credit categories shown below. Percentages are computed on a
dollar-weighted basis and are an average of twelve monthly calculations.
<TABLE>
<CAPTION>
Advantage Fund II
---------------------------------------
Percentage of Advisor's Assessment of
Rating Investments* Unrated Securities
- ------------------------------------------------
<S> <C> <C>
AAA 40.7% --
AA 7.4 --
A 23.4 --
BBB 14.8 .6%
BB 12.8 .3
B -- --
CCC -- --
CC -- --
C -- --
D -- --
Unrated .9 --
Total 100.0% .9%
- ------------------------------------------------
</TABLE>
* The indicated percentages are based on the highest rating received from any
one NRSRO. Each of the NRSROs utilizes rating categories that are
substantially similar to those used in this chart (see the preceding table for
the rating categories of the six NRSROs).
----------------------
PROSPECTUS PAGE A-2
<PAGE> 251
STATEMENT OF ADDITIONAL INFORMATION
STRONG ADVANTAGE FUND II
P.O. Box 2936
Milwaukee, Wisconsin 53201
Toll-Free: (800) 368-1683
Strong Advantage Fund II (the "Fund") is a diversified series of the
Strong Variable Insurance Funds, Inc. (the "Corporation"), an open-end
management investment company designed to provide an investment vehicle for
variable annuity and variable life insurance contracts of certain insurance
companies. Shares in the Fund are only offered and sold to the separate
accounts of such insurance companies. The Fund is described herein and in the
Prospectus for the Fund dated May 1, 1997.
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the Prospectus for the Fund dated May 1, 1997 and the
prospectus for the separate account of the specific insurance product.
Requests for copies of the Fund's Prospectus may be made by calling one of the
numbers listed above. The financial statements appearing in the Fund's Annual
Report, which accompanies this Statement of Additional Information, are
incorporated herein by reference.
This Statement of Additional Information is dated May 1, 1997.
<PAGE> 252
STRONG ADVANTAGE FUND II
TABLE OF CONTENTS PAGE
INVESTMENT RESTRICTIONS ........................................ 3
INVESTMENT POLICIES AND TECHNIQUES ............................. 4
Borrowing .................................................... 4
Convertible Securities ....................................... 5
Depositary Receipts .......................................... 5
Derivative Instruments ....................................... 6
Foreign Investment Companies ................................. 15
Foreign Securities ........................................... 15
High-Yield (High-Risk) Securities ............................ 16
Illiquid Securities .......................................... 17
Lending of Portfolio Securities .............................. 18
Loan Interests ............................................... 18
Maturity ..................................................... 19
Mortgage- and Asset-Backed Securities ........................ 20
Mortgage Dollar Rolls and Reverse Repurchase Agreements ...... 21
Municipal Obligations ........................................ 21
Repurchase Agreements ........................................ 22
Short Sales Against the Box .................................. 22
Temporary Defensive Position ................................. 22
Variable- or Floating-Rate Securities ........................ 22
Warrants ..................................................... 23
When-Issued Securities ....................................... 23
Zero-Coupon, Step-Coupon and Pay-in-Kind Securities .......... 24
DIRECTORS AND OFFICERS OF THE CORPORATION ...................... 24
PRINCIPAL SHAREHOLDERS ......................................... 27
INVESTMENT ADVISOR AND DISTRIBUTOR ............................. 27
PORTFOLIO TRANSACTIONS AND BROKERAGE ........................... 29
CUSTODIAN ...................................................... 32
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT ................... 32
ADMINISTRATIVE SERVICES ........................................ 32
TAXES .......................................................... 32
DETERMINATION OF NET ASSET VALUE ............................... 35
FUND ORGANIZATION .............................................. 35
PERFORMANCE INFORMATION ........................................ 35
GENERAL INFORMATION ............................................ 41
PORTFOLIO MANAGEMENT ........................................... 42
INDEPENDENT ACCOUNTANTS ........................................ 42
LEGAL COUNSEL .................................................. 43
FINANCIAL STATEMENTS ........................................... 43
APPENDIX ....................................................... A-1
--------------------------------
No person has been authorized to give any information or to make any
representations other than those contained in this Statement of Additional
Information and the Prospectus dated May 1, 1997 and, if given or made, such
information or representations may not be relied upon as having been authorized
by the Fund.
This Statement of Additional Information does not constitute an offer to
sell securities.
2
<PAGE> 253
INVESTMENT RESTRICTIONS
The investment objective of the Fund is to seek current income with a very
low degree of share-price fluctuation. The Fund's investment objective and
policies are described in detail in the Prospectus under the caption
"Investment Objective and Policies." The following are the Fund's fundamental
investment limitations which cannot be changed without shareholder approval.
The Fund:
1. May not with respect to 75% of its total assets, purchase the securities
of any issuer (except securities issued or guaranteed by the U.S.
government or its agencies or instrumentalities) if, as a result, (i) more
than 5% of the Fund's total assets would be invested in the securities of
that issuer, or (ii) the Fund would hold more than 10% of the outstanding
voting securities of that issuer.
2. May (i) borrow money from banks and (ii) make other investments or engage
in other transactions permissible under the Investment Company Act of 1940
(the "1940 Act") which may involve a borrowing, provided that the
combination of (i) and (ii) shall not exceed 33 1/3% of the value of the
Fund's total assets (including the amount borrowed), less the Fund's
liabilities (other than borrowings), except that the Fund may borrow up to
an additional 5% of its total assets (not including the amount borrowed)
from a bank for temporary or emergency purposes (but not for leverage or
the purchase of investments). The Fund may also borrow money from the
other Strong Funds or other persons to the extent permitted by applicable
law.
3. May not issue senior securities, except as permitted under the 1940 Act.
4. May not act as an underwriter of another issuer's securities, except to
the extent that the Fund may be deemed to be an underwriter within the
meaning of the Securities Act of 1933 in connection with the purchase and
sale of portfolio securities.
5. May not purchase or sell physical commodities unless acquired as a result
of ownership of securities or other instruments (but this shall not
prevent the Fund from purchasing or selling options, futures contracts, or
other derivative instruments, or from investing in securities or other
instruments backed by physical commodities).
6. May not make loans if, as a result, more than 33 1/3% of the Fund's total
assets would be lent to other persons, except through (i) purchases of
debt securities or other debt instruments, or (ii) engaging in repurchase
agreements.
7. May not purchase the securities of any issuer if, as a result, more than
25% of the Fund's total assets would be invested in the securities of
issuers, the principal business activities of which are in the same
industry.
8. May not purchase or sell real estate unless acquired as a result of
ownership of securities or other instruments (but this shall not prohibit
the Fund from purchasing or selling securities or other instruments backed
by real estate or of issuers engaged in real estate activities).
9. May, notwithstanding any other fundamental investment policy or
restriction, invest all of its assets in the securities of a single
open-end management investment company with substantially the same
fundamental investment objective, policies, and restrictions as the Fund.
3
<PAGE> 254
The following are the Fund's non-fundamental operating policies which may
be changed by the Board of Directors of the Corporation without shareholder
approval.
The Fund may not:
1. Sell securities short, unless the Fund owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short, or
unless it covers such short sale as required by the current rules and
positions of the Securities and Exchange Commission or its staff, and
provided that transactions in options, futures contracts, options on
futures contracts, or other derivative instruments are not deemed to
constitute selling securities short.
2. Purchase securities on margin, except that the Fund may obtain such
short-term credits as are necessary for the clearance of transactions; and
provided that margin deposits in connection with futures contracts,
options on futures contracts, or other derivative instruments shall not
constitute purchasing securities on margin.
3. Invest in illiquid securities if, as a result of such investment, more
than 15% of its net assets would be invested in illiquid securities, or
such other amounts as may be permitted under the 1940 Act.
4. Purchase securities of other investment companies except in compliance
with the 1940 Act and applicable state law.
5. Invest all of its assets in the securities of a single open-end
investment management company with substantially the same fundamental
investment objective, restrictions and policies as the Fund.
6. Engage in futures or options on futures transactions which are
impermissible pursuant to Rule 4.5 under the Commodity Exchange Act and,
in accordance with Rule 4.5, will use futures or options on futures
transactions solely for bona fide hedging transactions (within the meaning
of the Commodity Exchange Act), provided, however, that the Fund may, in
addition to bona fide hedging transactions, use futures and options on
futures transactions if the aggregate initial margin and premiums required
to establish such positions, less the amount by which any such options
positions are in the money (within the meaning of the Commodity Exchange
Act), do not exceed 5% of the Fund's net assets.
7. Borrow money except (i) from banks or (ii) through reverse repurchase
agreements or mortgage dollar rolls, and will not purchase securities when
bank borrowings exceed 5% of its total assets.
8. Make any loans other than loans of portfolio securities, except through
(i) purchases of debt securities or other debt instruments, or (ii)
engaging in repurchase agreements.
Except for the fundamental investment limitations listed above and the
Fund's investment objective, the other investment policies described in the
Prospectus and this Statement of Additional Information are not fundamental and
may be changed with approval of the Corporation's Board of Directors. Unless
noted otherwise, if a percentage restriction is adhered to at the time of
investment, a later increase or decrease in percentage resulting from a change
in the Fund's assets (i.e., due to cash inflows or redemptions) or in market
value of the investment or the Fund's assets will not constitute a violation of
that restriction.
INVESTMENT POLICIES AND TECHNIQUES
The information supplements the discussion of the Fund's investment
objective, policies, techniques that are described in detail in the Prospectus
under the captions "Investment Objectives and Policies" and "Implementation of
Policies and Risks."
BORROWING
The Fund may borrow money from banks and make other investments or engage
in other transactions permissible under the 1940 Act which may be considered a
borrowing (such as mortgage dollar rolls and reverse repurchase agreements) as
4
<PAGE> 255
discussed under "Investment Restrictions." However, the Fund may not purchase
securities when bank borrowings exceed 5% of the Fund's total assets.
Presently, the Fund only intends to borrow from banks for temporary or
emergency purposes.
The Fund has established a line-of-credit (LOC) with certain banks by
which they may borrow funds for temporary or emergency purposes. A borrowing
is presumed to be for temporary or emergency purposes if it is repaid by the
Fund within sixty days and is not extended or renewed. The Fund intends to use
the LOC to meet large or unexpected redemptions that would otherwise force the
Fund to liquidate securities under circumstances which are unfavorable to the
Fund's remaining shareholders. The Fund pays a commitment fee to the banks for
the LOC.
CONVERTIBLE SECURITIES
The Fund may invest in convertible securities, which are bonds,
debentures, notes, preferred stocks, or other securities that may be converted
into or exchanged for a specified amount of common stock of the same or a
different issuer within a particular period of time at a specified price or
formula. A convertible security entitles the holder to receive interest
normally paid or accrued on debt or the dividend paid on preferred stock until
the convertible security matures or is redeemed, converted, or exchanged.
Convertible securities have unique investment characteristics in that they
generally (i) have higher yields than common stocks, but lower yields than
comparable non-convertible securities, (ii) are less subject to fluctuation in
value than the underlying stock since they have fixed income characteristics,
and (iii) provide the potential for capital appreciation if the market price of
the underlying common stock increases. Most convertible securities currently
are issued by U.S. companies, although a substantial Eurodollar convertible
securities market has developed, and the markets for convertible securities
denominated in local currencies are increasing.
The value of a convertible security is a function of its "investment
value" (determined by its yield in comparison with the yields of other
securities of comparable maturity and quality that do not have a conversion
privilege) and its "conversion value" (the security's worth, at market value,
if converted into the underlying common stock). The investment value of a
convertible security is influenced by changes in interest rates, with
investment value declining as interest rates increase and increasing as
interest rates decline. The credit standing of the issuer and other factors
also may have an effect on the convertible security's investment value. The
conversion value of a convertible security is determined by the market price of
the underlying common stock. If the conversion value is low relative to the
investment value, the price of the convertible security is governed principally
by its investment value. Generally, the conversion value decreases as the
convertible security approaches maturity. To the extent the market price of
the underlying common stock approaches or exceeds the conversion price, the
price of the convertible security will be increasingly influenced by its
conversion value. A convertible security generally will sell at a premium over
its conversion value by the extent to which investors place value on the right
to acquire the underlying common stock while holding a fixed income security.
A convertible security may be subject to redemption at the option of the
issuer at a price established in the convertible security's governing
instrument. If a convertible security held by the Fund is called for
redemption, the Fund will be required to permit the issuer to redeem the
security, convert it into the underlying common stock, or sell it to a third
party.
DEPOSITARY RECEIPTS
The Fund may invest in foreign securities by purchasing depositary
receipts, including American Depositary Receipts ("ADRs") and European
Depositary Receipts ("EDRs"), or other securities convertible into securities
of foreign issuers. These securities may not necessarily be denominated in the
same currency as the securities into which they may be converted. Generally,
ADRs, in registered form, are denominated in U.S. dollars and are designed for
use in the U.S. securities markets, while EDRs, in bearer form, may be
denominated in other currencies and are designed for use in the European
securities markets. ADRs are receipts typically issued by a U.S. bank or
trust company evidencing ownership of the underlying securities. EDRs are
European receipts evidencing a similar arrangement. For purposes of the Fund's
investment policies, ADRs and EDRs are deemed to have the same classification
as the underlying securities they represent, except that ADRs and EDRs shall be
treated as indirect foreign investments. Thus, an ADR or EDR representing
ownership of common stock will be treated as common stock. ADR and EDR
depositary receipts do not eliminate all of the risks associated with directly
investing in the securities of foreign issuers.
5
<PAGE> 256
ADR facilities may be established as either "unsponsored" or "sponsored."
While ADRs issued under these two types of facilities are in some respects
similar, there are distinctions between them relating to the rights and
obligations of ADR holders and the practices of market participants.
A depositary may establish an unsponsored facility without participation
by (or even necessarily the acquiescence of) the issuer of the deposited
securities, although typically the depositary requests a letter of
non-objection from such issuer prior to the establishment of the facility.
Holders of unsponsored ADRs generally bear all the costs of such facilities.
The depositary usually charges fees upon the deposit and withdrawal of the
deposited securities, the conversion of dividends into U.S. dollars, the
disposition of non-cash distributions, and the performance of other services.
The depositary of an unsponsored facility frequently is under no obligation to
pass through voting rights to ADR holders in respect of the deposited
securities. In addition, an unsponsored facility is generally not obligated to
distribute communications received from the issuer of the deposited securities
or to disclose material information about such issuer in the U.S. and thus
there may not be a correlation between such information and the market value of
the depositary receipts.
Sponsored ADR facilities are created in generally the same manner as
unsponsored facilities, except that the issuer of the deposited securities
enters into a deposit agreement with the depositary. The deposit agreement
sets out the rights and responsibilities of the issuer, the depositary, and the
ADR holders. With sponsored facilities, the issuer of the deposited securities
generally will bear some of the costs relating to the facility (such as
dividend payment fees of the depositary), although ADR holders continue to bear
certain other costs (such as deposit and withdrawal fees). Under the terms of
most sponsored arrangements, depositories agree to distribute notices of
shareholder meetings and voting instructions, and to provide shareholder
communications and other information to the ADR holders at the request of the
issuer of the deposited securities.
DERIVATIVE INSTRUMENTS
IN GENERAL. The Fund may use derivative instruments for any lawful
purpose consistent with the Fund's investment objective such as hedging or
managing risk. Derivative instruments are commonly defined to include
securities or contracts whose values depend on (or "derive" from) the value of
one or more other assets, such as securities, currencies, or commodities.
These "other assets" are commonly referred to as "underlying assets."
A derivative instrument generally consists of, is based upon, or exhibits
characteristics similar to options or forward contracts. Options and forward
contracts are considered to be the basic "building blocks" of derivatives. For
example, forward-based derivatives include forward contracts, swap contracts,
as well as exchange-traded futures. Option-based derivatives include privately
negotiated, over-the-counter (OTC) options (including caps, floors, collars,
and options on forward and swap contracts) and exchange-traded options on
futures. Diverse types of derivatives may be created by combining options or
forward contracts in different ways, and by applying these structures to a wide
range of underlying assets.
An option is a contract in which the "holder" (the buyer) pays a certain
amount (the "premium") to the "writer" (the seller) to obtain the right, but
not the obligation, to buy from the writer (in a "call") or sell to the writer
(in a "put") a specific asset at an agreed upon price at or before a certain
time. The holder pays the premium at inception and has no further financial
obligation. The holder of an option-based derivative generally will benefit
from favorable movements in the price of the underlying asset but is not
exposed to corresponding losses due to adverse movements in the value of the
underlying asset. The writer of an option-based derivative generally will
receive fees or premiums but generally is exposed to losses due to changes in
the value of the underlying asset.
A forward is a sales contract between a buyer (holding the "long"
position) and a seller (holding the "short" position) for an asset with
delivery deferred until a future date. The buyer agrees to pay a fixed price
at the agreed future date and the seller agrees to deliver the asset. The
seller hopes that the market price on the delivery date is less than the agreed
upon price, while the buyer hopes for the contrary. The change in value of a
forward-based derivative generally is roughly proportional to the change in
value of the underlying asset.
HEDGING. The Fund may use derivative instruments to protect against
possible adverse changes in the market value of securities held in, or are
anticipated to be held in, the Fund's portfolio. Derivatives may also be used
by the Fund to "lock-in" the Fund's realized but unrecognized gains in the
value of its portfolio securities. Hedging strategies, if successful, can
reduce the risk of loss by wholly or partially offsetting the negative effect
of unfavorable price movements in the investments
6
<PAGE> 257
being hedged. However, hedging strategies can also reduce the opportunity for
gain by offsetting the positive effect of favorable price movements in the
hedged investments.
MANAGING RISK. The Fund may also use derivative instruments to manage the
risks of the Fund's portfolio. Risk management strategies include, but are not
limited to, facilitating the sale of portfolio securities, managing the
effective maturity or duration of debt obligations in the Fund's portfolio,
establishing a position in the derivatives markets as a substitute for buying
or selling certain securities, or creating or altering exposure to certain
asset classes, such as equity, debt, and foreign securities. The use of
derivative instruments may provide a less expensive, more expedient or more
specifically focused way for the Fund to invest than "traditional" securities
(i.e., stocks or bonds) would.
EXCHANGE OR OTC DERIVATIVES. Derivative instruments may be
exchange-traded or traded in OTC transactions between private parties.
Exchange-traded derivatives are standardized options and futures contracts
traded in an auction on the floor of a regulated exchange. Exchange contracts
are generally very liquid. The exchange clearinghouse is the counterparty of
every contract. Thus, each holder of an exchange contract bears the credit
risk of the clearinghouse (and has the benefit of its financial strength)
rather than that of a particular counterparty. Over-the-counter transactions
are subject to additional risks, such as the credit risk of the counterparty to
the instrument and are less liquid than exchange-traded derivatives since they
often can only be closed out with the other party to the transaction.
RISKS AND SPECIAL CONSIDERATIONS. The use of derivative instruments
involves risks and special considerations as described below. Risks pertaining
to particular derivative instruments are described in the sections that follow.
(1) MARKET RISK. The primary risk of derivatives is the same as the risk
of the underlying assets, namely that the value of the underlying asset may go
up or down. Adverse movements in the value of an underlying asset can expose
the Fund to losses. Derivative instruments may include elements of leverage
and, accordingly, the fluctuation of the value of the derivative instrument in
relation to the underlying asset may be magnified. The successful use of
derivative instruments depends upon a variety of factors, particularly Strong
Capital Management, Inc.'s (the "Advisor") ability to predict movements of the
securities, currencies, and commodity markets, which requires different skills
than predicting changes in the prices of individual securities. There can be
no assurance that any particular strategy adopted will succeed. The Advisor's
decision to engage in a derivative instrument will reflect the Advisor's
judgment that the derivative transaction will provide value to the Fund and its
shareholders and is consistent with the Fund's objectives, investment
limitations, and operating policies. In making such a judgment, the Advisor
will analyze the benefits and risks of the derivative transaction and weigh
them in the context of the Fund's entire portfolio and investment objective.
(2) CREDIT RISK. The Fund will be subject to the risk that a loss may be
sustained by the Fund as a result of the failure of a counterparty to comply
with the terms of a derivative instrument. The counterparty risk for
exchange-traded derivative instruments is generally less than for
privately-negotiated or OTC derivative instruments, since generally a clearing
agency, which is the issuer or counterparty to each exchange-traded instrument,
provides a guarantee of performance. For privately-negotiated instruments,
there is no similar clearing agency guarantee. In all transactions, the Fund
will bear the risk that the counterparty will default, and this could result in
a loss of the expected benefit of the derivative transaction and possibly other
losses to the Fund. The Fund will enter into transactions in derivative
instruments only with counterparties that the Advisor reasonably believes are
capable of performing under the contract.
(3) CORRELATION RISK. When a derivative transaction is used to completely
hedge another position, changes in the market value of the combined position
(the derivative instrument plus the position being hedged) result from an
imperfect correlation between the price movements of the two instruments. With
a perfect hedge, the value of the combined position remains unchanged for any
change in the price of the underlying asset. With an imperfect hedge, the
values of the derivative instrument and its hedge are not perfectly correlated.
Correlation risk is the risk that there might be imperfect correlation, or
even no correlation, between price movements of an instrument and price
movements of investments being hedged. For example, if the value of a
derivative instruments used in a short hedge (such as writing a call option,
buying a put option, or selling a futures contract) increased by less than the
decline in value of the hedged investments, the hedge would not be perfectly
correlated. Such a lack of correlation might occur due to factors unrelated to
the value of the investments being hedged, such as speculative or other
pressures on the markets in which these instruments are traded. The
effectiveness of hedges using instruments on indices will depend, in part, on
the degree of correlation between price movements in the index and price
movements in the investments being hedged.
7
<PAGE> 258
(4) LIQUIDITY RISK. Derivatives are also subject to liquidity risk.
Liquidity risk is the risk that a derivative instrument cannot be sold, closed
out, or replaced quickly at or very close to its fundamental value. Generally,
exchange contracts are very liquid because the exchange clearinghouse is the
counterparty of every contract. OTC transactions are less liquid than
exchange-traded derivatives since they often can only be closed out with the
other party to the transaction. The Fund might be required by applicable
regulatory requirement to maintain assets as "cover," maintain segregated
accounts, and/or make margin payments when it takes positions in derivative
instruments involving obligations to third parties (i.e., instruments other
than purchased options). If the Fund was unable to close out its positions in
such instruments, it might be required to continue to maintain such assets or
accounts or make such payments until the position expired, matured, or was
closed out. The requirements might impair the Fund's ability to sell a
portfolio security or make an investment at a time when it would otherwise be
favorable to do so, or require that the Fund sell a portfolio security at a
disadvantageous time. The Fund's ability to sell or close out a position in an
instrument prior to expiration or maturity depends on the existence of a liquid
secondary market or, in the absence of such a market, the ability and
willingness of the counterparty to enter into a transaction closing out the
position. Therefore, there is no assurance that any derivatives position can
be sold or closed out at a time and price that is favorable to the Fund.
(5) LEGAL RISK. Legal risk is the risk of loss caused by the legal
unenforcibility of a party's obligations under the derivative. While a party
seeking price certainty agrees to surrender the potential upside in exchange
for downside protection, the party taking the risk is looking for a positive
payoff. Despite this voluntary assumption of risk, a counterparty that has
lost money in a derivative transaction may try to avoid payment by exploiting
various legal uncertainties about certain derivative products.
(6) SYSTEMIC OR "INTERCONNECTION" RISK. Interconnection risk is the risk
that a disruption in the financial markets will cause difficulties for all
market participants. In other words, a disruption in one market will spill
over into other markets, perhaps creating a chain reaction. Much of the OTC
derivatives market takes place among the OTC dealers themselves, thus creating
a large interconnected web of financial obligations. This interconnectedness
raises the possibility that a default by one large dealer could create losses
at other dealers and destabilize the entire market for OTC derivative
instruments.
GENERAL LIMITATIONS. The use of derivative instruments is subject to
applicable regulations of the Securities and Exchange Commission (the "SEC"),
the several options and futures exchanges upon which they may be traded, the
Commodity Futures Trading Commission ("CFTC"), and various state regulatory
authorities. In addition, the Fund's ability to use derivative instruments may
be limited by certain tax considerations. For a discussion of the federal
income tax treatment of the Fund's derivative instruments, see "Taxes -
Derivative Instruments."
The Fund has filed a notice of eligibility for exclusion from the
definition of the term "commodity pool operator" with the CFTC and the National
Futures Association, which regulate trading in the futures markets. In
accordance with Rule 4.5 of the regulations under the Commodity Exchange Act
(the "CEA"), the notice of eligibility for the Fund includes representations
that the Fund will use futures contracts and related options solely for bona
fide hedging purposes within the meaning of CFTC regulations, provided that the
Fund may hold other positions in futures contracts and related options that do
not qualify as a bona fide hedging position if the aggregate initial margin
deposits and premiums required to establish these positions, less the amount by
which any such futures contracts and related options positions are "in the
money," do not exceed 5% of the Fund's net assets. Adherence to these
guidelines does not limit the Fund's risk to 5% of the Fund's assets.
The SEC has identified certain trading practices involving derivative
instruments that involve the potential for leveraging the Fund's assets in a
manner that raises issues under the 1940 Act. In order to limit the potential
for the leveraging of the Fund's assets, as defined under the 1940 Act, the SEC
has stated that the Fund may use coverage or the segregation of the Fund's
assets. To the extent required by SEC guidelines, the Fund will not enter into
any such transactions unless it owns either: (i) an offsetting ("covered")
position in securities, options, futures, or derivative instruments; or (ii)
cash or liquid securities positions with a value sufficient at all times to
cover its potential obligations to the extent that the position is not
"covered". The Fund will also set aside cash and/or appropriate liquid assets
in a segregated custodial account if required to do so by the SEC and CFTC
regulations. Assets used as cover or held in a segregated account cannot be
sold while the
>
8
<PAGE> 259
derivative position is open, unless they are replaced with similar assets. As
a result, the commitment of a large portion of the Fund's assets to segregated
accounts could impede portfolio management or the Fund's ability to meet
redemption requests or other current obligations.
In some cases the Fund may be required to maintain or limit exposure to a
specified percentage of its assets to a particular asset class. In such cases,
when the Fund uses a derivative instrument to increase or decrease exposure to
an asset class and is required by applicable SEC guidelines to set aside liquid
assets in a segregated account to secure its obligations under the derivative
instruments, the Advisor may, where reasonable in light of the circumstances,
measure compliance with the applicable percentage by reference to the nature of
the economic exposure created through the use of the derivative instrument and
not by reference to the nature of the exposure arising from the liquid assets
set aside in the segregated account (unless another interpretation is specified
by applicable regulatory requirements).
OPTIONS. The Fund may use options for any lawful purpose consistent with
the Fund's investment objective such as hedging or managing risk. An option is
a contract in which the "holder" (the buyer) pays a certain amount (the
"premium") to the "writer" (the seller) to obtain the right, but not the
obligation, to buy from the writer (in a "call") or sell to the writer (in a
"put") a specific asset at an agreed upon price (the "strike price" or
"exercise price") at or before a certain time (the "expiration date"). The
holder pays the premium at inception and has no further financial obligation.
The holder of an option will benefit from favorable movements in the price of
the underlying asset but is not exposed to corresponding losses due to adverse
movements in the value of the underlying asset. The writer of an option will
receive fees or premiums but is exposed to losses due to changes in the value
of the underlying asset. The Fund may buy or write (sell) put and call options
on assets, such as securities, currencies, commodities, and indices of debt and
equity securities ("underlying assets") and enter into closing transactions
with respect to such options to terminate an existing position. Options used
by the Fund may include European, American, and Bermuda style options. If an
option is exercisable only at maturity, it is a "European" option; if it is
also exercisable prior to maturity, it is an "American" option. If it is
exercisable only at certain times, it is a "Bermuda" option.
The Fund may purchase (buy) and write (sell) put and call options
underlying assets and enter into closing transactions with respect to such
options to terminate an existing position. The purchase of call options serves
as a long hedge, and the purchase of put options serves as a short hedge.
Writing put or call options can enable the Fund to enhance income by reason of
the premiums paid by the purchaser of such options. Writing call options
serves as a limited short hedge because declines in the value of the hedged
investment would be offset to the extent of the premium received for writing
the option. However, if the security appreciates to a price higher than the
exercise price of the call option, it can be expected that the option will be
exercised and the Fund will be obligated to sell the security at less than its
market value or will be obligated to purchase the security at a price greater
than that at which the security must be sold under the option. All or a
portion of any assets used as cover for OTC options written by the Fund would
be considered illiquid to the extent described under "Investment Policies and
Techniques -- Illiquid Securities." Writing put options serves as a limited
long hedge because increases in the value of the hedged investment would be
offset to the extent of the premium received for writing the option. However,
if the security depreciates to a price lower than the exercise price of the put
option, it can be expected that the put option will be exercised and the Fund
will be obligated to purchase the security at more than its market value.
The value of an option position will reflect, among other things, the
historical price volatility of the underlying investment, the current market
value of the underlying investment, the time remaining until expiration, the
relationship of the exercise price to the market price of the underlying
investment, and general market conditions.
The Fund may effectively terminate its right or obligation under an option
by entering into a closing transaction. For example, the Fund may terminate
its obligation under a call or put option that it had written by purchasing an
identical call or put option; this is known as a closing purchase transaction.
Conversely, the Fund may terminate a position in a put or call option it had
purchased by writing an identical put or call option; this is known as a
closing sale transaction. Closing transactions permit the Fund to realize the
profit or limit the loss on an option position prior to its exercise or
expiration.
The Fund may purchase or write both exchange-traded and OTC options.
Exchange-traded options are issued by a clearing organization affiliated with
the exchange on which the option is listed that, in effect, guarantees
completion of every exchange-traded option transaction. In contrast, OTC
options are contracts between the Fund and the other party to the transaction
("counter party") (usually a securities dealer or a bank) with no clearing
organization guarantee. Thus, when the Fund purchases or writes an OTC option,
it relies on the counter party to make or take delivery of the underlying
investment
9
<PAGE> 260
upon exercise of the option. Failure by the counter party to do so would
result in the loss of any premium paid by the Fund as well as the loss of any
expected benefit of the transaction.
The Fund's ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The Fund intends to
purchase or write only those exchange-traded options for which there appears to
be a liquid secondary market. However, there can be no assurance that such a
market will exist at any particular time. Closing transactions can be made for
OTC options only by negotiating directly with the counter party, or by a
transaction in the secondary market if any such market exists. Although the
Fund will enter into OTC options only with counter parties that are expected to
be capable of entering into closing transactions with the Fund, there is no
assurance that the Fund will in fact be able to close out an OTC option at a
favorable price prior to expiration. In the event of insolvency of the counter
party, the Fund might be unable to close out an OTC option position at any time
prior to its expiration. If the Fund were unable to effect a closing
transaction for an option it had purchased, it would have to exercise the
option to realize any profit.
The Fund may engage in options transactions on indices in much the same
manner as the options on securities discussed above, except the index options
may serve as a hedge against overall fluctuations in the securities market in
general.
The writing and purchasing of options is a highly specialized activity
that involves investment techniques and risks different from those associated
with ordinary portfolio securities transactions. Imperfect correlation between
the options and securities markets may detract from the effectiveness of
attempted hedging.
SPREAD TRANSACTIONS. The Fund may use spread transactions for any lawful
purpose consistent with the Fund's investment objective such as hedging or
managing risk. The Fund may purchase covered spread options from securities
dealers. Such covered spread options are not presently exchange-listed or
exchange-traded. The purchase of a spread option gives the Fund the right to
put, or sell, a security that it owns at a fixed dollar spread or fixed yield
spread in relationship to another security that the Fund does not own, but
which is used as a benchmark. The risk to the Fund in purchasing covered
spread options is the cost of the premium paid for the spread option and any
transaction costs. In addition, there is no assurance that closing
transactions will be available. The purchase of spread options will be used to
protect the Fund against adverse changes in prevailing credit quality spreads,
i.e., the yield spread between high quality and lower quality securities. Such
protection is only provided during the life of the spread option.
FUTURES CONTRACTS. The Fund may use futures contracts for any lawful
purpose consistent with the Fund's investment objective such as hedging or
managing risk. The Fund may enter into futures contracts, including interest
rate, index, and currency futures. The Fund may also purchase put and call
options, and write covered put and call options, on futures in which it is
allowed to invest. The purchase of futures or call options thereon can serve
as a long hedge, and the sale of futures or the purchase of put options thereon
can serve as a short hedge. Writing covered call options on futures contracts
can serve as a limited short hedge, and writing covered put options on futures
contracts can serve as a limited long hedge, using a strategy similar to that
used for writing covered options in securities. The Fund's hedging may include
purchases of futures as an offset against the effect of expected increases in
currency exchange rates and securities prices and sales of futures as an offset
against the effect of expected declines in currency exchange rates and
securities prices. The Fund may also write put options on futures contracts
while at the same time purchasing call options on the same futures contracts in
order to create synthetically a long futures contract position. Such options
would have the same strike prices and expiration dates. The Fund will engage
in this strategy only when the Advisor believes it is more advantageous to the
Fund than is purchasing the futures contract.
To the extent required by regulatory authorities, the Fund only enters
into futures contracts that are traded on national futures exchanges and are
standardized as to maturity date and underlying financial instrument. Futures
exchanges and trading are regulated under the CEA by the CFTC. Although
techniques other than sales and purchases of futures contracts could be used to
reduce the Fund's exposure to market, currency, or interest rate fluctuations,
the Fund may be able to hedge its exposure more effectively and perhaps at a
lower cost through using futures contracts.
An interest rate futures contract provides for the future sale by one
party and purchase by another party of a specified amount of a specific
financial instrument (e.g., debt security) or currency for a specified price at
a designated date, time, and place. An index futures contract is an agreement
pursuant to which the parties agree to take or make delivery of an amount of
cash equal to the difference between the value of the index at the close of the
last trading day of the contract and the price at which the index futures
contract was originally written. Transaction costs are incurred when a futures
contract is bought or sold
10
<PAGE> 261
and margin deposits must be maintained. A futures contract may be satisfied by
delivery or purchase, as the case may be, of the instrument, the currency or by
payment of the change in the cash value of the index. More commonly, futures
contracts are closed out prior to delivery by entering into an offsetting
transaction in a matching futures contract. Although the value of an index
might be a function of the value of certain specified securities, no physical
delivery of those securities is made. If the offsetting purchase price is less
than the original sale price, the Fund realizes a gain; if it is more, the Fund
realizes a loss. Conversely, if the offsetting sale price is more than the
original purchase price, the Fund realizes a gain; if it is less, the Fund
realizes a loss. The transaction costs must also be included in these
calculations. There can be no assurance, however, that the Fund will be able
to enter into an offsetting transaction with respect to a particular futures
contract at a particular time. If the Fund is not able to enter into an
offsetting transaction, the Fund will continue to be required to maintain the
margin deposits on the futures contract.
No price is paid by the Fund upon entering into a futures contract.
Instead, at the inception of a futures contract, the Fund is required to
deposit in a segregated account with its custodian, in the name of the futures
broker through whom the transaction was effected, "initial margin" consisting
of cash and/or other appropriate liquid assets in an amount generally equal to
10% or less of the contract value. Margin must also be deposited when writing
a call or put option on a futures contract, in accordance with applicable
exchange rules. Unlike margin in securities transactions, initial margin on
futures contracts does not represent a borrowing, but rather is in the nature
of a performance bond or good-faith deposit that is returned to the Fund at the
termination of the transaction if all contractual obligations have been
satisfied. Under certain circumstances, such as periods of high volatility,
the Fund may be required by an exchange to increase the level of its initial
margin payment, and initial margin requirements might be increased generally in
the future by regulatory action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of the Fund's obligations to or from a futures
broker. When the Fund purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast, when the Fund purchases
or sells a futures contract or writes a call or put option thereon, it is
subject to daily variation margin calls that could be substantial in the event
of adverse price movements. If the Fund has insufficient cash to meet daily
variation margin requirements, it might need to sell securities at a time when
such sales are disadvantageous. Purchasers and sellers of futures positions
and options on futures can enter into offsetting closing transactions by
selling or purchasing, respectively, an instrument identical to the instrument
held or written. Positions in futures and options on futures may be closed
only on an exchange or board of trade that provides a secondary market. The
Fund intends to enter into futures transactions only on exchanges or boards of
trade where there appears to be a liquid secondary market. However, there can
be no assurance that such a market will exist for a particular contract at a
particular time.
Under certain circumstances, futures exchanges may establish daily limits
on the amount that the price of a future or option on a futures contract can
vary from the previous day's settlement price; once that limit is reached, no
trades may be made that day at a price beyond the limit. Daily price limits do
not limit potential losses because prices could move to the daily limit for
several consecutive days with little or no trading, thereby preventing
liquidation of unfavorable positions.
If the Fund were unable to liquidate a futures or option on a futures
contract position due to the absence of a liquid secondary market or the
imposition of price limits, it could incur substantial losses. The Fund would
continue to be subject to market risk with respect to the position. In
addition, except in the case of purchased options, the Fund would continue to
be required to make daily variation margin payments and might be required to
maintain the position being hedged by the future or option or to maintain cash
or securities in a segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or options on futures contracts
might not correlate perfectly with movements in the prices of the investments
being hedged. For example, all participants in the futures and options on
futures contracts markets are subject to daily variation margin calls and might
be compelled to liquidate futures or options on futures contracts positions
whose prices are moving unfavorably to avoid being subject to further calls.
These liquidations could increase price volatility of the instruments and
distort the normal price relationship between the futures or options and the
investments being hedged. Also, because initial margin deposit requirements in
the futures markets are less onerous than margin requirements in the securities
markets, there might be increased participation by speculators in the future
markets. This participation also might cause temporary price distortions. In
11
<PAGE> 262
addition, activities of large traders in both the futures and securities
markets involving arbitrage, "program trading" and other investment strategies
might result in temporary price distortions.
FOREIGN CURRENCIES. The Fund may purchase and sell foreign currency on a
spot basis, and may use currency-related derivatives instruments such as
options on foreign currencies, futures on foreign currencies, options on
futures on foreign currencies and forward currency contracts (i.e., an
obligation to purchase or sell a specific currency at a specified future date,
which may be any fixed number of days from the contract date agreed upon by the
parties, at a price set at the time the contract is entered into). The Fund
may use these instruments for hedging or any other lawful purpose consistent
with its investment objective, including transaction hedging, anticipatory
hedging, cross hedging, proxy hedging, and position hedging. The Fund's use of
currency-related derivative instruments will be directly related to the Fund's
current or anticipated portfolio securities, and the Fund may engage in
transactions in currency-related derivative instruments as a means to protect
against some or all of the effects of adverse changes in foreign currency
exchange rates on its portfolio investments. In general, if the currency in
which a portfolio investment is denominated appreciates against the U.S.
dollar, the dollar value of the security will increase. Conversely, a decline
in the exchange rate of the currency would adversely affect the value of the
portfolio investment expressed in U.S. dollars.
For example, the Fund might use currency-related derivative instruments to
"lock in" a U.S. dollar price for a portfolio investment, thereby enabling the
Fund to protect itself against a possible loss resulting from an adverse change
in the relationship between the U.S. dollar and the subject foreign currency
during the period between the date the security is purchased or sold and the
date on which payment is made or received. The Fund also might use
currency-related derivative instruments when the Advisor believes that one
currency may experience a substantial movement against another currency,
including the U.S. dollar, and it may use currency-related derivative
instruments to sell or buy the amount of the former foreign currency,
approximating the value of some or all of the Fund's portfolio securities
denominated in such foreign currency. Alternatively, where appropriate, the
Fund may use currency-related derivative instruments to hedge all or part of
its foreign currency exposure through the use of a basket of currencies or a
proxy currency where such currency or currencies act as an effective proxy for
other currencies. The use of this basket hedging technique may be more
efficient and economical than using separate currency-related derivative
instruments for each currency exposure held by the Fund. Furthermore,
currency-related derivative instruments may be used for short hedges - for
example, the Fund may sell a forward currency contract to lock in the U.S.
dollar equivalent of the proceeds from the anticipated sale of a security
denominated in a foreign currency.
In addition, the Fund may use a currency-related derivative instrument to
shift exposure to foreign currency fluctuations from one foreign country to
another foreign country where the Advisor believes that the foreign currency
exposure purchased will appreciate relative to the U.S. dollar and thus better
protect the Fund against the expected decline in the foreign currency exposure
sold. For example, if the Fund owns securities denominated in a foreign
currency and the Advisor believes that currency will decline, it might enter
into a forward contract to sell an appropriate amount of the first foreign
currency, with payment to be made in a second foreign currency that the Advisor
believes would better protect the Fund against the decline in the first
security than would a U.S. dollar exposure. Hedging transactions that use two
foreign currencies are sometimes referred to as "cross hedges." The effective
use of currency-related derivative instruments by the Fund in a cross hedge is
dependent upon a correlation between price movements of the two currency
instruments and the underlying security involved, and the use of two currencies
magnifies the risk that movements in the price of one instrument may not
correlate or may correlate unfavorably with the foreign currency being hedged.
Such a lack of correlation might occur due to factors unrelated to the value of
the currency instruments used or investments being hedged, such as speculative
or other pressures on the markets in which these instruments are traded.
The Fund also might seek to hedge against changes in the value of a
particular currency when no hedging instruments on that currency are available
or such hedging instruments are more expensive than certain other hedging
instruments. In such cases, the Fund may hedge against price movements in that
currency by entering into transactions using currency-related derivative
instruments on another foreign currency or a basket of currencies, the values
of which the Advisor believes will have a high degree of positive correlation
to the value of the currency being hedged. The risk that movements in the
price of the hedging instrument will not correlate perfectly with movements in
the price of the currency being hedged is magnified when this strategy is used.
The use of currency-related derivative instruments by the Fund involves a
number of risks. The value of currency-related derivative instruments depends
on the value of the underlying currency relative to the U.S. dollar. Because
foreign
12
<PAGE> 263
currency transactions occurring in the interbank market might involve
substantially larger amounts than those involved in the use of such derivative
instruments, the Fund could be disadvantaged by having to deal in the 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 (generally consisting of transactions of greater than $1 million).
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis.
Quotation information generally is representative of very large transactions in
the interbank market and thus might not reflect odd-lot transactions where
rates might be less favorable. The interbank market in foreign currencies is a
global, round-the-clock market. To the extent the U.S. options or futures
markets are closed while the markets for the underlying currencies remain open,
significant price and rate movements might take place in the underlying markets
that cannot be reflected in the markets for the derivative instruments until
they re-open.
Settlement of transactions in currency-related derivative instruments
might be required to take place within the country issuing the underlying
currency. Thus, the Fund might be required to accept or make delivery of the
underlying foreign currency in accordance with any U.S. or foreign regulations
regarding the maintenance of foreign banking arrangements by U.S. residents
and might be required to pay any fees, taxes and charges associated with such
delivery assessed in the issuing country.
When the Fund engages in a transaction in a currency-related derivative
instrument, it relies on the counterparty to make or take delivery of the
underlying currency at the maturity of the contract or otherwise complete the
contract. In other words, the Fund will be subject to the risk that a loss may
be sustained by the Fund as a result of the failure of the counterparty to
comply with the terms of the transaction. The counterparty risk for
exchange-traded instruments is generally less than for privately-negotiated or
OTC currency instruments, since generally a clearing agency, which is the
issuer or counterparty to each instrument, provides a guarantee of performance.
For privately-negotiated instruments, there is no similar clearing agency
guarantee. In all transactions, the Fund will bear the risk that the
counterparty will default, and this could result in a loss of the expected
benefit of the transaction and possibly other losses to the Fund. The Fund
will enter into transactions in currency-related derivative instruments only
with counterparties that the Advisor reasonably believes are capable of
performing under the contract.
Purchasers and sellers of currency-related derivative instruments may
enter into offsetting closing transactions by selling or purchasing,
respectively, an instrument identical to the instrument purchased or sold.
Secondary markets generally do not exist for forward currency contracts, with
the result that closing transactions generally can be made for forward currency
contracts only by negotiating directly with the counterparty. Thus, there can
be no assurance that the Fund will in fact be able to close out a forward
currency contract (or any other currency-related derivative instrument) at a
time and price favorable to the Fund. In addition, in the event of insolvency
of the counterparty, the Fund might be unable to close out a forward currency
contract at any time prior to maturity. In the case of an exchange-traded
instrument, the Fund will be able to close the position out only on an exchange
which provides a market for the instruments. The ability to establish and
close out positions on an exchange is subject to the maintenance of a liquid
market, and there can be no assurance that a liquid market will exist for any
instrument at any specific time. In the case of a privately-negotiated
instrument, the Fund will be able to realize the value of the instrument only
by entering into a closing transaction with the issuer or finding a third party
buyer for the instrument. While the Fund will enter into privately-negotiated
transactions only with entities who are expected to be capable of entering into
a closing transaction, there can be no assurance that the Fund will in fact be
able to enter into such closing transactions.
The precise matching of currency-related derivative instrument amounts and
the value of the portfolio securities involved generally will not be possible
because the value of such securities, measured in the foreign currency, will
change after the currency-related derivative instrument position has been
established. Thus, the Fund might need to purchase or sell foreign currencies
in the spot (cash) market. The projection of short-term currency market
movements is extremely difficult, and the successful execution of a short-term
hedging strategy is highly uncertain.
Permissible foreign currency options will include options traded primarily
in the OTC market. Although options on foreign currencies are traded primarily
in the OTC market, the Fund will normally purchase or sell OTC options on
foreign currency only when the Advisor reasonably believes a liquid secondary
market will exist for a particular option at any specific time.
13
<PAGE> 264
There will be a cost to the Fund of engaging in transactions in
currency-related derivative instruments that will vary with factors such as the
contract or currency involved, the length of the contract period and the market
conditions then prevailing. The Fund using these instruments may have to pay a
fee or commission or, in cases where the instruments are entered into on a
principal basis, foreign exchange dealers or other counterparties will realize
a profit based on the difference ("spread") between the prices at which they
are buying and selling various currencies. Thus, for example, a dealer may
offer to sell a foreign currency to the Fund at one rate, while offering a
lesser rate of exchange should the Fund desire to resell that currency to the
dealer.
When required by the SEC guidelines, the Fund will set aside permissible
liquid assets in segregated accounts or otherwise cover its potential
obligations under currency-related derivatives instruments. To the extent the
Fund's assets are so set aside, they cannot be sold while the corresponding
currency position is open, unless they are replaced with similar assets. As a
result, if a large portion of the Fund's assets are so set aside, this could
impede portfolio management or the Fund's ability to meet redemption requests
or other current obligations.
The Advisor's decision to engage in a transaction in a particular
currency-related derivative instrument will reflect the Advisor's judgment that
the transaction will provide value to the Fund and its shareholders and is
consistent with the Fund's objectives and policies. In making such a judgment,
the Advisor will analyze the benefits and risks of the transaction and weigh
them in the context of the Fund's entire portfolio and objectives. The
effectiveness of any transaction in a currency-related derivative instrument is
dependent on a variety of factors, including the Advisor's skill in analyzing
and predicting currency values and upon a correlation between price movements
of the currency instrument and the underlying security. There might be
imperfect correlation, or even no correlation, between price movements of an
instrument and price movements of investments being hedged. Such a lack of
correlation might occur due to factors unrelated to the value of the
investments being hedged, such as speculative or other pressures on the markets
in which these instruments are traded. In addition, the Fund's use of
currency-related derivative instruments is always subject to the risk that the
currency in question could be devalued by the foreign government. In such a
case, any long currency positions would decline in value and could adversely
affect any hedging position maintained by the Fund.
The Fund's dealing in currency-related derivative instruments will
generally be limited to the transactions described above. However, the Fund
reserves the right to use currency-related derivatives instruments for
different purposes and under different circumstances. Of course, the Fund is
not required to use currency-related derivatives instruments and will not do so
unless deemed appropriate by the Advisor. It also should be realized that use
of these instruments does not eliminate, or protect against, price movements in
the Fund's securities that are attributable to other (i.e., non-currency
related) causes. Moreover, while the use of currency-related derivatives
instruments may reduce the risk of loss due to a decline in the value of a
hedged currency, at the same time the use of these instruments tends to limit
any potential gain which may result from an increase in the value of that
currency.
SWAP AGREEMENTS. The Fund may enter into interest rate, securities index,
commodity, or security and currency exchange rate swap agreements for any
lawful purpose consistent with the Fund's investment objective, such as for the
purpose of attempting to obtain or preserve a particular desired return or
spread at a lower cost to the Fund than if the Fund had invested directly in an
instrument that yielded that desired return or spread. The Fund also may enter
into swaps in order to protect against an increase in the price of, or the
currency exchange rate applicable to, securities that the Fund anticipates
purchasing at a later date. Swap agreements are two-party contracts entered
into primarily by institutional investors for periods ranging from a few weeks
to several years. In a standard "swap" transaction, two parties agree to
exchange the returns (or differentials in rates of return) earned or realized
on particular predetermined investments or instruments. The gross returns to
be exchanged or "swapped" between the parties are calculated with respect to a
"notional amount," i.e., the return on or increase in value of a particular
dollar amount invested at a particular interest rate, in a particular foreign
currency, or in a "basket" of securities representing a particular index. Swap
agreements may include interest rate caps, under which, in return for a
premium, one party agrees to make payments to the other to the extent that
interest rates exceed a specified rate, or "cap;" interest rate floors, under
which, in return for a premium, one party agrees to make payments to the other
to the extent that interest rates fall below a specified level, or "floor;" and
interest rate collars, under which a party sells a cap and purchases a floor,
or vice versa, in an attempt to protect itself against interest rate movements
exceeding given minimum or maximum levels.
14
<PAGE> 265
The "notional amount" of the swap agreement is the agreed upon basis for
calculating the obligations that the parties to a swap agreement have agreed to
exchange. Under most swap agreements entered into by the Fund, the obligations
of the parties would be exchanged on a "net basis." Consequently, the Fund's
obligation (or rights) under a swap agreement will generally be equal only to
the net amount to be paid or received under the agreement based on the relative
values of the positions held by each party to the agreement (the "net amount").
The Fund's obligation under a swap agreement will be accrued daily (offset
against amounts owed to the Fund) and any accrued but unpaid net amounts owed
to a swap counterparty will be covered by the maintenance of a segregated
account consisting of cash, or liquid high grade debt obligations.
Whether the Fund's use of swap agreements will be successful in furthering
its investment objective will depend, in part, on the Advisor's ability to
predict correctly whether certain types of investments are likely to produce
greater returns than other investments. Swap agreements may be considered to
be illiquid. Moreover, the Fund bears the risk of loss of the amount expected
to be received under a swap agreement in the event of the default or bankruptcy
of a swap agreement counterparty. Certain restrictions imposed on the Fund by
the Internal Revenue Code may limit the Fund's ability to use swap agreements.
The swaps market is largely unregulated.
The Fund will enter swap agreements only with counterparties that the
Advisor reasonably believes are capable of performing under the swap
agreements. If there is a default by the other party to such a transaction,
the Fund will have to rely on its contractual remedies (which may be limited by
bankruptcy, insolvency or similar laws) pursuant to the agreements related to
the transaction.
ADDITIONAL DERIVATIVE INSTRUMENTS AND STRATEGIES. In addition to the
derivative instruments and strategies described above and in the Fund's
Prospectus, the Advisor expects to discover additional derivative instruments
and other hedging or risk management techniques. The Advisor may utilize these
new derivative instruments and techniques to the extent that they are
consistent with the Fund's investment objective and permitted by the Fund's
investment limitations, operating policies, and applicable regulatory
authorities.
FOREIGN INVESTMENT COMPANIES
The Fund may invest, to a limited extent, in foreign investment
companies. Some of the countries in which the Fund invests may not permit
direct investment by outside investors. Investments in such countries may
only be permitted through foreign government-approved or -authorized
investment vehicles, which may include other investment companies. In
addition, it may be less expensive and more expedient for the Fund to invest
in a foreign investment company in a country which permits direct foreign
investment. Investing through such vehicles may involve frequent or layered
fees or expenses and may also be subject to limitation under the 1940 Act.
Under the 1940 Act, the Fund may invest up to 10% of its assets in shares of
other investment companies and up to 5% of its assets in any one investment
company as long as the investment does not represent more than 3% of the
voting stock of the acquired investment company. The Fund does not intend to
invest in such investment companies unless, in the judgment of the Advisor,
the potential benefits of such investments justify the payment of any
associated fees and expenses.
FOREIGN SECURITIES
Investing in foreign securities involves a series of risks not present in
investing in U.S. securities. Many of the foreign securities held by the Fund
will not be registered with the Securities and Exchange Commission (the "SEC"),
nor will the foreign issuers be subject to SEC reporting requirements.
Accordingly, there may be less publicly available information concerning
foreign issuers of securities held by the Fund than is available concerning
U.S. companies. Disclosure and regulatory standards in many respects are less
stringent in emerging market countries than in the U.S. and other major
markets. There also may be a lower level of monitoring and regulation of
emerging markets and the activities of investors in such markets, and
enforcement of existing regulations may be extremely limited. Foreign
companies, and in particular, companies in smaller and emerging capital markets
are not generally subject to uniform accounting, auditing and financial
reporting standards, or to other regulatory requirements comparable to those
applicable to U.S. companies. The Fund's net investment income and capital
gains from its foreign investment activities may be subject to non-U.S.
withholding taxes.
The costs attributable to foreign investing that the Fund must bear
frequently are higher than those attributable to domestic investing; this is
particularly true with respect to emerging capital markets. For example, the
cost of maintaining
15
<PAGE> 266
custody of foreign securities exceeds custodian costs for domestic securities,
and transaction and settlement costs of foreign investing also frequently are
higher than those attributable to domestic investing. Costs associated with the
exchange of currencies also make foreign investing more expensive than domestic
investing. Investment income on certain foreign securities in which the Fund
may invest may be subject to foreign withholding or other government taxes that
could reduce the return of these securities. Tax treaties between the United
States and foreign countries, however, may reduce or eliminate the amount of
foreign tax to which the Fund would be subject.
Foreign markets also have different clearance and settlement procedures,
and in certain markets there have been times when settlements have failed to
keep pace with the volume of securities transactions, making it difficult to
conduct such transactions. Delays in settlement could result in temporary
periods when assets of the Fund are uninvested and no return is earned thereon.
The inability of the Fund to make intended security purchases due to
settlement problems could cause the Fund to miss investment opportunities.
Inability to dispose of a portfolio security due to settlement problems could
result either in losses to the Fund due to subsequent declines in the value of
such portfolio security or, if the Fund has entered into a contract to sell the
security, could result in possible liability to the purchaser.
HIGH-YIELD (HIGH-RISK) SECURITIES
IN GENERAL. The Fund may invest up to 25% of its net assets only in
non-investment grade debt obligations rated in the fifth highest rating
category (e.g., BB by S&P) or comparable unrated securities. Securities rated
BB are considered the least specultative of non-investment grade debt
obligations. Lower-quality securities, while generally offering higher yields
than investment grade securities with similar maturities, involve greater
risks, including the possibility of default or bankruptcy. They are regarded
as predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal. The special risk considerations in connection
with investments in these securities are discussed below. Refer to the
Appendix for a discussion of securities ratings.
EFFECT OF INTEREST RATES AND ECONOMIC CHANGES. The lower-quality and
comparable unrated security market is relatively new and its growth has
paralleled a long economic expansion. As a result, it is not clear how this
market may withstand a prolonged recession or economic downturn. Such
conditions could severely disrupt the market for and adversely affect the value
of such securities.
All interest-bearing securities typically experience appreciation when
interest rates decline and depreciation when interest rates rise. The market
values of lower-quality and comparable unrated securities tend to reflect
individual corporate developments to a greater extent than do higher rated
securities, which react primarily to fluctuations in the general level of
interest rates. Lower-quality and comparable unrated securities also tend to
be more sensitive to economic conditions than are higher-rated securities. As
a result, they generally involve more credit risks than securities in the
higher-rated categories. During an economic downturn or a sustained period of
rising interest rates, highly leveraged issuers of lower-quality and comparable
unrated securities may experience financial stress and may not have sufficient
revenues to meet their payment obligations. The issuer's ability to service
its debt obligations may also be adversely affected by specific corporate
developments, the issuer's inability to meet specific projected business
forecasts or the unavailability of additional financing. The risk of loss due
to default by an issuer of these securities is significantly greater than
issuers of higher-rated securities because such securities are generally
unsecured and are often subordinated to other creditors. Further, if the
issuer of a lower-quality or comparable unrated security defaulted, the Fund
might incur additional expenses to seek recovery. Periods of economic
uncertainty and changes would also generally result in increased volatility in
the market prices of these securities and thus in the Fund's net asset value.
As previously stated, the value of a lower-quality or comparable unrated
security will decrease in a rising interest rate market and accordingly, so
will the Fund's net asset value. If the Fund experiences unexpected net
redemptions in such a market, it may be forced to liquidate a portion of its
portfolio securities without regard to their investment merits. Due to the
limited liquidity of lower-quality and comparable unrated securities (discussed
below), the Fund may be forced to liquidate these securities at a substantial
discount. Any such liquidation would force the Fund to sell the more liquid
portion of its portfolio.
PAYMENT EXPECTATIONS. Lower-quality and comparable unrated securities
typically contain redemption, call or prepayment provisions which permit the
issuer of such securities containing such provisions to, at its discretion,
redeem the
16
<PAGE> 267
securities. During periods of falling interest rates, issuers of these
securities are likely to redeem or prepay the securities and refinance them
with debt securities with a lower interest rate. To the extent an issuer is
able to refinance the securities, or otherwise redeem them, the Fund may have
to replace the securities with a lower yielding security, which would result in
a lower return for the Fund.
CREDIT RATINGS. Credit ratings issued by credit rating agencies are
designed to evaluate the safety of principal and interest payments of rated
securities. They do not, however, evaluate the market value risk of
lower-quality securities and, therefore, may not fully reflect the true risks
of an investment. In addition, credit rating agencies may or may not make
timely changes in a rating to reflect changes in the economy or in the
condition of the issuer that affect the market value of the security.
Consequently, credit ratings are used only as a preliminary indicator of
investment quality. Investments in lower-quality and comparable unrated
obligations will be more dependent on the Advisor's credit analysis than would
be the case with investments in investment-grade debt obligations. The Advisor
employs its own credit research and analysis, which includes a study of
existing debt, capital structure, ability to service debt and to pay dividends,
the issuer's sensitivity to economic conditions, its operating history and the
current trend of earnings. The Advisor continually monitors the investments in
the Fund's portfolio and carefully evaluates whether to dispose of or to retain
lower-quality and comparable unrated securities whose credit ratings or credit
quality may have changed.
LIQUIDITY AND VALUATION. The Fund may have difficulty disposing of
certain lower-quality and comparable unrated securities because there may be a
thin trading market for such securities. Because not all dealers maintain
markets in all lower-quality and comparable unrated securities, there is no
established retail secondary market for many of these securities. The Fund
anticipates that such securities could be sold only to a limited number of
dealers or institutional investors. To the extent a secondary trading market
does exist, it is generally not as liquid as the secondary market for
higher-rated securities. The lack of a liquid secondary market may have an
adverse impact on the market price of the security. As a result, the Fund's
asset value and ability to dispose of particular securities, when necessary to
meet the Fund's liquidity needs or in response to a specific economic event,
may be impacted. The lack of a liquid secondary market for certain securities
may also make it more difficult for the Fund to obtain accurate market
quotations for purposes of valuing the Fund's portfolio. Market quotations are
generally available on many lower-quality and comparable unrated issues only
from a limited number of dealers and may not necessarily represent firm bids of
such dealers or prices for actual sales. During periods of thin trading, the
spread between bid and asked prices is likely to increase significantly. In
addition, adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of lower-quality
and comparable unrated securities, especially in a thinly traded market.
LEGISLATION. Legislation may be adopted, from time to time designed to
limit the use of certain lower-quality and comparable unrated securities by
certain issuers. It is anticipated that if additional legislation is enacted
or proposed, it could have a material affect on the value of these securities
and the existence of a secondary trading market for the securities.
ILLIQUID SECURITIES
The Fund may invest in illiquid securities (i.e., securities that are not
readily marketable). However, the Fund will not acquire illiquid securities
if, as a result, they would comprise more than 15% of the value of the Fund's
net assets (or such other amounts as may be permitted under the 1940 Act).
However, as a matter of internal policy, the Advisor intends to limit the
Fund's investments in illiquid securities to 10% of its net assets.
The Board of Directors of the Fund, or its delegate, has the ultimate
authority to determine, to the extent permissible under the federal securities
laws, which securities are illiquid for purposes of this limitation. Certain
securities exempt from registration or issued in transactions exempt from
registration under the Securities Act of 1933, as amended (the "Securities
Act"), such as securities that may be resold to institutional investors under
Rule 144A under the Securities Act and Section 4(2) commercial paper, may be
considered liquid under guidelines adopted by the Fund's Board of Directors.
The Board of Directors of the Fund has delegated to the Advisor the
day-to-day determination of the liquidity of a security, although it has
retained oversight and ultimate responsibility for such determinations. The
Board of Directors has directed the Advisor to look to such factors as (i) the
frequency of trades or quotes for a security, (ii) the number of dealers
willing to purchase or sell the security and number of potential buyers, (iii)
the willingness of dealers to undertake to make a market in the security, (iv)
the nature of the security and nature of the marketplace trades, such as the
time needed to dispose of
17
<PAGE> 268
the security, the method of soliciting offers, and the mechanics of transfer,
(v) the likelihood that the security's marketability will be maintained
throughout the anticipated holding period, and (vi) any other relevant factors.
The Advisor may determine 4(2) commercial paper to be liquid if (i) the 4(2)
commercial paper is not traded flat or in default as to principal and interest,
(ii) the 4(2) commercial paper is rated in one of the two highest rating
categories by at least two nationally rated statistical rating organizations
("NRSRO"), or if only one NRSRO rates the security, by that NRSRO, or is
determined by the Advisor to be of equivalent quality, and (iii) the Advisor
considers the trading market for the specific security taking into account all
relevant factors. With respect to the Fund's foreign holdings, a foreign
security may be considered liquid by the Advisor (despite its restricted nature
under the Securities Act) if the security can be freely traded in a foreign
securities market and all the facts and circumstances support a finding of
liquidity.
Restricted securities may be sold only in privately negotiated
transactions or in a public offering with respect to which a registration
statement is in effect under the Securities Act. Where registration is
required, the Fund may be obligated to pay all or part of the registration
expenses and a considerable period may elapse between the time of the decision
to sell and the time the Fund may be permitted to sell a security under an
effective registration statement. If, during such a period, adverse market
conditions were to develop, the Fund might obtain a less favorable price than
prevailed when it decided to sell. Restricted securities will be priced at
fair value as determined in good faith by the Board of Directors of the Fund.
If through the appreciation of restricted securities or the depreciation of
unrestricted securities, the Fund should be in a position where more than 15%
of the value of its net assets are invested in illiquid securities, including
restricted securities which are not readily marketable (except for 144A
Securities and 4(2) commercial paper deemed to be liquid by the Advisor), the
Fund will take such steps as is deemed advisable, if any, to protect liquidity.
The Fund may sell over-the-counter ("OTC") options and, in connection
therewith, segregate assets or cover its obligations with respect to OTC
options written by the Fund. The assets used as cover for OTC options written
by the Fund will be considered illiquid unless the OTC options are sold to
qualified dealers who agree that the Fund may repurchase any OTC option it
writes at a maximum price to be calculated by a formula set forth in the option
agreement. The cover for an OTC option written subject to this procedure would
be considered illiquid only to the extent that the maximum repurchase price
under the formula exceeds the intrinsic value of the option.
LENDING OF PORTFOLIO SECURITIES
The Fund is authorized to lend up to 33 1/3% of the total value of its
portfolio securities to broker-dealers or institutional investors that the
Advisor deems qualified, but only when the borrower maintains with the Fund's
custodian bank collateral either in cash or money market instruments in an
amount at least equal to the market value of the securities loaned, plus
accrued interest and dividends, determined on a daily basis and adjusted
accordingly. Although the Fund is authorized to lend, the Fund does not
presently intend to engage in lending. In determining whether to lend
securities to a particular broker-dealer or institutional investor, the Advisor
will consider, and during the period of the loan will monitor, all relevant
facts and circumstances, including the creditworthiness of the borrower. The
Fund will retain authority to terminate any loans at any time. The Fund may
pay reasonable administrative and custodial fees in connection with a loan and
may pay a negotiated portion of the interest earned on the cash or money market
instruments held as collateral to the borrower or placing broker. The Fund
will receive reasonable interest on the loan or a flat fee from the borrower
and amounts equivalent to any dividends, interest or other distributions on the
securities loaned. The Fund will retain record ownership of loaned securities
to exercise beneficial rights, such as voting and subscription rights and
rights to dividends, interest or other distributions, when retaining such
rights is considered to be in the Fund's interest.
LOAN INTERESTS
The Fund may acquire a loan interest (a "Loan Interest"). A Loan Interest
is typically originated, negotiated, and structured by a U.S. or foreign
commercial bank, insurance company, finance company, or other financial
institution (the "Agent") for a lending syndicate of financial institutions.
The Agent typically administers and enforces the loan on behalf of the other
lenders in the syndicate. In addition, an institution, typically but not
always the Agent (the "Collateral Bank"), holds collateral (if any) on behalf
of the lenders. These Loan Interests may take the form of participation
interests in, assignments of or novations of a loan during its secondary
distribution, or direct interests during a primary distribution. Such Loan
Interests may be acquired from U.S. or foreign banks, insurance companies,
finance companies, or other financial institutions who have made loans or are
members of a lending syndicate or from other holders of Loan Interests. The
Fund may also acquire Loan
18
<PAGE> 269
Interests under which the Fund derives its rights directly from the borrower.
Such Loan Interests are separately enforceable by the Fund against the borrower
and all payments of interest and principal are typically made directly to the
Fund from the borrower. In the event that the Fund and other lenders become
entitled to take possession of shared collateral, it is anticipated that such
collateral would be held in the custody of a Collateral Bank for their mutual
benefit. The Fund may not act as an Agent, a Collateral Bank, a guarantor or
sole negotiator or structurer with respect to a loan.
The Advisor will analyze and evaluate the financial condition of the
borrower in connection with the acquisition of any Loan Interest. The Advisor
also analyzes and evaluates the financial condition of the Agent and, in the
case of Loan Interests in which the Fund does not have privity with the
borrower, those institutions from or through whom the Fund derives its rights
in a loan (the "Intermediate Participants").
In a typical loan the Agent administers the terms of the loan agreement.
In such cases, the Agent is normally responsible for the collection of
principal and interest payments from the borrower and the apportionment of
these payments to the credit of all institutions which are parties to the loan
agreement. The Fund will generally rely upon the Agent or an Intermediate
Participant to receive and forward to the Fund its portion of the principal and
interest payments on the loan. Furthermore, unless under the terms of a
participation agreement the Fund has direct recourse against the borrower, the
Fund will rely on the Agent and the other members of the lending syndicate to
use appropriate credit remedies against the borrower. The Agent is typically
responsible for monitoring compliance with covenants contained in the loan
agreement based upon reports prepared by the borrower. The seller of the Loan
Interest usually does, but is often not obligated to, notify holders of Loan
Interests of any failures of compliance. The Agent may monitor the value of
the collateral and, if the value of the collateral declines, may accelerate the
loan, may give the borrower an opportunity to provide additional collateral or
may seek other protection for the benefit of the participants in the loan. The
Agent is compensated by the borrower for providing these services under a loan
agreement, and such compensation may include special fees paid upon structuring
and funding the loan and other fees paid on a continuing basis. With respect
to Loan Interests for which the Agent does not perform such administrative and
enforcement functions, the Fund will perform such tasks on its own behalf,
although a Collateral Bank will typically hold any collateral on behalf of the
Fund and the other lenders pursuant to the applicable loan agreement.
A financial institution's appointment as Agent may usually be terminated
in the event that it fails to observe the requisite standard of care or becomes
insolvent, enters Federal Deposit Insurance Corporation ("FDIC") receivership,
or, if not FDIC insured, enters into bankruptcy proceedings. A successor Agent
would generally be appointed to replace the terminated Agent, and assets held
by the Agent under the loan agreement should remain available to holders of
Loan Interests. However, if assets held by the Agent for the benefit of the
Fund were determined to be subject to the claims of the Agent's general
creditors, the Fund might incur certain costs and delays in realizing payment
on a loan interest, or suffer a loss of principal and/or interest. In
situations involving Intermediate Participants similar risks may arise.
Purchasers of Loan Interests depend primarily upon the creditworthiness of
the borrower for payment of principal and interest. If the Fund does not
receive scheduled interest or principal payments on such indebtedness, the
Fund's share price and yield could be adversely affected. Loans that are fully
secured offer the Fund more protections than an unsecured loan in the event of
non-payment of scheduled interest or principal. However, there is no assurance
that the liquidation of collateral from a secured loan would satisfy the
borrower's obligation, or that the collateral can be liquidated. Indebtedness
of borrowers whose creditworthiness is poor involves substantially greater
risks, and may be highly speculative. Borrowers that are in bankruptcy or
restructuring may never pay off their indebtedness, or may pay only a small
fraction of the amount owed. Direct indebtedness of developing countries will
also involve a risk that the governmental entities responsible for the
repayment of the debt may be unable, or unwilling, to pay interest and repay
principal when due.
MATURITY
The Fund's average portfolio maturity represents an average based on the
actual stated maturity dates of the debt securities in the Fund's portfolio,
except that (i) variable-rate securities are deemed to mature at the next
interest-rate adjustment date, (ii) debt securities with put features are
deemed to mature at the next put-exercise date, (iii) the maturity of
mortgage-backed securities is determined on an "expected life" basis as
determined by the Advisor, and (iv) securities being hedged with futures
contracts may be deemed to have a longer maturity, in the case of purchases of
futures contracts, and a shorter maturity, in the case of sales of futures
contracts, than they would otherwise be deemed to have. In addition, a
security that is subject to redemption at the option of the issuer on a
particular date (the "call date"), which is prior to the security's stated
maturity, may
19
<PAGE> 270
be deemed to mature on the call date rather than on its stated maturity date.
The call date of a security will be used to calculate average portfolio
maturity when the Advisor reasonably anticipates, based upon information
available to it, that the issuer will exercise its right to redeem the
security. The average portfolio maturity of the Fund is dollar-weighted based
upon the market value of the Fund's securities at the time of the calculation.
MORTGAGE- AND ASSET-BACKED SECURITIES
Mortgage-backed securities represent direct or indirect participations in,
or are secured by and payable from, mortgage loans secured by real property,
and include single- and multi-class pass-through securities and collateralized
mortgage obligations. Such securities may be issued or guaranteed by U.S.
government agencies or instrumentalities, such as the Government National
Mortgage Association and the Federal National Mortgage Association, or by
private issuers, generally originators and investors in mortgage loans,
including savings associations, mortgage bankers, commercial banks, investment
bankers, and special purpose entities (collectively, "private lenders").
Mortgage-backed securities issued by private lenders may be supported by pools
of mortgage loans or other mortgage-backed securities that are guaranteed,
directly or indirectly, by the U.S. government or one of its agencies or
instrumentalities, or they may be issued without any governmental guarantee of
the underlying mortgage assets but with some form of non-governmental credit
enhancement.
Asset-backed securities have structural characteristics similar to
mortgage-backed securities. Asset-backed debt obligations represent direct or
indirect participation in, or secured by and payable from, assets such as motor
vehicle installment sales contracts, other installment loan contracts, home
equity loans, leases of various types of property, and receivables from credit
card or other revolving credit arrangements. The credit quality of most
asset-backed securities depends primarily on the credit quality of the assets
underlying such securities, how well the entity issuing the security is
insulated from the credit risk of the originator or any other affiliated
entities, and the amount and quality of any credit enhancement of the
securities. Payments or distributions of principal and interest on
asset-backed debt obligations may be supported by non-governmental credit
enhancements including letters of credit, reserve funds, overcollateralization,
and guarantees by third parties. The market for privately issued asset-backed
debt obligations is smaller and less liquid than the market for government
sponsored mortgage-backed securities.
The rate of principal payment on mortgage- and asset-backed securities
generally depends on the rate of principal payments received on the underlying
assets which in turn may be affected by a variety of economic and other
factors. As a result, the yield on any mortgage- and asset-backed security is
difficult to predict with precision and actual yield to maturity may be more or
less than the anticipated yield to maturity. The yield characteristics of
mortgage- and asset-backed securities differ from those of traditional debt
securities. Among the principal differences are that interest and principal
payments are made more frequently on mortgage-and asset-backed securities,
usually monthly, and that principal may be prepaid at any time because the
underlying mortgage loans or other assets generally may be prepaid at any time.
As a result, if the Fund purchases these securities at a premium, a prepayment
rate that is faster than expected will reduce yield to maturity, while a
prepayment rate that is slower than expected will have the opposite effect of
increasing the yield to maturity. Conversely, if the Fund purchases these
securities at a discount, a prepayment rate that is faster than expected will
increase yield to maturity, while a prepayment rate that is slower than
expected will reduce yield to maturity. Amounts available for reinvestment by
a Fund are likely to be greater during a period of declining interest rates
and, as a result, are likely to be reinvested at lower interest rates than
during a period of rising interest rates. Accelerated prepayments on
securities purchased by the Fund at a premium also impose a risk of loss of
principal because the premium may not have been fully amortized at the time the
principal is prepaid in full. The market for privately issued mortgage- and
asset-backed securities is smaller and less liquid than the market for
government-sponsored mortgage- backed securities.
While many mortgage- and asset-backed securities are issued with only one
class of security, many are issued in more than one class, each with different
payment terms. Multiple class mortgage- and asset-backed securities are issued
for two main reasons. First, multiple classes may be used as a method of
providing credit support. This is accomplished typically through creation of
one or more classes whose right to payments on the security is made subordinate
to the right to such payments of the remaining class or classes. Second,
multiple classes may permit the issuance of securities with payment terms,
interest rates, or other characteristics differing both from those of each
other and from those of the underlying assets. Examples include so-called
"strips" (mortgage - and asset-backed securities entitling the holder to
disproportionate interests with respect to the allocation of interest and
principal of the assets backing the security), and securities with class or
classes having
20
<PAGE> 271
characteristics which mimic the characteristics of non-mortgage- or
asset-backed securities, such as floating interest rates (i.e., interest rates
which adjust as a specified benchmark changes) or scheduled amortization of
principal.
The Fund may invest in stripped mortgage- or asset-backed securities,
which receive differing proportions of the interest and principal payments from
the underlying assets. The market value of such securities generally is more
sensitive to changes in prepayment and interest rates than is the case with
traditional mortgage- and asset-backed securities, and in some cases such
market value may be extremely volatile. With respect to certain stripped
securities, such as interest only and principal only classes, a rate of
prepayment that is faster or slower than anticipated may result in the Fund
failing to recover all or a portion of its investment, even though the
securities are rated investment grade.
Mortgage- and asset-backed securities backed by assets, other than as
described above, or in which the payment streams on the underlying assets are
allocated in a manner different than those described above may be issued in the
future. The Fund may invest in such securities if such investment is otherwise
consistent with its investment objectives and policies and with the investment
restrictions of the Fund.
MORTGAGE DOLLAR ROLLS AND REVERSE REPURCHASE AGREEMENTS
The Fund may engage in reverse repurchase agreements to facilitate
portfolio liquidity, a practice common in the mutual fund industry, or for
arbitrage transactions discussed below. In a reverse repurchase agreement, the
Fund would sell a security and enter into an agreement to repurchase the
security at a specified future date and price. The Fund generally retains the
right to interest and principal payments on the security. Since the Fund
receives cash upon entering into a reverse repurchase agreement, it may be
considered a borrowing. (See "Borrowing".) When required by guidelines of the
SEC, the Fund will set aside permissible liquid assets in a segregated account
to secure its obligations to repurchase the security.
The Fund may also enter into mortgage dollar rolls, in which the Fund
would sell mortgage-backed securities for delivery in the current month and
simultaneously contract to purchase substantially similar securities on a
specified future date. While the Fund would forego principal and interest paid
on the mortgage-backed securities during the roll period, the Fund would be
compensated by the difference between the current sales price and the lower
price for the future purchase as well as by any interest earned on the proceeds
of the initial sale. The Fund also could be compensated through the receipt of
fee income equivalent to a lower forward price. At the time the Fund would
enter into a mortgage dollar roll, it would set aside permissible liquid assets
in a segregated account to secure its obligation for the forward commitment to
buy mortgage-backed securities. Mortgage dollar roll transactions may be
considered a borrowing by the Fund. (See "Borrowing".)
The mortgage dollar rolls and reverse repurchase agreements entered into
by the Fund may be used as arbitrage transactions in which the Fund will
maintain an offsetting position in investment grade debt obligations or
repurchase agreements that mature on or before the settlement date on the
related mortgage dollar roll or reverse repurchase agreements. Since the Fund
will receive interest on the securities or repurchase agreements in which it
invests the transaction proceeds, such transactions may involve leverage.
However, since such securities or repurchase agreements will be high quality
and will mature on or before the settlement date of the mortgage dollar roll or
reverse repurchase agreement, the Advisor believes that such arbitrage
transactions do not present the risks to the Fund that are associated with
other types of leverage.
MUNICIPAL OBLIGATIONS
General obligation bonds are secured by the issuer's pledge of its full
faith, credit, and taxing power for the payment of interest and principal.
Revenue bonds are payable only from the revenues derived from a project or
facility or from the proceeds of a specified revenue source. Industrial
development bonds are generally revenue bonds secured by payments from and the
credit of private users. Municipal notes are issued to meet the short-term
funding requirements of state, regional, and local governments. Municipal
notes include tax anticipation notes, bond anticipation notes, revenue
anticipation notes, tax and revenue anticipation notes, construction loan
notes, short-term discount notes, tax-exempt commercial paper, demand notes,
and similar instruments. Municipal obligations include obligations, the
interest on which is exempt from federal income tax, that may become available
in the future as long as the Board of Directors of the Fund determines that an
investment in any such type of obligation is consistent with that Fund's
investment objective.
21
<PAGE> 272
Municipal lease obligations may take the form of a lease, an installment
purchase, or a conditional sales contract. They are issued by state and local
governments and authorities to acquire land, equipment, and facilities, such as
state and municipal vehicles, telecommunications and computer equipment, and
other capital assets. The Fund may purchase these obligations directly, or it
may purchase participation interests in such obligations. Municipal leases are
generally subject to greater risks than general obligation or revenue bonds.
State constitutions and statutes set forth requirements that states or
municipalities must meet in order to issue municipal obligations. Municipal
leases may contain a covenant by the state or municipality to budget for,
appropriate, and make payments due under the obligation. Certain municipal
leases may, however, contain "non-appropriation" clauses which provide that the
issuer is not obligated to make payments on the obligation in future years
unless funds have been appropriated for this purpose each year. Accordingly,
such obligations are subject to "non-appropriation" risk. While municipal
leases are secured by the underlying capital asset, it may be difficult to
dispose of any such asset in the event of non-appropriation or other default.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with certain banks or
non-bank dealers. In a repurchase agreement, the Fund buys a security at one
price, and at the time of sale, the seller agrees to repurchase the obligation
at a mutually agreed upon time and price (usually within seven days). The
repurchase agreement, thereby, determines the yield during the purchaser's
holding period, while the seller's obligation to repurchase is secured by the
value of the underlying security. The Advisor will monitor, on an ongoing
basis, the value of the underlying securities to ensure that the value always
equals or exceeds the repurchase price plus accrued interest. Repurchase
agreements could involve certain risks in the event of a default or insolvency
of the other party to the agreement, including possible delays or restrictions
upon the Fund's ability to dispose of the underlying securities. Although no
definitive creditworthiness criteria are used, the Advisor reviews the
creditworthiness of the banks and non-bank dealers with which the Fund enter
into repurchase agreements to evaluate those risks. The Fund may, under
certain circumstances, deem repurchase agreements collateralized by U.S.
government securities to be investments in U.S. government securities.
SHORT SALES AGAINST THE BOX
The Fund may sell securities short against the box to hedge unrealized
gains on portfolio securities. Selling securities short against the box
involves selling a security that the Fund owns or has the right to acquire, for
delivery at a specified date in the future. If the Fund sells securities short
against the box, it may protect unrealized gains, but will lose the opportunity
to profit on such securities if the price rises.
TEMPORARY DEFENSIVE POSITION
When the Advisor determines that market conditions warrant a temporary
defensive position, the Fund may invest without limitation in cash and
short-term fixed income securities, including U.S. government securities,
commercial paper, banker's acceptances, certificates of deposit, and time
deposits.
VARIABLE- OR FLOATING-RATE SECURITIES
The Fund may invest in securities which offer a variable- or floating-rate
of interest. Variable-rate securities provide for automatic establishment of a
new interest rate at fixed intervals (e.g., daily, monthly, semi-annually,
etc.). Floating-rate securities generally provide for automatic adjustment of
the interest rate whenever some specified interest rate index changes. The
interest rate on variable- or floating-rate securities is ordinarily determined
by reference to or is a percentage of a bank's prime rate, the 90-day U.S.
Treasury bill rate, the rate of return on commercial paper or bank certificates
of deposit, an index of short-term interest rates, or some other objective
measure.
Variable- or floating-rate securities frequently include a demand feature
entitling the holder to sell the securities to the issuer at par. In many
cases, the demand feature can be exercised at any time on 7 days notice; in
other cases, the demand feature is exercisable at any time on 30 days notice or
on similar notice at intervals of not more than one year. Some securities
which do not have variable or floating interest rates may be accompanied by
puts producing similar results and price characteristics. When considering the
maturity of any instrument which may be sold or put to the issuer or a third
party, the Fund may consider that instrument's maturity to be shorter than its
stated maturity.
22
<PAGE> 273
Variable-rate demand notes include master demand notes which are
obligations that permit the Fund to invest fluctuating amounts, which may
change daily without penalty, pursuant to direct arrangements between the Fund,
as lender, and the borrower. The interest rates on these notes fluctuate from
time to time. The issuer of such obligations normally has a corresponding
right, after a given period, to prepay in its discretion the outstanding
principal amount of the obligations plus accrued interest upon a specified
number of days' notice to the holders of such obligations. The interest rate
on a floating-rate demand obligation is based on a known lending rate, such as
a bank's prime rate, and is adjusted automatically each time such rate is
adjusted. The interest rate on a variable-rate demand obligation is adjusted
automatically at specified intervals. Frequently, such obligations are secured
by letters of credit or other credit support arrangements provided by banks.
Because these obligations are direct lending arrangements between the lender
and borrower, it is not contemplated that such instruments will generally be
traded. There generally is not an established secondary market for these
obligations, although they are redeemable at face value. Accordingly, where
these obligations are not secured by letters of credit or other credit support
arrangements, the Fund's right to redeem is dependent on the ability of the
borrower to pay principal and interest on demand. Such obligations frequently
are not rated by credit rating agencies and, if not so rated, the Fund may
invest in them only if the Advisor determines that at the time of investment
the obligations are of comparable quality to the other obligations in which the
Fund may invest. The Advisor, on behalf of the Fund, will consider on an
ongoing basis the creditworthiness of the issuers of the floating- and
variable-rate demand obligations in the Fund's portfolio.
The Fund will not invest more than 15% of its net assets in variable- and
floating-rate demand obligations that are not readily marketable (a variable-
or floating-rate demand obligation that may be disposed of on not more than
seven days notice will be deemed readily marketable and will not be subject to
this limitation). (See "Illiquid Securities" and "Investment Restrictions.")
In addition, each variable- or floating-rate obligation must meet the credit
quality requirements applicable to all the Fund's investments at the time of
purchase. When determining whether such an obligation meets the Fund's credit
quality requirements, the Fund may look to the credit quality of the financial
guarantor providing a letter of credit or other credit support arrangement.
In determining the Fund's weighted average portfolio maturity, the Fund
will consider a floating or variable rate security to have a maturity equal to
its stated maturity (or redemption date if it has been called for redemption),
except that it may consider (i) variable rate securities to have a maturity
equal to the period remaining until the next readjustment in the interest rate,
unless subject to a demand feature, (ii) variable rate securities subject to a
demand feature to have a remaining maturity equal to the longer of (a) the next
readjustment in the interest rate or (b) the period remaining until the
principal can be recovered through demand, and (iii) floating rate securities
subject to a demand feature to have a maturity equal to the period remaining
until the principal can be recovered through demand. Variable and floating
rate securities generally are subject to less principal fluctuation than
securities without these attributes since the securities usually trade at
amoritzed cost following the readjustment in the interest rate.
WARRANTS
The Fund may acquire warrants. Warrants are securities giving the holder
the right, but not the obligation, to buy the stock of an issuer at a given
price (generally higher than the value of the stock at the time of issuance)
during a specified period or perpetually. Warrants may be acquired separately
or in connection with the acquisition of securities. Warrants do not carry
with them the right to dividends or voting rights with respect to the
securities that they entitle their holder to purchase, and they do not
represent any rights in the assets of the issuer. As a result, warrants may be
considered to have more speculative characteristics than certain other types of
investments. In addition, the value of a warrant does not necessarily change
with the value of the underlying securities, and a warrant ceases to have value
if it is not exercised prior to its expiration date.
WHEN-ISSUED SECURITIES
The Fund may purchase securities on a "when-issued" basis. The price of
debt obligations purchased on a when-issued basis, which may be expressed in
yield terms, generally is fixed at the time the commitment to purchase is made,
but delivery and payment for the securities take place at a later date.
Normally, the settlement date occurs within 45 days of the purchase although in
some cases settlement may take longer. During the period between the purchase
and settlement, no payment is made by the Fund to the issuer and no interest on
the debt obligations accrues to the Fund. Forward commitments 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
23
<PAGE> 274
the risk of decline in value of the Fund's other assets. While when-issued
securities may be sold prior to the settlement date, the Fund intends to
purchase such securities with the purpose of actually acquiring them unless a
sale appears desirable for investment reasons. At the time the Fund makes the
commitment to purchase a security on a when-issued basis, it will record the
transaction and reflect the value of the security in determining its net asset
value. The Fund does not believe that its net asset value will be adversely
affected by purchases of securities on a when-issued basis.
To the extent required by the SEC, the Fund will maintain cash and
marketable securities equal in value to commitments for when-issued securities.
Such segregated securities either will mature or, if necessary, be sold on or
before the settlement date. When the time comes to pay for when-issued
securities, the Fund will meet its obligations from then-available cash flow,
sale of the securities held in the separate account, described above, sale of
other securities or, although it would not normally expect to do so, from the
sale of the when-issued securities themselves (which may have a market value
greater or less than the Fund's payment obligation).
ZERO-COUPON, STEP-COUPON AND PAY-IN-KIND SECURITIES
The Fund may invest in zero-coupon, step-coupon, and pay-in-kind
securities. These securities are debt securities that do not make regular cash
interest payments. Zero-coupon and step-coupon securities are sold at a deep
discount to their face value. Pay-in-kind securities pay interest through the
issuance of additional securities. Because such securities do not pay current
cash income, the price of these securities can be volatile when interest rates
fluctuate. While these securities do not pay current cash income, federal
income tax law requires the holders of zero-coupon, step-coupon, and
pay-in-kind securities to include in income each year the portion of the
original issue discount (or deemed discount) and other non-cash income on such
securities accruing that year. In order to continue to qualify as a "regulated
investment company" under the Internal Revenue Code and avoid a certain excise
tax, the Fund may be required to distribute a portion of such discount and
income and may be required to dispose of other portfolio securities, which may
occur in periods of adverse market prices, in order to generate cash to meet
these distribution requirements.
DIRECTORS AND OFFICERS OF THE CORPORATION
Directors and officers of the Corporation, together with information as to
their principal business occupations during the last five years, and other
information are shown below. Each director who is deemed an "interested
person," as defined in the 1940 Act, is indicated by an asterisk (*). Each
officer and director holds the same position with the 25 registered open-end
management investment companies consisting of 38 mutual funds, which are
managed by the Advisor (the "Strong Funds"). The Strong Funds, in the
aggregate, pays each Director who is not a director, officer, or employee of
the Advisor, or any affiliated company (a "disinterested director") an annual
fee of $50,000, plus $100 per Board meeting for each Strong Fund. In addition,
each disinterested director is reimbursed by the Strong Funds for travel and
other expenses incurred in connection with attendance at such meetings. Other
officers and directors of the Strong Funds receive no compensation or expense
reimbursement from the Strong Funds.
*RICHARD S. STRONG (DOB 5/12/42), Chairman of the Board and Director of the
Corporation.
Prior to August 1985, Mr. Strong was Chief Executive Officer of the
Advisor, which he founded in 1974. Since August 1985, Mr. Strong has been a
Security Analyst and Portfolio Manager of the Advisor. In October 1991, Mr.
Strong also became the Chairman of the Advisor. Mr. Strong is a director of
the Advisor. Mr. Strong has been in the investment management business since
1967. Mr. Strong has served the Corporation as a director since December 1990
and Chairman of the Board since January 1992.
MARVIN E. NEVINS (DOB 7/9/18), Director of the Corporation.
Private Investor. From 1945 to 1980, Mr. Nevins was Chairman of Wisconsin
Centrifugal Inc.; a foundry. From July 1983 to December 1986, he was Chairman
of General Casting Corp., Waukesha, Wisconsin, a foundry. Mr. Nevins is a
former Chairman of the Wisconsin Association of Manufacturers & Commerce. He
was also a regent of the Milwaukee School of Engineering and a member of the
Board of Trustees of the Medical College of Wisconsin. Mr. Nevins has served
the Corporation as a director since December 1990.
24
<PAGE> 275
WILLIE D. DAVIS (DOB 7/24/34), Director of the Corporation.
Mr. Davis has been director of Alliance Bank Since 1980, Sara Lee
Corporation (a food/consumer products company) since 1983, KMart Corporation (a
discount consumer products company) since 1985, YMCA Metropolitan - Los Angeles
since 1985, Dow Chemical Company since 1988, MGM Grand, Inc. (an
entertainment/hotel company) since 1990, WICOR, Inc. (a utility company) since
1990, Johnson Controls, Inc. (an industrial company) since 1992, L.A. Gear (a
footwear/sportswear company) since 1992, and Rally's Hamburger, Inc. since
1994. Mr. Davis has been a trustee of the University of Chicago since 1980,
Marquette University since 1988, and Occidental College since 1990. Since
1977, Mr. Davis has been President and Chief Executive Officer of All Pro
Broadcasting, Inc. Mr. Davis was a director of the Fireman's Fund (an
insurance company) from 1975 until 1990. Mr. Davis has served the Corporation
as a director since July 1994.
*JOHN DRAGISIC (DOB 11/26/40), President and Director of the Corporation.
Mr. Dragisic has been President of the Advisor since October 1995, and a
director of the Advisor since July 1994. Mr. Dragisic served as Vice Chairman
of the Advisor from July 1994 until October 1995. Mr. Dragisic was the
President and Chief Executive Officer of Grunau Company, Inc. (a mechanical
contracting and engineering firm), Milwaukee, Wisconsin from 1987 until July
1994. From 1981 to 1987, he was an Executive Vice President with Grunau
Company, Inc. From 1969 until 1973, Mr. Dragisic worked for the InterAmerican
Development Bank. Mr. Dragisic received his Ph.D. in Economics in 1971 from
the University of Wisconsin - Madison and his B.A. degree in Economics in 1962
from Lake Forest College. Mr. Dragisic has served the Corporation as Vice
Chairman from July 1994 until October 1995; as President since October 1995;
and as a director from July 1991 until July 1994, and since April 1995.
STANLEY KRITZIK (DOB 1/9/30), Director of the Corporation.
Mr. Kritzik has been a Partner of Metropolitan Associates since 1962, a
Director of Aurora Health Care since 1987, and Health Network Ventures, Inc.
since 1992. Mr. Kritzik has served the Corporation as a director since April
1995.
WILLIAM F. VOGT (DOB 7/19/47), Director of the Corporation.
Mr. Vogt has been the President of Vogt Management Consulting, Inc. since
1990. From 1982 until 1990, he served as Executive Director of University
Physicians of the University of Colorado. Mr. Vogt is the Past President of
the Medical Group Management Association and a Fellow of the American College
of Medical Practice Executives. Mr. Vogt has served the Corporation as a
director since April 1995.
LAWRENCE A. TOTSKY (DOB 5/6/59), C.P.A., Vice President of the Corporation.
Mr. Totsky has been Senior Vice President of the Advisor since December
1994. Mr. Totsky acted as the Advisor's Manager of Shareholder Accounting and
Compliance from June 1987 to June 1991 when he was named Director of Mutual
Fund Administration. Mr. Totsky has served the Corporation as a Vice President
since May 1993.
THOMAS P. LEMKE (DOB 7/30/54), Vice President of the Corporation.
Mr. Lemke has been Senior Vice President, Secretary, and General Counsel
of the Advisor since September 1994. For two years prior to joining the
Advisor, Mr. Lemke acted as Resident Counsel for Funds Management at J.P.
Morgan & Co., Inc. From February 1989 until April 1992, Mr. Lemke acted as
Associate General Counsel to Sanford C. Bernstein Co., Inc. For two years
prior to that, Mr. Lemke was Of Counsel at the Washington, D.C. law firm of Tew
Jorden & Schulte, a successor of Finley, Kumble & Wagner. From August 1979
until December 1986, Mr. Lemke worked at the Securities and Exchange
Commission, most notably as the Chief Counsel to the Division of Investment
Management (November 1984 - December 1986), and as Special Counsel to the
Office of Insurance Products, Division of Investment Management (April 1982 -
October 1984). Mr. Lemke has served the Corporation as a Vice President since
October 1994.
25
<PAGE> 276
STEPHEN J. SHENKENBERG (DOB 6/14/58), Vice President and Secretary of the
Corporation.
Mr. Shenkenberg has been Deputy General Counsel to the Advisor since
November 1996. From December 1992 until November 1996 Mr. Shenkenberg acted as
Associate Counsel to the Advisor. From June 1987 until December 1992, Mr.
Shenkenberg was an attorney for Godfrey & Kahn, S.C., a Milwaukee law firm.
Mr. Shenkenberg has served the Corporation as a Vice President since April 1996
and as Secretary since October 1996.
JOHN S. WEITZER (DOB 10/31/67), Vice President of the Corporation.
Mr. Weitzer has been an Associate Counsel of the Advisor since July 1993.
Mr. Weitzer has served the Corporation as a Vice President since January 1996.
Except for Messrs. Nevins, Davis, Kritzik and Vogt, the address of all of
the above persons is P.O. Box 2936, Milwaukee, Wisconsin 53201. Mr. Nevins'
address is 6075 Pelican Bay Boulevard, Naples, Florida 34108. Mr. Davis'
address is 161 North La Brea, Inglewood, California 90301. Mr. Kritzik's
address is 1123 North Astor Street, P.O. Box 92547, Milwaukee, Wisconsin
53202-0547. Mr. Vogt's address is 2830 East Third Avenue, Denver, Colorado
80206.
In addition to the positions listed above, the following individuals also
hold the following positions with Strong Holdings, Inc. ("Holdings"), a
Wisconsin corporation and subsidiary of the Advisor; Strong Funds Distributors,
Inc., the Fund's underwriter ("Distributors"), Heritage Reserve Development
Corporation ("Heritage"), and Strong Service Corporation ("SSC"), each of which
is a Wisconsin corporation and subsidiary of Holdings; Fussville Real Estate
Holdings L.L.C. ("Real Estate Holdings") and Sherwood Development L.L.C.
("Sherwood"), each of which is a Wisconsin Limited Liability Company and
subsidiary of the Advisor and Heritage; and Fussville Development L.L.C.
("Fussville Development"), a Wisconsin Limited Liability Company and subsidiary
of the Advisor and Real Estate Holdings:
RICHARD S. STRONG:
Chairman and a Director - Holdings and Distributors (since October 1993);
Heritage (since January 1994); and SSC (since November 1995).
Chairman and a Member of the Managing Board - Real Estate Holdings and
Fussville Development (since December 1995 and February 1994,
respectively); and Sherwood (since October 1994).
JOHN DRAGISIC:
President and a Director - Holdings (since December 1995 and July 1994,
respectively); Distributors (since September 1996 and July 1994,
respectively); Heritage (since May 1994 and August 1994, respectively);
and SSC (since November 1995).
Vice Chairman and a Member of the Managing Board - Real Estate and
Fussville Development (since December 1995 and August 1994,
respectively); and Sherwood (since October 1994).
THOMAS P. LEMKE:
Vice President - Holdings, Heritage, Real Estate Holdings, and Fussville
Development (since December 1995); Distributors (since October 1996);
Sherwood (since October 1994); and SSC (since November 1995).
STEPHEN J. SHENKENBERG:
Vice President and Secretary - Distributors (since December 1995).
26
<PAGE> 277
Secretary - Holdings, Heritage, Fussville Development, Real Estate
Holdings, and Sherwood (since December 1995); and SSC (since November
1995).
As of March 31, 1997, the officers and directors of the Corporation in the
aggregate beneficially owned 14,841 shares of common stock of the Fund which
was 39.67% of the Fund's then outstanding shares.
PRINCIPAL SHAREHOLDERS
Except for the organizational shares of the Fund, the Fund's shares are
held of record by an insurance company separate account. As of March 31, 1997,
the following persons owned of record or is known by the Fund to own of record
or beneficially more than 5% of the Fund's outstanding shares:
Name and Address Shares Percent of Class
----------------------------------------------------------------
Fortis Benefits Insurance Co. 19,209 51.35%
P.O. Box 64284
St. Paul, MN 55164-0284
Acacia National Life Insurance Company 3,359 8.98%
51 Louisiana Avenue, NW
Washington, DC 20001-2105
A shareholder owning more than 25% of the Fund's shares may be considered a
"controlling person" of the Fund. Accordingly, its vote could have a more
significant effect on matters presented to shareholders for approval than the
vote of other Fund shareholders.
INVESTMENT ADVISOR AND DISTRIBUTOR
The Advisor to the Fund is Strong Capital Management, Inc. Mr. Richard S.
Strong controls the Advisor. Mr. Strong is the Chairman and a director of the
Advisor, Mr. Dragisic is the President and a director of the Advisor, Mr.
Totsky is a Senior Vice President of the Advisor, Mr. Lemke is a Senior Vice
President, Secretary, and General Counsel of the Advisor, Mr. Shenkenberg is
Vice President, Assistant Secretary, and Deputy General Counsel of the Advisor,
and Mr. Weitzer is an Associate Counsel of the Advisor. A brief description of
the Fund's investment advisory agreement ("Advisory Agreement") is set forth in
the Prospectus under "Management."
The Fund's Advisory Agreement is dated July 10, 1995, and will remain in
effect as to the Fund for a period of two years. The Advisory Agreement was
approved by the Fund's initial shareholder on its first day of operations.
Thereafter, the Advisory Agreement is required to be approved annually by the
Board of Directors of the Corporation or by vote of a majority of the Fund's
outstanding voting securities (as defined in the 1940 Act). In either case,
each annual renewal must also be approved by the vote of a majority of the
Corporation's directors who are not parties to the Advisory Agreement or
interested persons of any such party, cast in person at a meeting called for
the purpose of voting on such approval. The Advisory Agreement is terminable,
without penalty, on 60 days' written notice by the Board of Directors of the
Corporation, by vote of a majority of the Fund's outstanding voting securities,
or by the Advisor. In addition, the Advisory Agreement will terminate
automatically in the event of its assignment.
Under the terms of the Advisory Agreement, the Advisor manages the Fund's
investments subject to the supervision of the Corporation's Board of Directors.
The Advisor is responsible for investment decisions and supplies investment
research and portfolio management. At its expense, the Advisor provides office
space and all necessary office facilities, equipment, and personnel for
servicing the investments of the Fund. The Advisor places all orders for the
purchase and sale of the Fund's securities at its expense.
Except for expenses assumed by the Advisor, as set forth above, or by the
Distributor, as described below with respect to the distribution of the Fund's
shares, the Fund is responsible for all its other expenses, including, without
limitation,
27
<PAGE> 278
interest charges, taxes, brokerage commissions and similar expenses;
organizational expenses; expenses of issue, sale, repurchase or redemption of
shares; expenses of registering or qualifying shares for sale with the states
and the SEC; expenses for printing and distributing Prospectuses and quarterly
financial statements to existing shareholders; charges of custodians, transfer
agent fees (including the printing and mailing of reports and notices to
shareholders), registrars, auditing and legal services, clerical services
related to recordkeeping and shareholder relations, and printing of stock
certificates; and fees for directors who are not "interested persons" of the
Advisor; and its allocable share of the Corporation's expenses.
As compensation for its services, the Fund pays to the Advisor a
monthly management fee at the annual rate of .60% of the Fund's average daily
net asset value. (See "Additional Information - Calculation of Net Asset
Value" in the Prospectus.) From time to time, the Advisor may voluntarily
waive all or a portion of its management fee for the Fund. In 1995 and 1996,
the Fund paid the Advisor $266, and $2,095, respectively in management fees.
In 1996, the Advisor waived a portion of its management fee. Without this
waiver, the Fund would have paid the Advisor $3,429 in management fees.
The Advisory Agreement requires the Advisor to reimburse the Fund in the
event that the expenses and charges payable by the Fund in any fiscal year,
including the management fee but excluding taxes, interest, brokerage
commissions, and similar fees and to the extent permitted extraordinary
expenses, exceed two percent (2%) of the average net asset value of the Fund
for such year, as determined by valuations made as of the close of each
business day of the year. Reimbursement of expenses in excess of the
applicable limitation will be made on a monthly basis and will be paid to the
Fund by reduction of the Advisor's fee, subject to later adjustment month by
month for the remainder of the Fund's fiscal year. The Advisor may from time
to time absorb expenses for the Fund in addition to the reimbursement of
expenses in excess of applicable limitations.
On July 12, 1994, the Securities and Exchange Commission (the "SEC") filed
an administrative action (the "Order") against the Advisor, Mr. Strong, and
another employee of the Advisor in connection with conduct that occurred
between 1987 and early 1990. In re Strong/Corneliuson Capital Management, Inc.;
et al. Admin. Proc. File No. 3-8411. The proceeding was settled by consent
without admitting or denying the allegations in the Order. The Order found that
the Advisor and Mr. Strong aided and abetted violations of Section 17(a) of the
1940 Act by effecting trades between mutual funds, and between mutual funds and
Harbour Investments Ltd. ("Harbour"), without complying with the exemptive
provisions of SEC Rule 17a-7 or otherwise obtaining an exemption. It further
found that the Advisor violated, and Mr. Strong aided and abetted violations
of, the disclosure provisions of the 1940 Act and the Investment Advisers Act
of 1940 by misrepresenting the Advisor's policy on personal trading and by
failing to disclose trading by Harbour, an entity in which principals of the
Advisor owned between 18 and 25 percent of the voting stock. As part of the
settlement, the respondents agreed to a censure and a cease and desist order
and the Advisor agreed to various undertakings, including adoption of certain
procedures and a limitation for six months on accepting certain types of new
advisory clients.
On June 6, 1996, the Department of Labor (the "DOL") filed an action
against the Advisor for equitable relief alleging violations of the Employee
Retirement Income Security Act of 1974 ("ERISA") in connection with cross
trades that occurred between 1987 and late 1989 involving certain pension
accounts managed by the Advisor. Contemporaneous with this filing, the
Advisor, without admitting or denying the DOL's allegations, agreed to the
entry of a consent judgment resolving all matters relating to the allegations.
Reich V. Strong Capital Management, Inc., (U.S.D.C.E.D. WI) (the "Consent
Judgment"). Under the terms of the Consent Judgment, the Advisor agreed to
reimburse the affected accounts a total of $5.9 million. The settlement did
not have any material impact on the Advisor's financial position or operations.
The Fund and the Advisor have adopted a Code of Ethics (the "Code") which
governs the personal trading activities of all "Access Persons" of the Advisor.
Access Persons include every director and officer of the Advisor and the
investment companies managed by the Advisor, including the Fund, as well as
certain employees of the Advisor who have access to information relating to the
purchase or sale of securities by the Advisor on behalf of accounts managed by
it. The Code is based upon the principal that such Access Persons have a
fiduciary duty to place the interests of the Fund and the Advisor's other
clients ahead of their own.
The Code requires Access Persons (other than Access Persons who are
independent directors of the investment companies managed by the Advisor,
including the Fund) to, among other things, preclear their securities
transactions (with limited exceptions, such as transactions in shares of mutual
funds, direct obligations of the U.S. government, and certain options on
broad-based securities market indexes) and to execute such transactions through
the Advisor's trading department. The Code, which applies to all Access Persons
(other than Access Persons who are independent directors of the investment
28
<PAGE> 279
companies managed by the Advisor, including the Fund), includes a ban on
acquiring any securities in an initial public offering, other than a new
offering of a registered open-end investment company, and a prohibition from
profiting on short-term trading in securities. In addition, no Access Person
may purchase or sell any security which, is contemporaneously being purchased
or sold, or to the knowledge of the Access Person, is being considered for
purchase or sale, by the Advisor on behalf of any mutual fund or other account
managed by it. Finally, the Code provides for trading "black out" periods of
seven calendar days during which time Access Persons who are portfolio managers
may not trade in securities which have been purchased or sold by any mutual
fund or other account managed by the portfolio manager.
From time to time the Advisor votes the shares owned by the Fund according
to its Statement of General Proxy Voting Policy ("Proxy Voting Policy"). The
general principal of the Proxy Voting Policy is to vote any beneficial interest
in an equity security prudently and solely in the best long-term economic
interest of the Fund and its beneficiaries considering all relevant factors and
without undue influence from individuals or groups who may have an economic
interest in the outcome of a proxy vote. Shareholders may obtain a copy of the
Proxy Voting Policy upon request from the Advisor.
The Advisor provides investment advisory services for multiple clients and
may give advice and take action, with respect to any client, that may differ
from the advice given, or the timing or nature of action taken, with respect to
any one account. However, the Advisor will allocate over a period of time, to
the extent practical, investment opportunities to each account on a fair and
equitable basis relative to other similarly-situated client accounts. The
Advisor, its principals and associates (to the extent not prohibited by the
Code), and other clients of the Advisor may have, acquire, increase, decrease,
or dispose of securities or interests therein at or about the same time that
the Advisor is purchasing or selling securities or interests therein for an
account that are or may be deemed to be inconsistent with the actions taken by
such persons.
Under a Distribution Agreement dated July 10, 1995 with the Corporation
(the "Distribution Agreement"), Strong Funds Distributors, Inc.
("Distributor"), a subsidiary of the Advisor, acts as underwriter of the Fund's
shares. The Distribution Agreement provides that the Distributor will use its
best efforts to distribute the Fund's shares. Shares are only offered and sold
to the separate accounts of certain insurance companies. Since the Fund is a
"no-load" fund, no sales commissions are charged on the purchase of Fund
shares. Certain sales charges may apply to the variable annuity or life
insurance contract, which should be described in the prospectus of the
insurance company's separate account. The Distribution Agreement further
provides that the Distributor will bear the additional costs of printing
prospectuses and shareholder reports which are used for selling purposes, as
well as advertising and other costs attributable to the distribution of the
Fund's shares. The Distributor is an indirect subsidiary of the Advisor and
controlled by the Advisor and Richard S. Strong. The Distribution Agreement is
subject to the same termination and renewal provisions as are described above
with respect to the Advisory Agreement.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Advisor is responsible for decisions to buy and sell securities for
the Fund and for the placement of the Fund's investment business and the
negotiation of the commissions to be paid on such transactions. It is the
policy of the Advisor to seek the best execution at the best security price
available with respect to each transaction, in light of the overall quality of
brokerage and research services provided to the Advisor or the Fund. In
over-the-counter transactions, orders are placed directly with a principal
market maker unless it is believed that a better price and execution can be
obtained using a broker. The best price to the Fund means the best net price
without regard to the mix between purchase or sale price and commission, if
any. In selecting broker-dealers and in negotiating commissions, the Advisor
considers a variety of factors, including best price and execution, the full
range of brokerage services provided by the broker, as well as its capital
strength and stability, and the quality of the research and research services
provided by the broker. Brokerage will not be allocated based on the sale of
any shares of the Strong Funds.
The Advisor has adopted procedures that provide generally for the Advisor
to seek to bunch orders for the purchase or sale of the same security for the
Fund, other mutual funds managed by the Advisor, and other advisory clients
(collectively, the "client accounts"). The Advisor will bunch orders when it
deems it to be appropriate and in the best interest of the client accounts.
When a bunched order is filled in its entirety, each participating client
account will participate at the average share price for the bunched order on
the same business day, and transaction costs shall be shared pro rata based on
each client's participation in the bunched order. When a bunched order is only
partially filled, the securities purchased will be allocated on a pro rata
basis to each client account participating in the bunched order based upon the
initial amount requested for the account,
29
<PAGE> 280
subject to certain exceptions, and each participating account will participate
at the average share price for the bunched order on the same business day.
Section 28(e) of the Securities Exchange Act of 1934 ("Section 28(e)")
permits an investment advisor, under certain circumstances, to cause an account
to pay a broker or dealer a commission for effecting a transaction in excess of
the amount of commission another broker or dealer would have charged for
effecting the transaction in recognition of the value of the brokerage and
research services provided by the broker or dealer. Brokerage and research
services include (a) furnishing advice as to the value of securities, the
advisability of investing in, purchasing or selling securities, and the
availability of securities or purchasers or sellers of securities; (b)
furnishing analyses and reports concerning issuers, industries, securities,
economic factors and trends, portfolio strategy, and the performance of
accounts; and (c) effecting securities transactions and performing functions
incidental thereto (such as clearance, settlement, and custody).
In carrying out the provisions of the Advisory Agreement, the Advisor may
cause the Fund to pay a broker, which provides brokerage and research services
to the Advisor, a commission for effecting a securities transaction in excess
of the amount another broker would have charged for effecting the transaction.
The Advisor believes it is important to its investment decision-making process
to have access to independent research. The Advisory Agreement provides that
such higher commissions will not be paid by the Fund unless (a) the Advisor
determines in good faith that the amount is reasonable in relation to the
services in terms of the particular transaction or in terms of the Advisor's
overall responsibilities with respect to the accounts as to which it exercises
investment discretion; (b) such payment is made in compliance with the
provisions of Section 28(e), other applicable state and federal laws, and the
Advisory Agreement; and (c) in the opinion of the Advisor, the total
commissions paid by the Fund will be reasonable in relation to the benefits to
the Fund over the long term. The investment management fee paid by the Fund
under the Advisory Agreement is not reduced as a result of the Advisor's
receipt of research services.
Generally, research services provided by brokers may include information
on the economy, industries, groups of securities, individual companies,
statistical information, accounting and tax law interpretations, political
developments, legal developments affecting portfolio securities, technical
market action, pricing and appraisal services, credit analysis, risk
measurement analysis, performance analysis, and analysis of corporate
responsibility issues. Such research services are received primarily in the
form of written reports, telephone contacts, and personal meetings with
security analysts. In addition, such research services may be provided in the
form of access to various computer-generated data, computer hardware and
software, and meetings arranged with corporate and industry spokespersons,
economists, academicians, and government representatives. In some cases,
research services are generated by third parties but are provided to the
Advisor by or through brokers. Such brokers may pay for all or a portion of
computer hardware and software costs relating to the pricing of securities.
Where the Advisor itself receives both administrative benefits and
research and brokerage services from the services provided by brokers, it makes
a good faith allocation between the administrative benefits and the research
and brokerage services, and will pay for any administrative benefits with cash.
In making good faith allocations of costs between administrative benefits and
research and brokerage services, a conflict of interest may exist by reason of
the Advisor's allocation of the costs of such benefits and services between
those that primarily benefit the Advisor and those that primarily benefit the
Fund and other advisory clients.
From time to time, the Advisor may purchase new issues of securities for
the Fund in a fixed price offering. In these situations, the seller may be a
member of the selling group that will, in addition to selling the securities to
the Fund and other advisory clients, provide the Advisor with research. The
National Association of Securities Dealers has adopted rules expressly
permitting these types of arrangements under certain circumstances. Generally,
the seller will provide research "credits" in these situations at a rate that
is higher than that which is available for typical secondary market
transactions. These arrangements may not fall within the safe harbor of Section
28(e).
Each year, the Advisor considers the amount and nature of research and
research services provided by brokers, as well as the extent to which such
services are relied upon, and attempts to allocate a portion of the brokerage
business of the Fund and other advisory clients on the basis of that
consideration. In addition, brokers may suggest a level of business they would
like to receive in order to continue to provide such services. The actual
brokerage business received by a broker may be more or less than the suggested
allocations, depending upon the Advisor's evaluation of all applicable
considerations.
30
<PAGE> 281
The Advisor has informal arrangements with various brokers whereby, in
consideration for providing research services and subject to Section 28(e), the
Advisor allocates brokerage to those firms, provided that their brokerage and
research services were satisfactory to the Advisor and their execution
capabilities were compatible with the Advisor's policy of seeking best
execution at the best security price available, as discussed above. In no case
will the Advisor make binding commitments as to the level of brokerage
commissions it will allocate to a broker, nor will it commit to pay cash if any
informal targets are not met. The Advisor anticipates it will continue to
enter into such brokerage arrangements.
The Advisor may direct the purchase of securities on behalf of the Fund
and other advisory clients in secondary market transactions, in public
offerings directly from an underwriter, or in privately negotiated transactions
with an issuer. When the Advisor believes the circumstances so warrant,
securities purchased in public offerings may be resold shortly after
acquisition in the immediate aftermarket for the security in order to take
advantage of price appreciation from the public offering price or for other
reasons. Short-term trading of securities acquired in public offerings, or
otherwise, may result in higher portfolio turnover and associated brokerage
expenses.
The Advisor places portfolio transactions for other advisory accounts,
including other mutual funds managed by the Advisor. Research services
furnished by firms through which the Fund effects its securities transactions
may be used by the Advisor in servicing all of its accounts; not all of such
services may be used by the Advisor in connection with the Fund. In the
opinion of the Advisor, it is not possible to measure separately the benefits
from research services to each of the accounts (including the Fund) managed by
the Advisor. Because the volume and nature of the trading activities of the
accounts are not uniform, the amount of commissions in excess of those charged
by another broker paid by each account for brokerage and research services will
vary. However, in the opinion of the Advisor, such costs to the Fund will not
be disproportionate to the benefits received by the Fund on a continuing basis.
The Advisor seeks to allocate portfolio transactions equitably whenever
concurrent decisions are made to purchase or sell securities by the Fund and
another advisory account. In some cases, this procedure could have an adverse
effect on the price or the amount of securities available to the Fund. In
making such allocations between the Fund and other advisory accounts, the main
factors considered by the Advisor are the respective investment objectives, the
relative size of portfolio holdings of the same or comparable securities, the
availability of cash for investment, the size of investment commitments
generally held, and the opinions of the persons responsible for recommending
the investment.
Where consistent with a client's investment objectives, investment
restrictions, and risk tolerance, the Advisor may purchase securities sold in
underwritten public offerings for client accounts, commonly referred to as
"deal" securities. The Advisor has adopted deal allocation procedures (the
"procedures"), summarized below, that reflect the Advisor's overriding policy
that deal securities must be allocated among participating client accounts in a
fair and equitable manner and that deal securities may not be allocated in a
manner that unfairly discriminates in favor of certain clients or types of
clients.
The procedures provide that, in determining which client accounts a
portfolio manager team will seek to have purchase deal securities, the team
will consider all relevant factors including, but not limited to, the nature,
size, and expected allocation to the Advisor of deal securities; the size of
the account(s); the accounts' investment objectives and restrictions; the risk
tolerance of the client; the client's tolerance for possibly higher portfolio
turnover; the amount of commissions generated by the account during the past
year; and the number of other deals the client has participated in during the
past year.
Where more than one of the Advisor's portfolio manager team seeks to have
client accounts participate in a deal and the amount of deal securities
allocated to the Advisor by the underwriting syndicate is less than the
aggregate amount ordered by the Advisor (a "reduced allocation"), the deal
securities will be allocated among the portfolio manager teams based on all
relevant factors. The primary factor shall be assets under management,
although other factors that may be considered in the allocation decision
include, but are not limited to, the nature, size, and expected allocation of
the deal; the amount of brokerage commissions or other amounts generated by the
respective participating portfolio manager teams; and which portfolio manager
team is primarily responsible for the Advisor receiving securities in the deal.
Based on the relevant factors, the Advisor has established general allocation
percentages for its portfolio manager teams, and these percentages are reviewed
on a regular basis to determine whether asset growth or other factors make it
appropriate to use different general allocation percentages for reduced
allocations.
31
<PAGE> 282
When a portfolio manager team receives a reduced allocation of deal
securities, the portfolio manager team will allocate the reduced allocation
among client accounts in accordance with the allocation percentages set forth
in the team's initial allocation instructions for the deal securities, except
where this would result in a de minimis allocation to any client account. On a
regular basis, the Advisor reviews the allocation of deal securities to ensure
that they have been allocated in a fair and equitable manner that does not
unfairly discriminate in favor of certain clients or types of clients.
During 1995 and 1996 the Fund paid $0 and $0, respectively, in brokerage
commissions.
CUSTODIAN
As custodian of the Fund's assets, Firstar Trust Company, P.O. Box 761,
Milwaukee, Wisconsin 53201, has custody of all securities and cash of the Fund,
delivers and receives payment for securities sold, receives and pays for
securities purchased, collects income from investments, and performs other
duties, all as directed by officers of the Corporation. The custodian is in no
way responsible for any of the investment policies or decisions of the Fund.
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT
The Advisor acts as transfer agent and dividend-disbursing agent for the
Fund at no cost.
ADMINISTRATIVE SERVICES
From time to time the Fund and/or the Advisor may enter into arrangements
under which certain administrative services may be performed by the insurance
companies that purchase shares in the Fund. These administrative services may
include, among other things, responding to ministerial inquiries concerning the
Fund's investment objective, investment program, policies and performance,
transmitting, on behalf of the Fund, proxy statements, annual reports, updated
prospectuses, and other communications regarding the Fund, and providing only
related services as the Fund or its shareholders may reasonably request.
Depending on the arrangements, the Fund and/or Advisor may compensate such
insurance companies or their agents directly or indirectly for the
administrative services. To the extent the Fund compensates the insurance
company for these services, the Fund will pay the insurance company an annual
fee that will vary depending upon the number of contract holders that utilize
the Fund as the funding medium for their contracts. The insurance company may
impose other account or service charges. See the prospectus for the separate
account of the insurance company for additional information regarding such
charges.
TAXES
GENERAL
As indicated under "Additional Information - Distributions and Taxes" in
the Prospectus, the Fund intends to continue to qualify annually for treatment
as a regulated investment company ("RIC") under the Internal Revenue Code of
1986, as amended (the "Code"). This qualification does not involve government
supervision of the Fund's management practices or policies.
In order to qualify for treatment as a RIC under the Code, the Fund must
distribute to its shareholders for each taxable year at least 90% of its
investment company taxable income (consisting generally of net investment
income, net short-term capital gain, and net gains from certain foreign
currency transactions) ("Distribution Requirement") and must meet several
additional requirements. Among these requirements are the following: (1) the
Fund must derive at least 90% of its gross income each taxable year from
dividends, interest, payments with respect to securities loans, and gains from
the sale or other disposition of securities or foreign currencies, or other
income (including gains from options, futures, or forward contracts) derived
with respect to its business of investing in securities or those currencies
("Income Requirement"); (2) the Fund must derive less than 30% of its gross
income each taxable year from the sale or other disposition of securities, or
any of the following, that were held for less than three months - options or
futures (other than those on foreign currencies), or foreign currencies (or
options, futures, or forward contracts thereon) that are not directly related
to the Fund's principal business or investing in securities (or options and
futures with respect to securities) ("30% Limitation"); (3) at the close of
each quarter of
32
<PAGE> 283
the Fund's taxable year, at least 50% of the value of its total assets must be
represented by cash and cash items, U.S. government securities, securities of
other RICs, and other securities, with these other securities limited, in
respect of any one issuer, to an amount that does not exceed 5% of the value of
the Fund's total assets and that does not represent more than 10% of the
issuer's outstanding voting securities; and (4) at the close of each quarter of
the Fund's taxable year, not more than 25% of the value of its total assets may
be invested in securities (other than U.S. government securities or the
securities of other RICs) of any one issuer. From time to time the Advisor may
find it necessary to make certain types of investments for the purpose of
ensuring that the Fund continues to qualify for treatment as a RIC under the
Code.
If Fund shares are sold at a loss after being held for six months or less,
the loss will be treated as long-term, instead of short-term, capital loss to
the extent of any capital gain distributions received on those shares.
In addition, the Fund must satisfy the diversification requirements of
Section 817(h) of the Code. In general, for the Fund to meet these investment
diversification requirements, Treasury regulations require that no more than
55% of the total value of the assets of the Fund may be represented by any one
investment, no more than 70% by two investments, no more than 80% by three
investments and no more than 90% by four investments. Generally, for purposes
of the regulations, all securities of the same issuer are treated as a single
investment. With respect to the United States Government securities (including
any security that is issued, guaranteed or insured by the United States or an
instrumentality of the United States), each governmental agency or
instrumentality is treated as a separate issuer. Compliance with the
regulations is tested on the last day of each calendar year quarter. There is
a 30-day period after the end of each calendar year quarter in which to cure
any non-compliance with these requirements.
FOREIGN TRANSACTIONS
Interest and dividends received by the Fund may be subject to income,
withholding, or other taxes imposed by foreign countries and U.S. possessions
that would reduce the yield on its securities. Tax conventions between certain
countries and the United States may reduce or eliminate these foreign taxes,
however, and many foreign countries do not impose taxes on capital gains in
respect of investments by foreign investors.
The Fund maintains its accounts and calculates its income in U.S. dollars.
In general, gain or loss (1) from the disposition of foreign currencies and
forward currency contracts, (2) from the disposition of
foreign-currency-denominated debt securities that are attributable to
fluctuations in exchange rates between the date the securities are acquired and
their disposition date, and (3) attributable to fluctuations in exchange rates
between the time the Fund accrues interest or other receivables or expenses or
other liabilities denominated in a foreign currency and the time the Fund
actually collects those receivables or pays those liabilities, will be treated
as ordinary income or loss. A foreign-currency-denominated debt security
acquired by the Fund may bear interest at a high normal rate that takes into
account expected decreases in the value of the principal amount of the security
due to anticipated currency devaluations; in that case, the Fund would be
required to include the interest in income as it accrues but generally would
realize a currency loss with respect to the principal only when the principal
was received (through disposition or upon maturity).
The Fund may invest in the stock of "passive foreign investment companies"
("PFICs"). A PFIC is a foreign corporation that, in general, meets either of
the following tests: (1) at least 75% of its gross income is passive or (2) an
average of at least 50% of its assets produce, or are held for the production
of, passive income. Under certain circumstances, the Fund will be subject to
federal income tax on a portion of any "excess distribution" received on the
stock or of any gain on disposition of the stock (collectively, "PFIC income"),
plus interest thereon, even if the Fund distributes the PFIC income to its
shareholders. The balance of the PFIC income will be included in the Fund's
investment company taxable income and, accordingly, will not be taxable to it
to the extent that income is distributed to its shareholders. If the Fund
invests in a PFIC and elects to treat the PFIC as a "qualified electing fund,"
then in lieu of the foregoing tax and interest obligation, the Fund will be
required to include in income each year its pro rata share of the qualified
electing fund's annual ordinary earnings and net capital gain (the excess of
net long-term capital gain over net short-term capital loss) -- which probably
would have to be distributed to its shareholders to satisfy the Distribution
Requirement -- even if those earnings and gain were not received by the Fund.
In most instances it will be very difficult, if not impossible, to make this
election because of certain requirements thereof.
DERIVATIVE INSTRUMENTS
33
<PAGE> 284
The use of derivatives strategies, such as purchasing and selling
(writing) options and futures and entering into forward currency contracts,
involves complex rules that will determine for income tax purposes the
character and timing of recognition of the gains and losses the Fund realizes
in connection therewith. Gains from the disposition of foreign currencies
(except certain gains therefrom that may be excluded by future regulations),
and income from transactions in options, futures, and forward currency
contracts derived by the Fund with respect to its business of investing in
securities or foreign currencies, will qualify as permissible income under the
Income Requirement. However, income from the disposition of options and
futures (other than those on foreign currencies) will be subject to the 30%
Limitation if they are held for less than three months. Income from the
disposition of foreign currencies, and options, futures, and forward contracts
on foreign currencies, that are not directly related to the Fund's principal
business of investing in securities (or options and futures with respect to
securities) also will be subject to the 30% Limitation if they are held for
less than three months.
If the Fund satisfies certain requirements, any increase in value of a
position that is part of a "designated hedge" will be offset by any decrease in
value (whether realized or not) of the offsetting hedging position during the
period of the hedge for purposes of determining whether the Fund satisfies the
30% Limitation. Thus, only the net gain (if any) from the designated hedge
will be included in gross income for purposes of that limitation. The Fund
intends that, when it engages in hedging strategies, the hedging transactions
will qualify for this treatment, but at the present time it is not clear
whether this treatment will be available for all of the Fund's hedging
transactions. To the extent this treatment is not available or is not elected
by the Fund, it may be forced to defer the closing out of certain options,
futures, or forward currency contracts beyond the time when it otherwise would
be advantageous to do so, in order for the Fund to continue to qualify as a
RIC.
For federal income tax purposes, the Fund is required to recognize as
income for each taxable year its net unrealized gains and losses on options,
futures, and forward currency contracts that are subject to section 1256 of the
Code ("Section 1256 Contracts") and are held by the Fund as of the end of the
year, as well as gains and losses on Section 1256 Contracts actually realized
during the year. Except for Section 1256 Contracts that are part of a "mixed
straddle" and with respect to which the Fund makes a certain election, any gain
or loss recognized with respect to Section 1256 Contracts is considered to be
60% long-term capital gain or loss and 40% short-term capital gain or loss,
without regard to the holding period of the Section 1256 Contract. Unrealized
gains on Section 1256 Contracts that have been held by the Fund for less than
three months as of the end of its taxable year, and that are recognized for
federal income tax purposes as described above, will not be considered gains on
investments held for less than three months for purposes of the 30% Limitation.
ZERO-COUPON, STEP-COUPON, AND PAY-IN-KIND SECURITIES
The Fund may acquire zero-coupon, step-coupon, or other securities issued
with original issue discount. As a holder of those securities, the Fund must
include in its income the original issue discount that accrues on the
securities during the taxable year, even if the Fund receives no corresponding
payment on the securities during the year. Similarly, the Fund must include in
its income securities it receives as "interest" on pay-in-kind securities.
Because the Fund annually must distribute substantially all of its investment
company taxable income, including any original issue discount and other
non-cash income, to satisfy the Distribution Requirement, it may be required in
a particular year to distribute as a dividend an amount that is greater than
the total amount of cash it actually receives. Those distributions may be made
from the proceeds on sales of portfolio securities, if necessary. The Fund may
realize capital gains or losses from those sales, which would increase or
decrease its investment company taxable income or net capital gain, or both.
In addition, any such gains may be realized on the disposition of securities
held for less than three months. Because of the 30% Limitation, any such gains
would reduce the Fund's ability to sell other securities, or certain options,
futures, or forward currency contracts, held for less that three months that
it might wish to sell in the ordinary course of its portfolio management.
The foregoing federal tax discussion as well as the tax discussion
contained within the Prospectus under "Additional Information - Distributions
and Taxes" is intended to provide you with an overview of the impact of federal
income tax provisions on the Fund or its shareholders. These tax provisions
are subject to change by legislative or administrative action at the federal,
state, or local level, and any changes may be applied retroactively. Any such
action that limits or restricts the Fund's current ability to pass-through
earnings without taxation at the Fund level, or otherwise materially changes
the Fund's tax treatment, could adversely affect the value of a shareholder's
investment in the Fund. Because the Fund's taxes are a complex matter, you
should consult your tax adviser for more detailed information concerning the
taxation of the Fund and the federal, state, and local tax consequences to
shareholders of an investment in the Fund.
34
<PAGE> 285
DETERMINATION OF NET ASSET VALUE
A more complete discussion of the Fund's determination of net asset value
is contained in the Prospectus. Generally, the net asset value of the Fund
will be determined as of the close of trading on each day the New York Stock
Exchange (the "NYSE") is open for trading. The NYSE is open for trading Monday
through Friday except New Year's Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
Additionally, if any of the aforementioned holidays falls on a Saturday, the
NYSE will not be open for trading on the preceding Friday, and when any such
holiday falls on a Sunday, the NYSE will not be open for trading on the
succeeding Monday, unless unusual business conditions exist, such as the ending
of a monthly or the yearly accounting period.
FUND ORGANIZATION
The Fund is a series of Strong Variable Insurance Funds, Inc., a Wisconsin
corporation (the "Corporation"). The Corporation (formerly known as Strong
Discovery Fund II, Inc., formerly known as Strong D Fund, Inc.) was organized
on December 28, 1990 and is authorized to issue an indefinite number of shares
of common stock and series and classes of series of shares of common stock,
with a par value of $.00001 per share. The Corporation is authorized to issue
an indefinite number of shares of common stock of the Fund. Each share of the
Corporation has one vote, and all shares of a series participate equally in
dividends and other capital gains distributions and in the residual assets of
that Fund in the event of liquidation. Fractional shares have the same rights
proportionately as do full shares. Shares of the Corporation have no
preemptive, conversion, or subscription rights. The Corporation currently has
seven series of common stock outstanding. The assets belonging to each series
of shares is held separately by a custodian, and in effect each series is a
separate fund. All holders of shares of the Corporation would vote on each
matter presented to shareholders for action except with respect to any matter
which affects only one or more series or classes, in which case only the shares
of the affected series or class shall be entitled to vote. Because of current
federal securities law requirements the Corporation expects that its
shareholders will offer to owners of variable annuity and variable life
insurance contracts the opportunity to instruct them as to how shares allocable
to their contracts will be voted with respect to certain matters, such as
approval of changes to the investment advisory agreement.
PERFORMANCE INFORMATION
As described under "Additional Information - Performance Information" in
the Prospectus, the Fund's historical performance or return may be shown in the
form of "yield," "average annual total return," "total return," and "cumulative
total return." From time to time, the Advisor may voluntarily waive all or a
portion of its management fee and/or absorb certain expenses for the Fund.
Total returns contained in advertisements include the effect of deducting the
Fund's expenses, but may not include charges and expenses attributable to any
particular insurance product. Since shares may only be purchased by the
separate accounts of certain insurance companies, contracts owners should
carefully review the prospectus of the separate account for information on fees
and expenses. Excluding such fees and expenses from the Fund's total return
quotations has the effect of increasing the performance quoted.
YIELD
The Fund's yield is computed in accordance with a standardized method
prescribed by rules of the SEC. Under that method, the current yield quotation
for the Fund is based on a one month or 30-day period. The yield is computed
by dividing the net investment income per share earned during the 30-day or one
month period by the maximum offering price per share on the last day of the
period, according to the following formula:
35
<PAGE> 286
YIELD = 2[( a-b + 1)6 - 1]
---
cd)
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursements).
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends.
d = the maximum offering price per share on the last day of the
period.
For the 30-day period ended December 31, 1996, the Fund's yield was 1.70%.
During this period, the Advisor waived management fees of .60% and absorbed
expenses of .68%. Without this waiver and absorption, the Fund's yield would
have been .42%.
In computing yield, the Fund follows certain standardized accounting
practices specified by SEC rules. These practices are not necessarily
consistent with those that the Fund uses to prepare annual and interim
financial statements in conformity with generally accepted accounting
principles.
DISTRIBUTION RATE
The distribution rate is computed, according to a non-standardized
formula, by dividing the total amount of actual distributions per share paid by
the Fund over a twelve month period by the Fund's net asset value on the last
day of the period. The distribution rate differs from the Fund's yield because
the distribution rate includes distributions to shareholders from sources other
than dividends and interest, such as premium income from option writing and
short-term capital gains. Therefore, the Fund's distribution rate may be
substantially different than its yield. Both the Fund's yield and distribution
rate will fluctuate.
AVERAGE ANNUAL TOTAL RETURN
The Fund's average annual total return quotation is computed in accordance
with a standardized method prescribed by rules of the SEC. The average annual
total return for the Fund for a specific period is found by first taking a
hypothetical $10,000 investment ("initial investment") in the Fund's shares on
the first day of the period and computing the "redeemable value" of that
investment at the end of the period. The redeemable value is then divided by
the initial investment, and this quotient is taken to the Nth root (N
representing the number of years in the period) and one is subtracted from the
result, which is then expressed as a percentage. The calculation assumes that
all income and capital gains dividends paid by the Fund have been reinvested at
net asset value on the reinvestment dates during the period.
TOTAL RETURN
Calculation of the Fund's total return is not subject to a standardized
formula. Total return performance for a specific period is calculated by first
taking an investment (assumed below to be $10,000) ("initial investment") in
the Fund's shares on the first day of the period and computing the "ending
value" of that investment at the end of the period. The total return
percentage is then determined by subtracting the initial investment from the
ending value and dividing the remainder by the initial investment and
expressing the result as a percentage. The calculation assumes that all income
and capital gains dividends paid by the Fund have been reinvested at net asset
value on the reinvestment dates during the period. Total return may also be
shown as the increased dollar value of the hypothetical investment over the
period.
CUMULATIVE TOTAL RETURN
Calculation of the Fund's cumulative total return is not subject to a
standardized formula and represents the simple change in value of an investment
over a stated period and may be quoted as a percentage or as a dollar amount.
Total returns and cumulative total returns may be broken down into their
components of income and capital (including capital gains and changes in share
price) in order to illustrate the relationship between these factors and their
contributions to total return.
36
<PAGE> 287
The Fund's performance figures are based upon historical results and do
not represent future performance. The Fund's shares are sold at net asset
value per share. The Fund's returns and net asset value will fluctuate and
shares are redeemable at the then current net asset value of the Fund, which
may be more or less than original cost. Factors affecting the Fund's
performance include general market conditions, operating expenses, and
investment management. Any additional fees charged by an insurance company or
other financial services firm would reduce the returns described in this
section.
The table below shows performance information for various periods ended
December 31, 1996. Securities prices fluctuated during these periods.
ADVANTAGE FUND II
<TABLE>
<CAPTION>
Average
Total Return Annual Total Return
Initial $10,000 Ending Value Percentage Percentage
Investment December 31, 1996 Increase Increase
<S> <C> <C> <C> <C>
Life of Fund* $10,000 $10,572 5.72% 5.24%
One Year $10,000 $10,492 4.92% 4.92%
</TABLE>
- -------------------------------------
* Commenced operations on November 30, 1995.
The Fund's total return for the three months ending March 31, 1997, was
1.40%.
COMPARISONS
(1) U.S. TREASURY BILLS, NOTES, OR BONDS
Investors may also wish to compare the performance of the Fund to that of
United States Treasury bills, notes, or bonds, which are issued by the U.S.
government, because such instruments represent alternative income producing
products. Treasury obligations are issued in selected denominations. Rates of
Treasury obligations are fixed at the time of issuance and payment of principal
and interest is backed by the full faith and credit of the United States
Treasury. The market value of such instruments will generally fluctuate
inversely with interest rates prior to maturity and will equal par value at
maturity.
(2) CERTIFICATES OF DEPOSIT
Investors may wish to compare the Fund's performance to that of
certificates of deposit offered by banks and other depositary institutions.
Certificates of deposit represent an alternative income producing product.
Certificates of deposit may offer fixed or variable interest rates and
principal is guaranteed and may be insured. Withdrawal of the deposits prior to
maturity normally will be subject to a penalty. Rates offered by banks and
other depositary institutions are subject to change at any time specified by
the issuing institution.
(3) MONEY MARKET FUNDS
Investors may also want to compare performance of the Fund to that of
money market funds. Money market fund yields will fluctuate and an investment
in money market fund shares is neither insured nor guaranteed by the U.S.
government, but share values usually remain stable.
(4) LIPPER ANALYTICAL SERVICES, INC. ("LIPPER") AND OTHER INDEPENDENT RANKING
ORGANIZATIONS
From time to time, in marketing and other fund literature, the Fund's
performance may be compared to the performance of other mutual funds in general
or to the performance of particular types of mutual funds, with similar
investment goals, as tracked by independent organizations. Among these
organizations, Lipper, a widely used independent research firm which ranks
mutual funds by overall performance, investment objectives, and assets, may be
cited. Lipper performance figures are based on changes in net asset value,
with all income and capital gain dividends reinvested. Such calculations do
not include the effect of any sales charges imposed by other funds. The Fund
will be compared to Lipper's appropriate fund category, that is, by fund
objective and portfolio holdings.
37
<PAGE> 288
(5) MORNINGSTAR, INC.
The Fund's performance may also be compared to the performance of other
mutual funds by Morningstar, Inc. which rates funds on the basis of historical
risk and total return. Morningstar's ratings range from five stars (highest)
to one star (lowest) and represent Morningstar's assessment of the historical
risk level and total return of the Fund as a weighted average for 3, 5, and 10
year periods. Ratings are not absolute and do not represent future results.
(6) VARDS REPORT
The Fund's performance may also be compared to the performance of other
variable annuity products in general or to the performance of particular types
of variable annuity products, with similar investment goals, as tracked by the
VARDS Report (Variable Annuity Research and Data Service Report) produced by
Financial Planning Resources, Inc. The VARDS Report is a monthly performance
analysis of the variable annuity industry.
(7) INDEPENDENT SOURCES
Evaluations of Fund performance made by independent sources may also be
used in advertisements concerning the Fund, including reprints of, or
selections from, editorials or articles about the Fund, especially those with
similar objectives. Sources for Fund performance information and articles
about the Fund may include publications such as Money, Forbes, Kiplinger's,
Smart Money, Morningstar, Inc., Financial World, Business Week, U.S. News and
World Report, The Wall Street Journal, Barron's, and a variety of investment
newsletters.
(8) VARIOUS BANK PRODUCTS
The Fund's performance also may be compared on a before or after-tax basis
to various bank products, including the average rate of bank and thrift
institution money market deposit accounts, Super N.O.W. accounts and
certificates of deposit of various maturities as reported in the Bank Rate
Monitor, National Index of 100 leading banks, and thrift institutions as
published by the Bank Rate Monitor, Miami Beach, Florida. The rates published
by the Bank Rate Monitor National Index are averages of the personal account
rates offered on the Wednesday prior to the date of publication by 100 large
banks and thrifts in the top ten Consolidated Standard Metropolitan Statistical
Areas. The rates provided for the bank accounts assume no compounding and are
for the lowest minimum deposit required to open an account. Higher rates may
be available for larger deposits.
With respect to money market deposit accounts and Super N.O.W. accounts,
account minimums range upward from $2,000 in each institution and compounding
methods vary. Super N.O.W. accounts generally offer unlimited check writing
while money market deposit accounts generally restrict the number of checks
that may be written. If more than one rate is offered, the lowest rate is
used. Rates are determined by the financial institution and are subject to
change at any time specified by the institution. Generally, the rates offered
for these products take market conditions and competitive product yields into
consideration when set. Bank products represent a taxable alternative income
producing product. Bank and thrift institution deposit accounts may be
insured. Shareholder accounts in the Fund are not insured. Bank passbook
savings accounts compete with money market mutual fund products with respect to
certain liquidity features but may not offer all of the features available from
a money market mutual fund, such as check writing. Bank passbook savings
accounts normally offer a fixed rate of interest while the yield of the Fund
fluctuates. Bank checking accounts normally do not pay interest but compete
with money market mutual fund products with respect to certain liquidity
features (e.g., the ability to write checks against the account). Bank
certificates of deposit may offer fixed or variable rates for a set term.
(Normally, a variety of terms are available.) Withdrawal of these deposits
prior to maturity will normally be subject to a penalty.
(9) INDICES
The Fund may compare its performance to a wide variety of indices
including the following:
(a) The Consumer Price Index
(b) Merrill Lynch 91 Day Treasury Bill Index
(c) Merrill Lynch Government/Corporate 1-3 Year Index
(d) IBC/Donoghue's Taxable Money Fund Average(TM)
(e) IBC/Donoghue's Government Money Fund Average(TM)
(f) Salomon Brothers 1-Month Treasury Bill Index
(g) Salomon Brothers 3-Month Treasury Bill Index
(h) Salomon Brothers 1-Year Treasury Benchmark-on-the-Run Index
38
<PAGE> 289
(i) Salomon Brothers 1-3 Year Treasury/Government-Sponsored/Corporate
Bond Index
(j) Salomon Brothers Corporate Bond Index
(k) Salomon Brothers AAA, AA, A, BBB, and BB Corporate Bond Indexes
(l) Salomon Brothers Broad Investment-Grade Bond Index
(m) Salomon Brothers High-Yield BBB Index
(n) Lehman Brothers Aggregate Bond Index
(o) Lehman Brothers 1-3 Year Government/Corporate Bond Index
(p) Lehman Brothers Intermediate Government/Corporate Bond Index
(q) Lehman Brothers Intermediate AAA, AA, and A Corporate Bond Indexes
(r) Lehman Brothers Government/Corporate Bond Index
(s) Lehman Brothers Corporate Baa Index
(t) Lehman Brothers Intermediate Corporate Baa Index
(10) HISTORICAL ASSET CLASS RETURNS
From time to time, marketing materials may portray the historical returns
of various asset classes. Such presentations will typically compare the
average annual rates of return of inflation, U.S. Treasury bills, bonds, common
stocks, and small stocks. There are important differences between each of these
investments that should be considered in viewing any such comparison. The
market value of stocks will fluctuate with market conditions, and small-stock
prices generally will fluctuate more than large-stock prices. Stocks are
generally more volatile than bonds. In return for this volatility, stocks have
generally performed better than bonds or cash over time. Bond prices generally
will fluctuate inversely with interest rates and other market conditions, and
the prices of bonds with longer maturities generally will fluctuate more than
those of shorter-maturity bonds. Interest rates for bonds may be fixed at the
time of issuance, and payment of principal and interest may be guaranteed by
the issuer and, in the case of U.S. Treasury obligations, backed by the full
faith and credit of the U.S. Treasury.
(11) STRONG VARIABLE INSURANCE FUNDS
The Strong Variable Insurance Funds offer a range of investment options.
All of the members of the Strong Variable Insurance Funds and their investment
objectives are listed below. The Fund are listed in ascending order of risk and
return, as determined by the Fund's Advisor.
FUND NAME INVESTMENT OBJECTIVE
Strong Advantage Fund II Current income with a very low degree of
share-price fluctuation.
Strong Government Securities Fund II Total return by investing for a high
level of current income with a moderate
degree of share-price fluctuation.
Strong Asset Allocation Fund II High total return consistent with
reasonable risk over the long term.
Strong Special Fund II Capital growth.
Strong Growth Fund II Capital growth.
Strong Discovery Fund II Capital growth.
Strong International Stock Fund II Capital growth.
The Fund may from time to time be compared to the other Funds in the
Strong Variable Insurance Funds based on a risk/reward spectrum. In general,
the amount of risk associated with any investment product is commensurate with
that product's potential level of reward. The Strong Variable Insurance Fund's
risk/reward continuum or any Fund's position on the continuum may be described
or diagrammed in marketing materials. The Strong Variable Insurance Fund's
risk/reward continuum positions the risk and reward potential of the Fund
relative to the other Strong Variable Insurance Funds, but is not intended to
position any Fund relative to other mutual funds or investment products.
Marketing materials may also discuss the relationship between risk and reward
as it relates to an individual investor's portfolio. Financial goals vary from
person to person. You may choose one or more of the Strong Variable Insurance
Funds to help you reach your financial goals.
The Advisor also serves as advisor to the Strong Family of Funds, which is
a retail fund complex composed of 26 open-end management investment companies.
39
<PAGE> 290
ADDITIONAL FUND INFORMATION
(1) DURATION
Duration is a calculation that seeks to measure the price sensitivity of a
bond or a bond fund to changes in interest rates. It measures bond price
sensitivity to interest rate changes by taking into account the time value of
cash flows generated over the bond's life. future interest and principal
payments are discounted to reflect their present value and then are multiplied
by the number of years they will be received to produce a value that is
expressed in years. Since duration can also be computed for the Funds, you can
estimate the effect of interest rates on a Fund's share price. Simply multiply
the Fund's duration by an expected change in interest rates. For example, the
price of a Fund with a duration of two years would be expected to fall
approximately two percent if market interest rates rose by one percentage
point.
(2) PORTFOLIO CHARACTERISTICS
In order to present a more complete picture of the Fund's portfolio,
marketing materials may include various actual or estimated portfolio
characteristics, including but not limited to median market capitalizations,
earnings per share, alphas, betas, price/earnings ratios, returns on equity,
dividend yields, capitalization ranges, growth rates, price/book ratios, top
holdings, sector breakdowns, asset allocations, quality breakdowns, and
breakdowns by geographic region.
(3) MEASURES OF VOLATILITY AND RELATIVE PERFORMANCE
Occasionally statistics may be used to specify Fund volatility or risk.
The general premise is that greater volatility connotes greater risk undertaken
in achieving performance. Measures of volatility or risk are generally used to
compare the Fund's net asset value or performance relative to a market index.
One measure of volatility is beta. Beta is the volatility of the Fund relative
to the total market as represented by the Standard & Poor's 500 Stock Index. A
beta of more than 1.00 indicates volatility greater than the market, and a beta
of less than 1.00 indicates volatility less than the market. Another measure
of volatility or risk is standard deviation. Standard deviation is a
statistical tool that measures the degree to which the Fund's performance has
varied from its average performance during a particular time period.
Standard deviation is calculated using the following formula:
2
Standard deviation = the square root of E(x - x )
i m
-----------
n-1
where E = "the sum of",
x = each individual return during the time period,
i
x = the average return over the time period, and
m
n = the number of individual returns during the time period.
Statistics may also be used to discuss the Fund's relative performance.
One such measure is alpha. Alpha measures the actual return of the Fund
compared to the expected return of the Fund given its risk (as measured by
beta). The expected return is based on how the market as a whole performed,
and how the particular fund has historically performed against the market.
Specifically, alpha is the actual return less the expected return. The expected
return is computed by multiplying the advance or decline in a market
representation by the Fund's beta. A positive alpha quantifies the value that
the fund manager has added, and a negative alpha quantifies the value that the
fund manager has lost.
Other measures of volatility and relative performance may be used as
appropriate. However, all such measures will fluctuate and do not represent
future results.
40
<PAGE> 291
GENERAL INFORMATION
BUSINESS PHILOSOPHY
The Advisor is an independent, Midwestern-based investment advisor, owned
by professionals active in its management. Recognizing that investors are the
focus of its business, the Advisor strives for excellence both in investment
management and in the service provided to investors. This commitment affects
many aspects of the business, including professional staffing, product
development, investment management, and service delivery.
The increasing complexity of the capital markets requires specialized
skills and processes for each asset class and style. Therefore, the Advisor
believes that active management should produce greater returns than a passively
managed index. The Advisor has brought together a group of top-flight
investment professionals with diverse product expertise, and each concentrates
on their investment specialty. The Advisor believes that people are the firm's
most important asset. For this reason, continuity of professionals is critical
to the firm's long-term success.
INVESTMENT ENVIRONMENT
Discussions of economic, social, and political conditions and their impact
on the Fund may be used in advertisements and sales materials. Such factors
that may impact the Fund include, but are not limited to, changes in interest
rates, political developments, the competitive environment, consumer behavior,
industry trends, technological advances, macroeconomic trends, and the supply
and demand of various financial instruments. In addition, marketing materials
may cite the portfolio management's views or interpretations of such factors.
EIGHT BASIC PRINCIPLES FOR SUCCESSFUL MUTUAL FUND INVESTING
These common sense rules are followed by many successful investors.
They make sense for beginners, too. If you have a question on these principles,
or would like to discuss them with us, please contact us at 1-800-368-3863.
1. Have a plan - even a simple plan can help you take control of your
financial future. Review your plan once a year, or if your circumstances
change.
2. Start investing as soon as possible. Make time a valuable ally. Let it
put the power of compounding to work for you, while helping to reduce your
potential investment risk.
3. Diversify your portfolio. By investing in different asset classes -
stocks, bonds, and cash - you help protect against poor performance in one
type of investment while including investments most likely to help you
achieve your important goals.
4. Invest regularly. Investing is a process, not a one-time event. By
investing regularly over the long term, you reduce the impact of
short-term market gyrations, and you attend to your long-term plan before
you're tempted to spend those assets on short-term needs.
5. Maintain a long-term perspective. For most individuals, the best
discipline is staying invested as market conditions change. Reactive,
emotional investment decisions are all too often a source of regret - and
principal loss.
6. Consider stocks to help achieve major long-term goals. Over time, stocks
have provided the more powerful returns needed to help the value of your
investments stay well ahead of inflation.
7. Keep a comfortable amount of cash in your portfolio. To meet current
needs, including emergencies, use a money market fund or a bank account -
not your long-term investment assets.
41
<PAGE> 292
8. Know what you're buying. Make sure you understand the potential risks and
rewards associated with each of your investments. Ask questions... request
information...make up your own mind. And choose a fund company that helps
you make informed investment decisions.
PORTFOLIO MANAGEMENT
The portfolio manager works with a team of analysts, traders, and
administrative personnel. From time to time, marketing materials may discuss
various members of the team, including their education, investment experience,
and other credentials.
The Advisor believes that actively managing the Fund's portfolio and
adjusting the average portfolio maturity according to the Advisor's interest
rate outlook is the best way to achieve the Fund's objectives. This policy is
based on a fundamental belief that economic and financial conditions create
favorable and unfavorable investment periods (or seasons) and that these
different seasons require different investment approaches. Through its active
management approach, the Advisor seeks to avoid or reduce any negative change
in the Fund's net asset value per share during the periods of falling bond
prices and provide consistently positive annual returns throughout the seasons
of investment.
The Advisor's investment philosophy includes the following basic beliefs:
1. Active management pursued by a team with a uniform discipline across the
fixed income spectrum can produce results that are superior to those
produced through passive management.
2. Controlling risk by making only moderate deviations from the defined
benchmark is the cornerstone of successful fixed income investing.
3. Successful fixed income management is best pursued on a top-down basis
utilizing fundamental techniques.
The investment process includes decisions made at four levels that are
consistent with the Advisor's viewpoint of the path of economic activity,
interest rates, and the supply of and demand for credit. The goal is to derive
equivalent amounts of excess performance and risk control over the long run
from each of the four levels of decision-making:
1. Duration. The Fund's portfolio duration is managed within a range
relative to its benchmark.
2. Yield Curve. Modest overweights and underweights along the yield curve
are made to benefit from changes in the yield curve's shape.
3. Sector/Quality. Sector weightings are generally maintained between zero
and two times those of the benchmark.
4. Security Selection. Quantitative analysis drives issue selection in the
Treasury and mortgage marketplace. Proactive credit research drives
corporate issue selection.
Risk control is pursued at three levels:
1. Portfolio structure. In structuring the portfolio, the Advisor carefully
considers such factors as position sizes, duration, benchmark
characteristics, and the use of illiquid securities.
2. Credit research. Proactive credit research is used to identify issues
which the Advisor believes will be candidates for credit upgrade. This
research includes visiting company management, establishing appropriate
values for credit ratings, and monitoring yield spread relationships.
3. Portfolio monitoring. Portfolio fundamentals are re-evaluated
continuously, and buy/sell targets are established and generally adhered
to.
INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P., 411 East Wisconsin Avenue, Milwaukee,
Wisconsin 53202, have been selected as the independent accountants for the Fund,
providing audit services and assistance and consultation with respect to the
preparation of filings with the SEC.
42
<PAGE> 293
LEGAL COUNSEL
Godfrey & Kahn, S.C., 780 North Water Street, Milwaukee, Wisconsin 53202,
acts as outside legal counsel for the Fund.
FINANCIAL STATEMENTS
The Annual Report for the year ended December 31, 1996 that is attached
hereto contains the following financial information for the Fund:
(a) Schedule of Investments in Securities.
(b) Statement of Operations.
(c) Statement of Assets and Liabilities.
(d) Statement of Changes in Net Assets.
(e) Notes to Financial Statements.
(f) Financial Highlights.
(g) Report of Independent Accountants.
43
<PAGE> 294
APPENDIX
BOND RATINGS
STANDARD & POOR'S DEBT RATINGS
A Standard & Poor's corporate or municipal debt rating is a current
assessment of the creditworthiness of an obligor with respect to a specific
obligation. This assessment may take into consideration obligors such as
guarantors, insurers, or lessees.
The debt rating is not a recommendation to purchase, sell, or hold a
security, inasmuch as it does not comment as to market price or suitability for
a particular investor.
The ratings are based on current information furnished by the issuer or
obtained by S&P from other sources it considers reliable. S&P does not perform
an audit in connection with any rating and may, on occasion, rely on unaudited
financial information. The ratings may be changed, suspended, or withdrawn as
a result of changes in, or unavailability of, such information, or based on
other circumstances.
The ratings are based, in varying degrees, on the following considerations:
1. Likelihood of default capacity and willingness of
the obligor as to the timely payment of interest and repayment
of principal in accordance with the terms of the obligation.
2. Nature of and provisions of the obligation.
3. Protection afforded by, and relative position of,
the obligation in the event of bankruptcy, reorganization, or
other arrangement under the laws of bankruptcy and other laws
affecting creditors' rights.
INVESTMENT GRADE
AAA Debt rated 'AAA' has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA Debt rated 'AA' has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree.
A Debt rated 'A' has a strong capacity to pay interest and repay
principal, although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher-rated
categories.
BBB Debt rated 'BBB' is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
SPECULATIVE GRADE
Debt rated 'BB', 'B', 'CCC', 'CC' and 'C' is regarded as having
predominantly speculative characteristics with respect to capacity to pay
interest and repay principal. 'BB' indicates the least degree of speculation
and 'C' the highest. While such debt will likely have some quality and
protective characteristics, these are outweighed by large uncertainties or
major exposures to adverse conditions.
BB Debt rated 'BB' has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The 'BB'
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied 'BBB-' rating.
A-1
<PAGE> 295
B Debt rated 'B' has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial, or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The 'B' rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied 'BB' or 'BB-' rating.
CCC Debt rated 'CCC' has a currently identifiable vulnerability to
default, and is dependent upon favorable business, financial, and economic
conditions to meet timely payment of interest and repayment of principal. In
the event of adverse business, financial, or economic conditions, it is not
likely to have the capacity to pay interest and repay principal. The 'CCC'
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied 'B' or 'B-' rating.
CC Debt rated 'CC' typically is applied to debt subordinated to senior
debt that is assigned an actual or implied 'CCC' rating.
C Debt rated 'C' typically is applied to debt subordinated to senior debt
which is assigned an actual or implied 'CCC-' rating. The 'C' rating may be
used to cover a situation where a bankruptcy petition has been filed, but debt
service payments are continued.
CI The rating 'CI' is reserved for income bonds on which no interest is
being paid.
D Debt rated 'D' is in payment default. The 'D' rating category is used
when interest payments or principal payments are not made on the date due, even
if the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grade period. The 'D' rating also will be
used upon the filing of a bankruptcy petition if debt service payments are
jeopardized.
MOODY'S LONG-TERM DEBT RATINGS
Aaa - Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edged". Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa - Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risk appear somewhat larger than in Aaa
securities.
A - Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper-medium grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may be
present which suggest a susceptibility to impairment some time in the future.
Baa - Bonds which are rated Baa are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest
payments and principal security appear adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable over
any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba - Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate, and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
maintenance of other terms of the contract over any long period of time may be
small.
A-2
<PAGE> 296
Caa - Bonds which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to principal
or interest.
Ca - Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other marked
shortcomings.
C - Bonds which are rated C are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
FITCH INVESTORS SERVICE, INC. BOND RATINGS
Fitch investment grade bond and preferred stock ratings provide a guide to
investors in determining the credit risk associated with a particular security.
The ratings represent Fitch's assessment of the issuer's ability to meet the
obligations of a specific debt or preferred issue in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the
issuer's future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided
by insurance policies or financial guaranties unless otherwise indicated.
Bonds and preferred stock carrying the same rating are of similar but not
necessarily identical credit quality since the rating categories do not fully
reflect small differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for other reasons.
AAA Bonds and preferred stock considered to be investment grade
and of the highest credit quality. The obligor has an exceptionally
strong ability to pay interest and/or dividends and repay principal,
which is unlikely to be affected by reasonably foreseeable events.
AA Bonds and preferred stock considered to be investment grade
and of very high credit quality. The obligor's ability to pay
interest and/or dividends and repay principal is very strong,
although not quite as strong as bonds rated 'AAA'. Because bonds
and preferred stock rated in the 'AAA' and 'AA' categories are not
significantly vulnerable to foreseeable future developments,
short-term debt of the issuers is generally rated 'F-1+'.
A Bonds and preferred stock considered to be investment grade
and of high credit quality. The obligor's ability to pay interest
and/or dividends and repay principal is considered to be strong,
but may be more vulnerable to adverse changes in economic
conditions and circumstances than debt or preferred securities with
higher ratings.
BBB Bonds and preferred stock considered to be investment grade
and of satisfactory credit quality. The obligor's ability to pay
interest or dividends and repay principal is considered to be
adequate. Adverse changes in economic conditions and circumstances,
however, are more likely to have adverse impact on these securities
and, therefore, impair timely payment. The likelihood that the
ratings of these bonds or preferred will fall below investment grade
is higher than for securities with higher ratings.
A-3
<PAGE> 297
Fitch speculative grade bond or preferred stock ratings provide a guide to
investors in determining the credit risk associated with a particular security.
The ratings ('BB' to 'C') represent Fitch's assessment of the likelihood of
timely payment of principal and interest or dividends in accordance with the
terms of obligation for issues not in default. For defaulted bonds or
preferred stock, the rating ('DDD' to 'D') is an assessment of the ultimate
recovery value through reorganization or liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer or possible recovery value in
bankruptcy, the current and prospective financial condition and operating
performance of the issuer and any guarantor, as well as the economic and
political environment that might affect the issuer's future financial strength.
Bonds or preferred stock that have the same rating are of similar but not
necessarily identical credit quality since the rating categories cannot fully
reflect the differences in the degrees of credit risk.
BB Bonds or preferred stock are considered speculative. The
obligor's ability to pay interest or dividends and repay principal
may be affected over time by adverse economic changes. However,
business and financial alternatives can be identified, which could
assist the obligor in satisfying its debt service requirements.
B Bonds or preferred stock are considered highly speculative.
While bonds in this class are currently meeting debt service
requirements or paying dividends, the probability of continued
timely payment of principal and interest reflects the obligor's
limited margin of safety and the need for reasonable business and
economic activity throughout the life of the issue.
CCC Bonds or preferred stock have certain identifiable
characteristics that, if not remedied, may lead to default. The
ability to meet obligations requires an advantageous business and
economic environment.
CC Bonds or preferred stock are minimally protected. Default
in payment of interest and/or principal seems probable over time.
C Bonds are in imminent default in payment of interest or
principal or suspension of preferred stock dividends is imminent.
DDD, DD,
and D Bonds are in default on interest and/or principal payments
or preferred stock dividends are suspended. Such securities are
extremely speculative and should be valued on the basis of their
ultimate recovery value in liquidation or reorganization of the
obligor. 'DDD' represents the highest potential for recovery of
these securities, and 'D' represents the lowest potential for
recovery.
DUFF & PHELPS, INC. LONG-TERM DEBT RATINGS
These ratings represent a summary opinion of the issuer's long-term
fundamental quality. Rating determination is based on qualitative and
quantitative factors which may vary according to the basic economic and
financial characteristics of each industry and each issuer. Important
considerations are vulnerability to economic cycles as well as risks related to
such factors as competition, government action, regulation, technological
obsolescence, demand shifts, cost structure, and management depth and
expertise. The projected viability of the obligor at the trough of the cycle
is a critical determination.
Each rating also takes into account the legal form of the security, (e.g.,
first mortgage bonds, subordinated debt, preferred stock, etc.). The extent of
rating dispersion among the various classes of securities is determined by
several factors including relative weightings of the different security classes
in the capital structure, the overall credit strength of the issuer, and the
nature of covenant protection. Review of indenture restrictions is important
to the analysis of a company's operating and financial constraints. From time
to time, Duff & Phelps Credit Rating Co. places issuers or security classes on
Rating Watch. The Rating Watch Status results from a need to notify investors
and the issuer that there are conditions present leading us to re-evaluate the
current rating(s). A listing on Rating Watch, however, does not mean a rating
change is inevitable. The Rating Watch Status can either be resolved quickly
or over a longer period of time, depending on the reasons surrounding the
A-4
<PAGE> 298
placement on Rating Watch. The "up" designation means a rating may be upgraded;
the "down" designation means a rating may be downgraded, and the uncertain
designation means a rating may be raised or lowered.
The Credit Rating Committee formally reviews all ratings once per quarter
(more frequently, if necessary). Ratings of 'BBB-' and higher fall within the
definition of investment grade securities, as defined by bank and insurance
supervisory authorities. Structured finance issues, including real estate,
asset-backed and mortgage-backed financings, use this same rating scale with
minor modification in the definitions. Thus, an investor can compare the
credit quality of investment alternatives across industries and structural
types. A "Cash Flow Rating" (as noted for specific ratings) addresses the
likelihood that aggregate principal and interest will equal or exceed the rated
amount under appropriate stress conditions.
RATING SCALE DEFINITION
AAA Highest credit quality. The risk factors are negligible, being
only slightly more than for risk-free U.S. Treasury debt.
AA+ High credit quality. Protection factors are strong. Risk is
AA modest, but may vary slightly from time to time because of
AA- economic conditions.
A+ Protection factors are average but adequate. However, risk
A factors are more variable and greater in periods of economic
A- stress.
BBB+ Below-average protection factors but still considered sufficient
BBB for prudent investment. Considerable variability in risk during
BBB- economic cycles.
BB+ Below investment grade but deemed likely to meet obligations
BB when due. Present or prospective financial protection factors
BB- fluctuate according to industry conditions or company fortunes.
Overall quality may move up or down frequently within this
category.
B+ Below investment grade and possessing risk that obligations will
B not be met when due. Financial protection factors will
B- fluctuate widely according to economic cycles, industry
conditions and/or company fortunes. Potential exists for
frequent changes in the rating within this category or into a
higher or lower rating grade.
CCC Well below investment grade securities. Considerable
uncertainty exists as to timely payment of principal, interest or
preferred dividends. Protection factors are narrow and risk can
be substantial with unfavorable economic/industry conditions,
and/or with unfavorable company developments.
DD Defaulted debt obligations. Issuer failed to meet scheduled
principal and/or interest payments.
DP Preferred stock with dividend arrearages.
A-5
<PAGE> 299
--------------------------------------------------------------------
A-6
<PAGE> 300
IBCA LONG-TERM DEBT RATINGS
AAA - Obligations for which there is the lowest expectation of investment
risk. Capacity for timely repayment of principal and interest is substantial,
such that adverse changes in business, economic or financial conditions are
unlikely to increase investment risk substantially.
AA - Obligations for which there is a very low expectation of investment
risk. Capacity for timely repayment of principal and interest is substantial.
Adverse changes in business, economic or financial conditions may increase
investment risk, albeit not very significantly.
A - Obligations for which there is a low expectation of investment risk.
Capacity for timely repayment of principal and interest is strong, although
adverse changes in business, economic or financial conditions may lead to
increased investment risk.
BBB - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial
conditions are more likely to lead to increased investment risk than for
obligations in other categories.
BB - Obligations for which there is a possibility of investment risk
developing. Capacity for timely repayment of principal and interest exists,
but is susceptible over time to adverse changes in business, economic or
financial conditions.
B - Obligations for which investment risk exists. Timely repayment of
principal and interest is not sufficiently protected against adverse changes in
business, economic or financial conditions.
CCC - Obligations for which there is a current perceived possibility of
default. Timely repayment of principal and interest is dependent on favorable
business, economic or financial conditions.
CC - Obligations which are highly speculative or which have a high risk of
default.
C - Obligations which are currently in default.
Notes: "+" or "-" may be appended to a rating below AAA to denote relative
status within major rating categories. Ratings of BB and below are
assigned where it is considered that speculative characteristics
are present.
THOMSON BANKWATCH LONG-TERM DEBT RATINGS
Long-Term Debt Ratings assigned by Thomson BankWatch also weigh heavily
government ownership and support. The quality of both the company's management
and franchise are of even greater importance in the Long-Term Debt Rating
decisions. Long-Term Debt Ratings look out over a cycle and are not adjusted
frequently for what we believe are short-term performance aberrations.
Long-Term Debt Ratings can be restricted to local currency debt - ratings
will be identified by the designation LC. In addition, Long-Term Debt Ratings
may include a plus (+) or minus (-) to indicate where within the category the
issue is placed. BankWatch Long-Term Debt Ratings are based on the following
scale:
Investment Grade
AAA (LC-AAA) - Indicates that the ability to repay principal and interest
on a timely basis is extremely high.
AA (LC-AA) - Indicates a very strong ability to repay principal and
interest on a timely basis, with limited incremental risk compared to issues
rated in the highest category.
A (LC-A) - Indicates the ability to repay principal and interest is
strong. Issues rated A could be more vulnerable to adverse developments (both
internal and external) than obligations with higher ratings.
A-7
<PAGE> 301
BBB (LC-BBB) - The lowest investment-grade category; indicates an
acceptable capacity to repay principal and interest. BBB issues are more
vulnerable to adverse developments (both internal and external) than
obligations with higher ratings.
Non-Investment Grade - may be speculative in the likelihood of timely repayment
of principal and interest
BB (LC-BB) - While not investment grade, the BB rating suggests that the
likelihood of default is considerably less than for lower-rated issues.
However, there are significant uncertainties that could affect the ability to
adequately service debt obligations.
B (LC-B) - Issues rated B show higher degree of uncertainty and therefore
greater likelihood of default than higher-rated issues. Adverse developments
could negatively affect the payment of interest and principal on a timely
basis.
CCC (LC-CCC) - Issues rated CCC clearly have a high likelihood of default,
with little capacity to address further adverse changes in financial
circumstances.
CC (LC-CC) - CC is applied to issues that are subordinate to other
obligations rated CCC and are afforded less protection in the event of
bankruptcy or reorganization.
D (LC-D) - Default.
SHORT-TERM RATINGS
STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt considered short-term in the relevant
market.
Ratings are graded into several categories, ranging from 'A-1' for the
highest quality obligations to 'D' for the lowest. These categories are as
follows:
A-1 This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus sign (+) designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated 'A-1'.
A-3 Issues carrying this designation have adequate capacity for timely
payment. They are, however, more vulnerable to the adverse effects of changes
in circumstances than obligations carrying the higher designations.
B Issues rated 'B' are regarded as having only speculative capacity for
timely payment.
C This rating is assigned to short-term debt obligations with doubtful
capacity for payment.
D Debt rated 'D' is in payment default. The 'D' rating category is used
when interest payments or principal payments are not made on the date due, even
if the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grace period.
STANDARD & POOR'S NOTE RATINGS
An S&P note rating reflects the liquidity factors and market-access risks
unique to notes. Notes maturing in three years or less will likely receive a
note rating. Notes maturing beyond three years will most likely receive a
long-term debt rating.
A-8
<PAGE> 302
The following criteria will be used in making the assessment:
- Amortization schedule - the larger the final maturity
relative to other maturities, the more likely the issue is to be
treated as a note.
- Source of payment - the more the issue depends on the market
for its refinancing, the more likely it is to be treated as a note.
Note rating symbols and definitions are as follows:
SP-1 Strong capacity to pay principal and interest. Issues determined to
possess very strong characteristics are given a plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term of the
notes.
SP-3 Speculative capacity to pay principal and interest.
MOODY'S SHORT-TERM RATINGS
Moody's short-term debt ratings are opinions of the ability of issuers to
repay punctually senior debt obligations. These obligations have an original
maturity not exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment ability of rated issuers:
Issuers rated PRIME-1 (or supporting institutions) have a superior ability
for repayment of senior short-term debt obligations. Prime-1 repayment ability
will often be evidenced by many of the following characteristics: (i) leading
market positions in well-established industries, (ii) high rates of return on
funds employed, (iii) conservative capitalization structure with moderate
reliance on debt and ample asset protection, (iv) broad margins in earnings
coverage of fixed financial charges and high internal cash generation, and (v)
well established access to a range of financial markets and assured sources of
alternate liquidity.
Issuers rated PRIME-2 (or supporting institutions) have a strong ability
for repayment of senior short-term debt obligations. This will normally be
evidenced by many of the characteristics cited above, but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be
more affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated PRIME-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The effect of industry
characteristics and market compositions may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt
protection measurements and may require relatively high financial leverage.
Adequate alternate liquidity is maintained.
Issuers rated NOT PRIME do not fall within any of the Prime rating
categories.
FITCH INVESTORS SERVICE, INC. SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes.
A-9
<PAGE> 303
The short-term rating places greater emphasis than a long-term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
F-1+ Exceptionally Strong Credit Quality. Issues assigned this
rating are regarded as having the strongest degree of assurance for
timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating
reflect an assurance of timely payment only slightly less in degree
than issues rated 'F-1+'.
F-2 Good Credit Quality. Issues assigned this rating have a
satisfactory degree of assurance for timely payment but the margin
of safety is not as great as for issues assigned 'F-1+' and 'F-1'
ratings.
F-3 Fair Credit Quality. Issues assigned this rating have
characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause
these securities to be rated below investment grade.
F-S Weak Credit Quality. Issues assigned this rating have
characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial
and economic conditions.
D Default. Issues assigned this rating are in actual or
imminent payment default.
LOC The symbol LOC indicates that the rating is based on a letter
of credit issued by a commercial bank.
DUFF & PHELPS, INC. SHORT-TERM DEBT RATINGS
Duff & Phelps' short-term ratings are consistent with the rating criteria
used by money market participants. The ratings apply to all obligations with
maturities of under one year, including commercial paper, the uninsured portion
of certificates of deposit, unsecured bank loans, master notes, bankers
acceptances, irrevocable letters of credit, and current maturities of long-term
debt. Asset-backed commercial paper is also rated according to this scale.
Emphasis is placed on liquidity which is defined as not only cash from
operations, but also access to alternative sources of funds including trade
credit, bank lines, and the capital markets. An important consideration is the
level of an obligor's reliance on short-term funds on an ongoing basis.
The distinguishing feature of Duff & Phelps' short-term ratings is the
refinement of the traditional '1' category. The majority of short-term debt
issuers carry the highest rating, yet quality differences exist within that
tier. As a consequence, Duff & Phelps has incorporated gradations of '1+' (one
plus) and '1-' (one minus) to assist investors in recognizing those
differences.
From time to time, Duff & Phelps places issuers or security classes on
Rating Watch. The Rating Watch status results from a need to notify investors
and the issuer that there are conditions present leading us to re-evaluate the
current rating(s). A listing on Rating Watch, however, does not mean a rating
change is inevitable.
The Rating Watch status can either be resolved quickly or over a longer
period of time, depending on the reasons surrounding the placement on Rating
Watch. The "up" designation means a rating may be upgraded; the "down"
designation means a rating may be downgraded, and the "uncertain" designation
means a rating may be raised or lowered.
Rating Scale: Definition
High Grade
A-10
<PAGE> 304
D-1+ Highest certainty of timely payment. Short-Term liquidity,
including internal operating factors and/or access to alternative
sources of funds, is outstanding, and safety is just below risk-free
U.S. Treasury short-term obligations.
D-1 Very high certainty of timely payment. Liquidity factors are
excellent and supported by good fundamental protection factors.
Risk factors are minor.
D-1- High certainty of timely payment. Liquidity factors are
strong and supported by good fundamental protection factors. Risk
factors are very small.
Good Grade
D-2 Good certainty of timely payment. Liquidity factors and
company fundamentals are sound. Although ongoing funding needs may
enlarge total financing requirements, access to capital markets is
good. Risk factors are small.
Satisfactory Grade
D-3 Satisfactory liquidity and other protection factors qualify
issues as to investment grade. Risk factors are larger and subject
to more variation. Nevertheless, timely payment is expected.
Non-Investment Grade
D-4 Speculative investment characteristics. Liquidity is not
sufficient to insure against disruption in debt service. Operating
factors and market access may be subject to a high degree of
variation.
Default
D-5 Issuer failed to meet scheduled principal and/or interest payments.
THOMSON BANKWATCH (TBW) SHORT-TERM RATINGS
The TBW Short-Term Ratings apply, unless otherwise noted, to specific debt
instruments of the rated entities with a maturity of one year or less. TBW
Short-Term Ratings are intended to assess the likelihood of an untimely or
incomplete payments of principal or interest.
TBW-1 The highest category; indicates a very high likelihood that
principal and interest will be paid on a timely basis.
TBW-2 The second highest category; while the degree of safety regarding
timely repayment of principal and interest is strong, the relative degree of
safety is not as high as for issues rated "TBW-1".
TBW-3 The lowest investment-grade category; indicates that while the
obligation is more susceptible to adverse developments (both internal and
external) than those with higher ratings, the capacity to service principal and
interest in a timely fashion is considered adequate.
TBW-4 The lowest rating category; this rating is regarded as
non-investment grade and therefore speculative.
IBCA SHORT-TERM RATINGS
IBCA Short-Term Ratings assess the borrowing characteristics of banks and
corporations, and the capacity for timely repayment of debt obligations. The
Short-Term Ratings relate to debt which has a maturity of less than one year.
A-11
<PAGE> 305
A1 Obligations supported by the highest capacity for timely repayment.
Where issues possess a particularly strong credit feature, a rating of
A1+ is assigned.
A2 Obligations supported by a good capacity for timely repayment.
A3 Obligations supported by a satisfactory capacity for timely repayment.
B Obligations for which there is an uncertainty as to the capacity to
ensure timely repayment.
C Obligations for which there is a high risk of default or which are
currently in default.
A-12
<PAGE> 306
STRONG GROWTH FUND II
Strong Growth Fund II (the "Fund") is a diversified series of the Strong
Variable Insurance Funds, Inc. (the "Corporation"), an open-end management
investment company, commonly called a mutual fund. The Fund seeks capital
growth. The Fund invests primarily in equity securities that the Fund's Advisor
believes have above-average growth prospects.
Shares of the Fund are only offered and sold to the separate accounts of
certain insurance companies for the purpose of funding variable annuity and
variable life insurance contracts. This Prospectus should be read together with
the prospectus of the separate account of the specific insurance product which
preceded or accompanies this Prospectus.
This Prospectus contains information that you should consider before you
invest. Please read it carefully and keep it for future reference. A Statement
of Additional Information for the Fund, dated May 1, 1997, which contains
further information, is incorporated by reference into this Prospectus, and has
been filed with the Securities and Exchange Commission ("SEC"). This Statement,
which may be revised from time to time, is available upon request and without
charge by writing to the Fund at P.O. Box 2936, Milwaukee, Wisconsin 53201 or by
calling 1-800-368-1683.
============================================================================
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
- ----------------------------------------------------------------------------
May 1, 1997
-------------------
PROSPECTUS PAGE 1
<PAGE> 307
TABLE OF CONTENTS
<TABLE>
<S> <C> <C>
THE FUND................................. 2
FINANCIAL HIGHLIGHTS..................... 3
INVESTMENT OBJECTIVE AND POLICIES........ 4
IMPLEMENTATION OF POLICIES AND RISKS..... 5
SPECIAL CONSIDERATIONS................... 11
MANAGEMENT............................... 13
ADDITIONAL INFORMATION................... 16
</TABLE>
No person has been authorized to give any information or to make any
representations other than those contained in this Prospectus and the Statement
of Additional Information and, if given or made, such information or
representations may not be relied upon as having been authorized by the Fund.
This Prospectus does not constitute an offer to sell securities to any person in
any state or jurisdiction in which such offering may not lawfully be made.
THE FUND
The Fund is a diversified series of the Corporation, which is an open-end
management investment company. The Fund offers and sells its shares only to
separate accounts of insurance companies for the purpose of funding variable
annuity and variable life insurance contracts. The Fund does not impose any
sales or redemption charges. Strong Capital Management, Inc. (the "Advisor") is
the investment advisor for the Fund.
-------------------
PROSPECTUS PAGE 2
<PAGE> 308
FINANCIAL HIGHLIGHTS
The following interim Financial Highlights for the Fund are unaudited. Please
note that the total return shown in the Financial Highlights does not reflect
expenses that apply to the separate account or the related insurance policies.
Inclusion of these charges would reduce the total return for the periods shown.
The following presents information relating to a share of common stock
outstanding for the December 31, 1996 (inception) to March 31, 1997.
<TABLE>
<CAPTION>
MARCH 31,
1997*
---------
<S> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $10.00
INCOME FROM INVESTMENT OPERATIONS
Net Investment Loss (0.01)
Net Realized and Unrealized Losses on Investments (0.27)
---------
TOTAL FROM INVESTMENT OPERATIONS (0.28)
NET ASSET VALUE, END OF PERIOD $ 9.72
=========
Total Return (2.8%)
Net Assets, End of Period (In Thousands) $353
Ratio of Expenses to Average Net Assets 2.0%**
Ratio of Net Investment Income to Average Net Assets (0.5%)**
Portfolio Turnover Rate 119.9%
Average Commission Rate Paid $ 0.0661
</TABLE>
*Inception date is December 31, 1996. Total return and portfolio turnover rate
are not annualized.
**Calculated on an annualized basis.
-------------------
PROSPECTUS PAGE 3
<PAGE> 309
INVESTMENT OBJECTIVE AND POLICIES
The Fund has adopted certain fundamental investment restrictions that are set
forth in the Fund's Statement of Additional Information ("SAI"). Those
restrictions, the Fund's investment objective and any other investment policies
identified as "fundamental" cannot be changed without shareholder approval. To
further guide investment activities, the Fund has also instituted a number of
non-fundamental operating policies, which are described throughout this
Prospectus and in the SAI. Although these additional policies may be changed by
the Corporation's Board of Directors without shareholder approval, the Fund will
promptly notify shareholders of any material change in operating policies.
The Fund seeks capital growth. The Fund invests primarily in equity
securities that the Advisor believes have above-average growth prospects.
Under normal market conditions, the Fund will invest at least 65% of its
total assets in equity securities, including common stocks, preferred stocks,
and securities that are convertible into common or preferred stocks, such as
warrants and convertible bonds. While the emphasis of the Fund is clearly on
equity securities, the Fund may invest a limited portion of its assets in debt
obligations when the Advisor perceives that they are more attractive than stocks
on a long-term basis. The Fund may invest up to 35% of its total assets in debt
obligations, including intermediate- to long-term corporate or U.S. government
debt securities. When the Advisor determines that market conditions warrant a
temporary defensive position, the Fund may invest without limitation in cash and
short-term fixed-income securities. Although the debt obligations in which it
invests will be primarily investment grade, the Fund may invest up to 5% of its
net assets in non-investment-grade debt obligations. (See "Implementation of
Policies and Risks - Debt Obligations.")
The Fund may invest up to 25% of its net assets in foreign securities,
including both direct investments and investments made through depositary
receipts. (See "Implementation of Policies and Risks - Foreign Securities and
Currencies" for the special risks associated with foreign investments.)
The Fund generally will invest in companies whose earnings are believed to be
in a relatively strong growth trend, and, to a lesser extent, in companies in
which significant further growth is not anticipated but whose market value is
thought to be undervalued. In identifying companies with favorable growth
prospects, the Advisor ordinarily looks to certain other characteristics, such
as the following:
- - prospects for above-average sales and earnings growth;
- - high return on invested capital;
- - overall financial strength, including sound financial and accounting policies
and a strong balance sheet;
- - competitive advantages, including innovative products and service;
- - effective research, product development, and marketing; and
- - stable, capable management.
-------------------
PROSPECTUS PAGE 4
<PAGE> 310
IMPLEMENTATION OF POLICIES AND RISKS
In addition to the Fund's investment policies described above (and subject to
certain restrictions described herein), the Fund may invest in some or all of
the following securities and employ some or all of the following investment
techniques, some of which may present special risks as described below. The Fund
may also engage in reverse repurchase agreements and mortgage dollar roll
transactions. A more complete discussion of these securities and investment
techniques and their associated risks is contained in the Fund's SAI.
FOREIGN SECURITIES AND CURRENCIES
The Fund may invest in foreign securities either directly or indirectly
through the use of depositary receipts. Depositary receipts are generally issued
by banks or trust companies and evidence ownership of underlying foreign
securities. Foreign investments involve special risks, including:
- - expropriation, confiscatory taxation, and withholding taxes on dividends and
interest;
- - less extensive regulation of foreign brokers, securities markets, and issuers;
- - less publicly available information and different accounting standards;
- - costs incurred in conversions between currencies, possible delays in
settlement in foreign securities markets, limitations on the use or transfer
of assets (including suspension of the ability to transfer currency from a
given country), and difficulty of enforcing obligations in other countries;
and
- - diplomatic developments and political or social instability.
Foreign economies may differ favorably or unfavorably from the U.S. economy
in various respects, including growth of gross domestic product, rates of
inflation, currency depreciation, capital reinvestment, resource
self-sufficiency, and balance-of-payments positions. Many foreign securities may
be less liquid and their prices more volatile than comparable U.S. securities.
Although the Fund generally invests only in securities that are regularly traded
on recognized exchanges or in over-the-counter markets, from time to time
foreign securities may be difficult to liquidate rapidly without adverse price
effects. Certain costs attributable to foreign investing, such as custody
charges and brokerage costs, may be higher than those attributable to domestic
investing.
Because most foreign securities are denominated in non-U.S. currencies, the
investment performance of the Fund could be affected by changes in foreign
currency exchange rates to some extent. The value of the Fund's assets
denominated in foreign currencies will increase or decrease in response to
fluctuations in the value of those foreign currencies relative to the U.S.
dollar. Currency exchange rates can be volatile at times in response to supply
and demand in the currency exchange markets, international balances of
-------------------
PROSPECTUS PAGE 5
<PAGE> 311
payments, governmental intervention, speculation, and other political and
economic conditions.
The Fund may purchase and sell foreign currency on a spot basis and may
engage in forward currency contracts, currency options, and futures transactions
for hedging or any other lawful purpose. (See "Derivative Instruments.")
FOREIGN INVESTMENT COMPANIES
The Fund may invest, to a limited extent, in foreign investment companies.
Some of the countries in which the Fund invests may not permit direct investment
by outside investors. Investments in such countries may only be permitted
through foreign government-approved or -authorized investment vehicles, which
may include other investment companies. In addition, it may be less expensive
and more expedient for the Fund to invest in a foreign investment company in a
country which permits direct foreign investment. Investing through such vehicles
may involve frequent or layered fees or expenses and may also be subject to
limitation under the Investment Company Act of 1940 (the "1940 Act"). The Fund
does not intend to invest in such investment companies unless, in the judgment
of the Advisor, the potential benefits of such investments justify the payment
of any associated fees or expenses.
DERIVATIVE INSTRUMENTS
The Fund may use derivative instruments for any lawful purpose consistent
with the Fund's investment objective such as hedging or managing risk.
Derivative instruments are commonly defined to include securities or contracts
whose values depend on (or "derive" from) the value of one or more other assets,
such as securities, currencies, or commodities. These "other assets" are
commonly referred to as "underlying assets."
A derivative instrument generally consists of, is based upon, or exhibits
characteristics similar to options or forward contracts. Options and forward
contracts are considered to be the basic "building blocks" of derivatives. For
example, forward-based derivatives include forward contracts, swap contracts, as
well as exchange-traded futures. Option-based derivatives include privately
negotiated, over-the-counter (OTC) options (including caps, floors, collars, and
options on forward and swap contracts) and exchange-traded options on futures.
Diverse types of derivatives may be created by combining options or forward
contracts in different ways, and by applying these structures to a wide range of
underlying assets.
An option is a contract in which the "holder" (the buyer) pays a certain
amount (the "premium") to the "writer" (the seller) to obtain the right, but not
the obligation, to buy from the writer (in a "call") or sell to the writer (in a
"put") a specific asset at an agreed upon price at or before a certain time. The
holder pays the premium at inception and has no further financial obligation.
The holder of an option-based derivative generally will benefit from favorable
movements in the price of the underlying asset but is not exposed to
-------------------
PROSPECTUS PAGE 6
<PAGE> 312
corresponding losses due to adverse movements in the value of the underlying
asset. The writer of an option-based derivative generally will receive fees or
premiums but generally is exposed to losses due to changes in the value of the
underlying asset.
A forward is a sales contract between a buyer (holding the "long" position)
and a seller (holding the "short" position) for an asset with delivery deferred
until a future date. The buyer agrees to pay a fixed price at the agreed future
date and the seller agrees to deliver the asset. The seller hopes that the
market price on the delivery date is less than the agreed upon price, while the
buyer hopes for the contrary. The change in value of a forward-based derivative
generally is roughly proportional to the change in value of the underlying
asset.
Derivative instruments may include (i) options; (ii) futures; (iii) options
on futures; (iv) short sales against the box, in which the Fund sells a security
it owns for delivery at a future date; (v) swaps, in which two parties agree to
exchange a series of cash flows in the future, such as interest-rate payments;
(vi) interest-rate caps, under which, in return for a premium, one party agrees
to make payments to the other to the extent that interest rates exceed a
specified rate, or "cap"; (vii) interest-rate floors, under which, in return for
a premium, one party agrees to make payments to the other to the extent that
interest rates fall below a specified level, or "floor"; (viii) forward currency
contracts and foreign currency exchange-related securities; and (ix) structured
instruments which combine the foregoing in different ways.
Derivatives may be exchange-traded or traded in OTC transactions between
private parties. OTC transactions are subject to additional risks, such as the
credit risk of the counterparty to the instrument and are less liquid than
exchange-traded derivatives since they often can only be closed out with the
other party to the transaction. Derivative instruments may include elements of
leverage and, accordingly, the fluctuation of the value of the derivative
instrument in relation to the underlying asset may be magnified. When required
by SEC guidelines, the Fund will set aside permissible liquid assets in a
segregated account to secure its obligations under the derivative.
The successful use of derivatives by the Fund is dependent upon a variety of
factors, particularly the Advisor's ability to correctly anticipate trends in
the underlying asset. In a hedging transaction, if the Advisor incorrectly
anticipates trends in the underlying asset, the Fund may be in a worse position
than if no hedging had occurred. In addition, there may be imperfect correlation
between the Fund's derivative transactions and the instruments being hedged. To
the extent that the Fund is engaging in derivative transactions for risk
management, the Fund's successful use of such transactions is more dependent
upon the Advisor's ability to correctly anticipate such trends, since losses in
these transactions may not be offset in gains in the Fund's portfolio or in
lower purchase prices for assets it intends to acquire. The Advisor's prediction
of trends in underlying assets may prove to be inaccurate, which could result in
substantial losses to the Fund.
-------------------
PROSPECTUS PAGE 7
<PAGE> 313
In addition to the derivative instruments and strategies described above, the
Advisor expects to discover additional derivative instruments and other trading
techniques. The Advisor may utilize these new derivative instruments and
techniques to the extent that they are consistent with the Fund's investment
objective and permitted by the Fund's investment limitations, operating
policies, and applicable regulatory authorities.
ILLIQUID SECURITIES
The Fund may invest up to 15% of its net assets in illiquid securities.
Illiquid securities are those securities that are not readily marketable,
including restricted securities and repurchase obligations maturing in more than
seven days. Certain restricted securities that may be resold to institutional
investors pursuant to Rule 144A under the Securities Act of 1933 and Section
4(2) commercial paper may be determined to be liquid under guidelines adopted by
the Corporation's Board of Directors.
SMALL AND MEDIUM COMPANIES
The Fund may invest a substantial portion of its assets in small and medium
companies. While small and medium companies generally have potential for rapid
growth, investments in small and medium companies often involve greater risks
than investments in larger, more established companies because small and medium
companies may lack the management experience, financial resources, product
diversification, and competitive strengths of larger companies. In addition, in
many instances the securities of small and medium companies are traded only
over-the-counter or on a regional securities exchange, and the frequency and
volume of their trading is substantially less than is typical of larger
companies. Therefore, the securities of small and medium companies may be
subject to greater and more abrupt price fluctuations. When making large sales,
the Fund may have to sell portfolio holdings at discounts from quoted prices or
may have to make a series of small sales over an extended period of time due to
the trading volume of small and medium company securities. Investors should be
aware that, based on the foregoing factors, an investment in the Fund may be
subject to greater price fluctuations than an investment in a fund that invests
primarily in larger, more established companies. The Advisor's research efforts
may also play a greater role in selecting securities for the Fund than in a fund
that invests in larger, more established companies.
DEBT OBLIGATIONS
IN GENERAL. Debt obligations in which the Fund may invest will be primarily
investment-grade debt obligations, although the Fund may invest up to 5% of its
net assets in non-investment-grade debt obligations. The market value of all
debt obligations is affected by changes in the prevailing interest rates.
-------------------
PROSPECTUS PAGE 8
<PAGE> 314
The market value of such instruments generally reacts inversely to interest rate
changes. If the prevailing interest rates decline, the market value of debt
obligations generally increases. If the prevailing interest rates increase, the
market value of debt obligations generally decreases. In general, the longer the
maturity of a debt obligation, the greater its sensitivity to changes in
interest rates.
Investment-grade debt obligations include:
- - U.S. government securities (as defined below);
- - bonds or bank obligations rated in one of the four highest rating categories
(e.g., BBB or higher by Standard & Poor's Ratings Group or "S&P");
- - short-term notes rated in one of the two highest rating categories (e.g., SP-2
or higher by S&P);
- - short-term bank obligations rated in one of the three highest rating
categories (e.g., A-3 or higher by S&P), with respect to obligations maturing
in one year or less;
- - commercial paper rated in one of the three highest rating categories (e.g.,
A-3 or higher by S&P);
- - unrated debt obligations determined by the Advisor to be of comparable
quality; and
- - repurchase agreements involving investment-grade debt obligations.
Investment-grade debt obligations are generally believed to have relatively
low degrees of credit risk. All ratings are determined at the time of
investment. Any subsequent rating downgrade of a debt obligation will be
monitored by the Advisor to consider what action, if any, the Fund should take
consistent with its investment objective. For purposes of determining whether a
security is investment grade, the Advisor may use the highest rating assigned to
that security by any nationally recognized statistical rating organization
("NRSRO"). Securities rated in the fourth-highest category (e.g., BBB by S&P),
although considered investment grade, have speculative characteristics and may
be subject to greater fluctuations in value than higher-rated securities.
Non-investment-grade debt obligations include:
- - securities rated as low as C by S&P or their equivalents;
- - commercial paper rated as low as C by S&P or its equivalent; and
- - unrated debt securities judged to be of comparable quality by the Advisor.
GOVERNMENT SECURITIES
U.S. government securities are issued or guaranteed by the U.S. government or
its agencies or instrumentalities. Securities issued by the government include
U.S. Treasury obligations, such as Treasury bills, notes, and bonds.
-------------------
PROSPECTUS PAGE 9
<PAGE> 315
Securities issued by government agencies or instrumentalities include, for
example, obligations of the following:
- - the Federal Housing Administration, Farmers Home Administration, Export-Import
Bank of the United States, Small Business Administration, and the Government
National Mortgage Association, including GNMA pass-through certificates, whose
securities are supported by the full faith and credit of the United States;
- - the Federal Home Loan Banks, Federal Intermediate Credit Banks, and the
Tennessee Valley Authority, whose securities are supported by the right of the
agency to borrow from the U.S. Treasury;
- - the Federal National Mortgage Association, whose securities are supported by
the discretionary authority of the U.S. government to purchase certain
obligations of the agency or instrumentality; and
- - the Student Loan Marketing Association, the Interamerican Development Bank,
and International Bank for Reconstruction and Development, whose securities
are supported only by the credit of such agencies.
Although the U.S. government provides financial support to such U.S.
government-sponsored agencies or instrumentalities, no assurance can be given
that it will always do so. The U.S. government and its agencies and
instrumentalities do not guarantee the market value of their securities;
consequently, the value of such securities will fluctuate.
WHEN-ISSUED SECURITIES
The Fund may invest in securities purchased on a when-issued or delayed-
delivery basis. Although the payment and interest terms of these securities are
established at the time the purchaser enters into the commitment, these
securities may be delivered and paid for at a future date, generally within 45
days. Purchasing when-issued securities allows the Fund to lock in a fixed price
or yield on a security it intends to purchase. However, when the Fund purchases
a when-issued security, it immediately assumes the risk of ownership, including
the risk of price fluctuation.
The greater the Fund's outstanding commitments for these securities, the
greater the exposure to potential fluctuations in the net asset value of the
Fund. Purchasing when-issued securities may involve the additional risk that the
yield available in the market when the delivery occurs may be higher or the
market price lower than that obtained at the time of commitment. Although the
Fund may be able to sell these securities prior to the delivery date, it will
purchase when-issued securities for the purpose of actually acquiring the
securities, unless after entering into the commitment a sale appears desirable
for investment reasons. When required by SEC guidelines, the Fund will set aside
permissible liquid assets in a segregated account to secure its outstanding
commitments for when-issued securities.
---------------------
PROSPECTUS PAGE 10
<PAGE> 316
CASH MANAGEMENT
The Fund may invest directly in cash and short-term fixed-income securities,
including, for this purpose, shares of one or more money market funds managed by
the Advisor (collectively, the "Strong Money Funds"). The Strong Money Funds
seek current income, a stable share price of $1.00, and daily liquidity. All
money market instruments can change in value when interest rates or an issuer's
creditworthiness change dramatically. The Strong Money Funds cannot guarantee
that they will always be able to maintain a stable net asset value of $1.00 per
share.
PORTFOLIO TURNOVER
The annual portfolio turnover rate indicates changes in the Fund's portfolio.
The turnover rate may vary from year to year, as well as within a year. It may
also be affected by sales of portfolio securities necessary to meet cash
requirements for redemption of shares. High portfolio turnover in any year will
result in the payment by the Fund of above-average amounts of transaction costs.
The Fund will not generally trade in securities for short-term profits, but,
when the Advisor determines that circumstances warrant, securities may be
purchased and sold without regard to the length of time held. Under normal
market conditions, the rate of portfolio turnover of the Fund generally will not
exceed 300%. However, during periods in which the Advisor deems it advisable to
engage in substantial short-term trading, the rate of portfolio turnover may
exceed 300%.
SPECIAL CONSIDERATIONS
The Fund is designed as an investment vehicle for variable annuity and
variable life insurance contracts funded by separate accounts of certain
insurance companies. Section 817(h) of the Internal Revenue Code of 1986, as
amended (the "Code") and the regulations thereunder impose certain
diversification standards on the investments underlying variable annuity and
variable life insurance contracts in order for such contracts to be treated for
tax purposes as annuities or life insurance. Section 817(h) of the Code provides
that a variable annuity and variable life insurance contract based on a separate
account shall not be treated as an annuity or life insurance contract for any
period (and any subsequent period) for which the account's investments are not
adequately diversified. These diversification requirements are in addition to
the diversification requirements applicable to the Fund under Subchapter M of
the Code and the 1940 Act and may affect the composition of the Fund's
investments.
Since the shares of the Fund are currently sold to segregated asset accounts
underlying such variable annuity and variable life insurance contracts, the Fund
intends to comply with the diversification requirements as set forth
---------------------
PROSPECTUS PAGE 11
<PAGE> 317
in the regulations. The Secretary of the Treasury may in the future issue
additional regulations or revenue rulings that may prescribe the circumstances
in which a contract owner's control of the investments of a separate account may
cause the contract owner, rather than the insurance company, to be treated as
the owner of assets of the separate account. Failure to comply with Section
817(h) of the Code or any regulation thereunder, or with any future regulations
or revenue rulings on contract owner control, would cause earnings regarding a
contract owner's interest in an insurance company's separate account to be
includible in the contract owner's gross income in the year earned. Such
standards may apply only prospectively, although retroactive application is
possible. In the event that any such regulations or revenue rulings are adopted,
the Fund may not be able to continue to operate as currently described in this
prospectus, or maintain its investment program.
The Fund will be managed in such a manner as to comply with the requirements
of Subchapter L of the Code. It is possible that in order to comply with such
requirements, less desirable investment decisions may be made which would affect
the investment performance of the Fund.
The Fund may sell its shares to the separate accounts of various insurance
companies, which are not affiliated with each other, for the purpose of funding
variable annuity and variable life insurance contracts. The Fund currently does
not foresee any disadvantages to contract owners arising out of the fact that it
offers its shares to separate accounts of various insurance companies, which are
not affiliated with each other, to serve as an investment medium for their
variable products. However, it is theoretically possible that the interests of
owners of various contracts participating in the Fund through the separate
accounts might at some time be in conflict. The Board of Directors of the
Corporation, however, will monitor events in order to identify any material
irreconcilable conflicts which may possibly arise and to determine what action,
if any, should be taken in response to such conflicts. If such a conflict were
to occur, one or more insurance companies' separate accounts might be required
to withdraw its investments in the Fund, and shares of another Fund may be
substituted. This might force the Fund to sell securities at disadvantageous
prices. In addition, the Board of Directors may refuse to sell Fund shares to
any separate account or may suspend or terminate the offering of Fund shares if
such action is required by law or regulatory authority or is in the best
interest of the shareholders of the Fund.
Except for the organizational shares of the Fund, the Fund's shares may be
held of record only by insurance company separate accounts. As of March 31,
1997, the Advisor owned approximately 65% and Strong Funds Distributors, Inc.,
the Fund's underwriter, owned approximately 35% of the Fund. This share
ownership represents the organizational shares of the Fund. Their ownership of
greater than 25% of the Fund's shares may result in them being deemed to be
controlling entities of the Fund. They may continue to be deemed as such until
insurance companies, if any, selling significant numbers of variable annuity and
variable life insurance contracts, make substantial investments in the Fund's
shares.
---------------------
PROSPECTUS PAGE 12
<PAGE> 318
MANAGEMENT
The Board of Directors of the Corporation is responsible for managing the
Fund's business and affairs. The Fund has entered into an investment advisory
agreement (an "Advisory Agreement") with the Advisor. Under the terms of the
Advisory Agreement, the Advisor manages the Fund's investments and business
affairs, subject to the supervision of the Board of Directors.
The Advisor began conducting business in 1974. Since then, its principal
business has been providing continuous investment supervision for individuals
and institutional accounts, such as pension funds and profit-sharing plans, as
well as mutual funds, several of which are funding vehicles for variable
insurance products. As of March 31, 1997, the Advisor had over $23 billion under
management. The Advisor's principal mailing address is P.O. Box 2936, Milwaukee,
Wisconsin 53201. Mr. Richard S. Strong, the Chairman of the Board of the
Corporation, is the controlling shareholder of the Advisor.
As compensation for its services, the Fund pays the Advisor a monthly
management fee. The annual fee is 1.00% of the average daily net asset value of
the Fund. Under the terms of the Advisory Agreement, the Advisor provides office
space and all necessary office facilities, equipment, and personnel for
servicing the investments of the Fund. From time to time, the Advisor may
voluntarily waive all or a portion of its management fee and/or absorb certain
expenses for the Fund without further notification of the commencement or
termination of any such waiver or absorption. Any such waiver or absorption will
have the effect of lowering the overall expense ratio of the Fund and increasing
the Fund's return to investors at the time such amounts were waived and/or
absorbed.
Except for expenses assumed by the Advisor or Strong Funds Distributors,
Inc., the Fund is responsible for all its other expenses, including, without
limitation, interest charges, taxes, brokerage commissions and similar expenses;
expenses of issue, sale, repurchase, or redemption of shares; expenses of
registering or qualifying shares for sale with the states and the SEC; expenses
of printing and distribution of prospectuses to existing shareholders; charges
of custodians (including fees as custodian for keeping books and similar
services for the Fund), transfer agents (including the printing and mailing of
reports and notices to shareholders), registrars, auditing and legal services,
and clerical services related to recordkeeping and shareholder relations;
printing of stock certificates; fees for directors who are not "interested
persons" of the Advisor; expenses of indemnification; extraordinary expenses;
and costs of shareholder and director meetings.
The Advisor permits portfolio managers and other persons who may have access
to information about the purchase or sale of securities in the Fund's portfolio
("access persons") to purchase and sell securities for their own accounts,
subject to the Advisor's policy governing personal investing. The policy
requires access persons to conduct their personal investment activities
---------------------
PROSPECTUS PAGE 13
<PAGE> 319
in a manner that the Advisor believes is not detrimental to the Fund or to the
Advisor's other advisory clients. Among other things, the policy requires access
persons to obtain preclearance before executing personal trades and prohibits
access persons from keeping profits derived from the purchase or sale of the
same security within 60 calendar days. See the SAI for more information.
PRIOR PERFORMANCE OF SIMILAR FUND MANAGED BY THE ADVISOR. The Strong Growth
Fund II, which commenced operations on December 31, 1996, has been modeled after
the Strong Growth Fund, an existing retail fund managed by the Advisor. The
Strong Growth Fund began operations on December 31, 1993 and, as of March 31,
1997, had 1 billion, two hundred million in assets. The investment objective,
policies, and strategies of the Strong Growth Fund are identical to those of the
Strong Growth Fund II. For the fiscal period ended December 31, 1996, the Strong
Growth Fund's expense ratio was 1.3% compared to 2.0% for the Strong Growth Fund
II. The Strong Growth Fund II's expense ratio was higher than that of Strong
Growth Fund due to the small asset size and subsequent lack of economics of
scale of Strong Growth Fund II. The Advisor expects the expense ratio of Strong
Growth Fund II to decrease as its asset size increases. The average annual and
cumulative total returns for the Strong Growth Fund II and Strong Growth Fund as
of March 31, 1997 are presented in the table below. These performance returns
have been audited through December 31, 1996, and are unaudited thereafter.
<TABLE>
<CAPTION>
PERFORMANCE STRONG STRONG
RETURNS(1) GROWTH FUND II GROWTH FUND
<S> <C> <C>
Average Annual Returns
1 Year -- 4.50%
Since inception -- 20.66%
Cumulative Returns -2.80% 84.13%
- -------------------------------------------------------------------
</TABLE>
(1)Average annual and cumulative total returns reflect changes in share prices
and reinvestment of dividends and distributions and are net of fund expenses.
Historical performance does not indicate future performance. THE STRONG
GROWTH FUND IS A SEPARATE FUND AND ITS HISTORICAL PERFORMANCE IS NOT INDICATIVE
OF THE PRESENT OR FUTURE PERFORMANCE OF THE STRONG GROWTH FUND II. THE
PERFORMANCE OF THE STRONG GROWTH FUND II MAY BE GREATER OR LESS THAN THE
PERFORMANCE OF THE STRONG GROWTH FUND DUE TO, AMONG OTHER THINGS, DIFFERENCES IN
EXPENSES AND CASH FLOWS. Share prices and investment returns will fluctuate.
---------------------
PROSPECTUS PAGE 14
<PAGE> 320
PORTFOLIO MANAGER. Mr. Ronald C. Ognar, a Chartered Financial Analyst with
more than 25 years of investment experience, joined the Advisor in April 1993
after two years as a principal and portfolio manager with RCM Capital
Management. For approximately three years prior to that, he was a portfolio
manager at Kemper Financial Services in Chicago. Mr. Ognar began his investment
career in 1968 at LaSalle National Bank in Chicago after serving two years in
the U.S. Army. He received his bachelor's degree in Accounting from the
University of Illinois in 1968. Mr. Ognar has managed the Fund since its
inception in June 1995.
PRIOR PERFORMANCE OF PORTFOLIO MANAGER. From February 1989 through July 1991,
Mr. Ronald C. Ognar, the current portfolio manager of the Strong Growth Fund II,
managed the Kemper Growth Fund. Mr. Ognar assumed portfolio management
responsibility from the Kemper Growth Fund's previous manager. As portfolio
manager, Mr. Ognar was primarily responsible for the day-to-day management of
the Kemper Growth Fund and no other person played a significant part in that
management. During the time that Mr. Ognar managed the Kemper Growth Fund, it
had an investment objective, policies, and strategies that were substantially
similar to the Strong Growth Fund II. The cumulative total return for the Kemper
Growth Fund from March 1, 1989 through June 30, 1991 was 62.93% as compared to
39.32% for the S&P 500 Index over the same period. The average annual total
returns for the Kemper Growth Fund for the one-year period ended June 30, 1991,
and for the entire period that Mr. Ognar managed the Kemper Growth Fund compared
with the performance of the S&P 500 Index were:
<TABLE>
<CAPTION>
KEMPER
YEAR GROWTH FUND (1) S&P 500 INDEX (2)
<S> <C> <C>
1 Year 15.13% 7.39%
3/1/89 - 6/30/91(3) 23.27% 15.27%
- -----------------------------------------------------------------------
</TABLE>
(1)Average annual total returns reflect changes in share prices and reinvestment
of dividends and distributions and are net of fund expenses.
(2)The S&P 500 Stock Index is an unmanaged index generally representative of the
U.S. stock market. The index does not reflect investment management fees,
brokerage commissions, and other expenses associated with investing in equity
securities.
(3)From July 1991 until he joined Strong Capital Management in April of 1993,
Mr. Ognar served RCM Capital Management as a portfolio manager of certain
separate accounts. Mr. Ognar has been managing the Strong Growth Fund II
since its inception December 31, 1996.
---------------------
PROSPECTUS PAGE 15
<PAGE> 321
Historical performance does not indicate future performance. THE KEMPER
GROWTH FUND IS A SEPARATE FUND AND ITS HISTORICAL PERFORMANCE IS NOT INDICATIVE
OF THE POTENTIAL PERFORMANCE OF THE STRONG GROWTH FUND II. Share prices and
investment returns will fluctuate.
ADDITIONAL INFORMATION
HOW TO INVEST. Investments in the Fund may only be made by separate accounts
established and maintained by insurance companies for purposes of funding
variable annuity and variable life insurance contracts. For instructions on how
to direct a separate account to purchase shares in the Fund, please refer to the
prospectus of the insurance company's separate account. The Fund does not impose
any sales charge or 12b-1 fee. Certain sales charges may apply to the variable
annuity or variable life insurance contract, which should be described in the
prospectus of the insurance company's separate account. The Fund may decline to
accept a purchase order upon receipt when, in the judgment of the Advisor, it
would not be in the best interest of the existing shareholders to accept the
order. Shares of the Fund will be sold at the net asset value next determined
after receipt by the Fund of a purchase order in proper form placed by an
insurance company invested in the Fund. Certificates for shares in the Fund will
not be issued.
CALCULATION OF NET ASSET VALUE. The net asset value ("NAV") per share for the
Fund is determined as of the close of trading on the New York Stock Exchange
(the "Exchange"), currently 3:00 p.m. Central Time, on days the Exchange is open
for business. The NAV will not be determined for the Fund on days during which
the Fund receives no orders to purchase shares and no shares are tendered for
redemption. The Fund's NAV is calculated by taking the fair value of the Fund's
total assets, subtracting all its liabilities, and dividing by the total number
of shares outstanding. Expenses are accrued daily and applied when determining
the NAV.
The Fund's portfolio securities are valued based on market quotations or at
fair value as determined by the method selected by the Board of Directors.
Equity securities traded on a national securities exchange or NASDAQ are valued
at the last sales price on the national securities exchange or NASDAQ on which
such securities are primarily traded. Securities traded on NASDAQ for which
there were no transactions on a given day or securities not listed on an
exchange or NASDAQ are valued at the average of the most recent bid and asked
prices. Other exchange-traded securities (generally foreign securities) will be
valued based on market quotations.
Securities quoted in foreign currency are valued daily in U.S. dollars at the
foreign currency exchange rates that are prevailing at the time the daily NAV
per share is determined. Although the Fund values its foreign assets in U.S.
dollars on a daily basis, the Fund does not intend to convert its holdings of
---------------------
PROSPECTUS PAGE 16
<PAGE> 322
foreign currencies into U.S. dollars on a daily basis. Foreign currency exchange
rates are generally determined prior to the close of trading on the Exchange.
Occasionally, events affecting the value of foreign investments and such
exchange rates occur between the time at which they are determined and the close
of trading on the Exchange. Such events would not normally be reflected in a
calculation of the Fund's NAV on that day. If events that materially affect the
value of the Fund's foreign investments or the foreign currency exchange rates
occur during such period, the investments will be valued at their fair value as
determined in good faith by or under the direction of the Board of Directors.
HOW TO REDEEM SHARES. Shares of the Fund may be redeemed on any business day.
The price received upon redemption will be the net asset value next determined
after the redemption request in proper form is received by the Fund. (See
"Calculation of Net Asset Value.") Contract owners should refer to the
withdrawal or surrender instructions in the prospectus of the separate account
for instructions on how to redeem shares. Once the redemption request is
received in proper form, the Fund will ordinarily forward payment to the
separate account no later than seven days after receipt.
The right of redemption may be suspended during any period in which: (i)
trading on the Exchange is restricted, as determined by the SEC, or the Exchange
is closed for other than weekends and holidays; (ii) the SEC has permitted such
suspension by order; or (iii) an emergency, as determined by the SEC, exists
which makes disposal of portfolio securities or valuation of net assets of the
Fund not reasonably practicable.
DISTRIBUTIONS AND TAXES. The policy of the Fund is to pay dividends to the
insurance company's separate accounts from net investment income quarterly and
to distribute substantially all net realized capital gains, after using any
available capital loss carryovers, annually. All dividends and capital gain
distributions paid to the insurance company's separate accounts will be
automatically reinvested in additional Fund shares.
The Fund intends to continue to qualify for treatment as a Regulated
Investment Company or "RIC" under Subchapter M of the Code and, if so qualified,
will not be liable for federal income tax on earnings and gains distributed to
its shareholders in a timely manner. If the Fund does not so qualify, however,
it would be treated for tax purposes as an ordinary corporation and would
receive no tax deduction for distributions made to its shareholders. For more
information regarding tax implications for owners of variable annuity or
variable life insurance contracts investing in the Fund, please refer to the
prospectus of your insurance company's separate account. (See "Special
Considerations" for a discussion of special tax considerations relating to the
Fund's compliance with Subchapter L of the Code, as an investment vehicle for
variable annuity and variable life insurance contracts of certain insurance
companies.)
---------------------
PROSPECTUS PAGE 17
<PAGE> 323
This section is not intended to be a full discussion of present or proposed
federal income tax law and its effect on the Fund and investors. (See the SAI
for a further discussion.) Investors are urged to consult their own tax adviser.
ORGANIZATION. The Fund is a series of common stock of the Corporation, which
is a Wisconsin corporation. The Corporation is authorized to issue an indefinite
number of shares of common stock and series and classes of series of shares of
common stock. All holders of shares of the Corporation would vote on each matter
presented to shareholders for action except with respect to any matter which
affects only one or more series or classes, in which case only the shares of the
affected series or class shall be entitled to vote.
All shares participate equally in dividends and other capital gains
distributions by the Fund and in the residual assets of the Fund in the event of
liquidation. Generally, the Corporation will not hold an annual meeting of
shareholders unless required by the 1940 Act.
The insurance company separate accounts, as the record shareholders in the
Fund, have the right to vote on matters submitted for a shareholder vote. Under
current interpretations of the 1940 Act, these insurance companies must solicit
voting instructions from contract owners and vote Fund shares in accordance with
the instructions received or, for Fund shares for which no voting instructions
were received, in the same proportion as those Fund shares for which
instructions were received. Contract owners should refer to the prospectus of
the insurance company's separate account for a complete description of their
voting rights.
TRANSFER AGENT, DIVIDEND-DISBURSING AGENT, AND DISTRIBUTOR. The Advisor, P.O.
Box 2936, Milwaukee, Wisconsin 53201, acts as transfer agent and
dividend-disbursing agent for the Fund. Strong Funds Distributors, Inc., P.O.
Box 2936, Milwaukee, Wisconsin 53201, an indirect subsidiary of the Advisor,
acts as distributor of the shares of the Fund.
PERFORMANCE INFORMATION. The Fund may advertise a variety of types of
performance information, including "average annual total return," "total
return," and "cumulative total return." Each of these figures is based upon
historical results and does not represent the future performance of the Fund.
Average annual total return and total return figures measure both the net
investment income generated by, and the effect of any realized and unrealized
appreciation or depreciation of, the underlying investments in the Fund assuming
the reinvestment of all dividends and distributions. Total return figures are
not annualized and simply represent the aggregate change of the Fund's
investments over a specified period of time.
The Fund's shares are sold at the net asset value per share of the Fund.
Returns and net asset value will fluctuate. Shares of the Fund are redeemable by
the separate accounts of insurance companies at the then current net asset value
per share for the Fund, which may be more or less than the original cost.
---------------------
PROSPECTUS PAGE 18
<PAGE> 324
TOTAL RETURNS CONTAINED IN ADVERTISEMENTS INCLUDE THE EFFECT OF DEDUCTING THE
FUND'S EXPENSES, BUT MAY NOT INCLUDE CHARGES AND EXPENSES ATTRIBUTABLE TO ANY
PARTICULAR INSURANCE PRODUCT. SINCE SHARES MAY ONLY BE PURCHASED BY THE SEPARATE
ACCOUNTS OF CERTAIN INSURANCE COMPANIES, CONTRACT OWNERS SHOULD CAREFULLY REVIEW
THE PROSPECTUS OF THE SEPARATE ACCOUNT FOR INFORMATION ON FEES AND EXPENSES.
Excluding such fees and expenses from the Fund's total return quotations has the
effect of increasing the performance quoted. The Fund will not use information
concerning its investment performance in advertisements or sales materials
unless appropriate information concerning the relevant separate account is also
included. Additional information concerning the Fund's performance appears in
the SAI.
---------------------
PROSPECTUS PAGE 19
<PAGE> 325
STATEMENT OF ADDITIONAL INFORMATION
STRONG GROWTH FUND II
P.O. Box 2936
Milwaukee, Wisconsin 53201
Toll-Free: (800) 368-1683
Strong Growth Fund II (the "Fund") is a diversified series of the Strong
Variable Insurance Funds, Inc. (the "Corporation"), an open-end management
investment company designed to provide an investment vehicle for variable
annuity and variable life insurance contracts of certain insurance companies.
Shares in the Fund are only offered and sold to the separate accounts of such
insurance companies. The Fund is described herein and in the Prospectus for
the Fund dated May 1, 1997.
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the Prospectus for the Fund dated May 1, 1997 and the
prospectus for the separate account of the specific insurance product.
Requests for copies of the Fund's Prospectus may be made by calling one of the
numbers listed above.
This Statement of Additional Information is dated May 1, 1997.
<PAGE> 326
STRONG GROWTH FUND II
<TABLE>
<CAPTION>
TABLE OF CONTENTS PAGE
<S> <C>
INVESTMENT RESTRICTIONS................................................. 3
INVESTMENT POLICIES AND TECHNIQUES...................................... 4
Borrowing.............................................................. 5
Convertible Securities................................................. 5
Debt Obligations....................................................... 5
Depositary Receipts.................................................... 6
Derivative Instruments................................................. 7
Foreign Investment Companies........................................... 16
Foreign Securities..................................................... 16
High-Yield (High-Risk) Securities...................................... 17
Illiquid Securities.................................................... 18
Lending of Portfolio Securities........................................ 19
Mortgage- and Asset-Backed Securities.................................. 19
Mortgage Dollar Rolls and Reverse Repurchase Agreements................ 20
Repurchase Agreements.................................................. 21
Short Sales Against the Box............................................ 21
Small and Medium Companies............................................. 21
Temporary Defensive Position........................................... 22
Warrants............................................................... 22
When-Issued Securities................................................. 22
Zero-Coupon, Step-Coupon and Pay-in-Kind Securities.................... 22
DIRECTORS AND OFFICERS OF THE CORPORATION............................... 23
PRINCIPAL SHAREHOLDERS.................................................. 25
INVESTMENT ADVISOR AND DISTRIBUTOR...................................... 25
PORTFOLIO TRANSACTIONS AND BROKERAGE.................................... 28
CUSTODIAN............................................................... 30
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT............................ 30
ADMINISTRATIVE SERVICES................................................. 30
TAXES................................................................... 31
DETERMINATION OF NET ASSET VALUE........................................ 33
FUND ORGANIZATION....................................................... 34
PERFORMANCE INFORMATION................................................. 34
GENERAL INFORMATION..................................................... 38
PORTFOLIO MANAGEMENT.................................................... 39
INDEPENDENT ACCOUNTANTS................................................. 40
LEGAL COUNSEL........................................................... 40
FINANCIAL STATEMENTS.................................................... 40
APPENDIX................................................................ A-1
</TABLE>
______________________________
No person has been authorized to give any information or to make any
representations other than those contained in this Statement of Additional
Information and the Prospectus dated May 1, 1997 and, if given or made, such
information or representations may not be relied upon as having been authorized
by the Fund.
This Statement of Additional Information does not constitute an offer to sell
securities.
2
<PAGE> 327
INVESTMENT RESTRICTIONS
The investment objective of the Fund is to seek capital growth. The
Fund's investment objective and policies are described in detail in the
Prospectus under the caption "Investment Objective and Policies." The
following are the Fund's fundamental investment limitations which cannot be
changed without shareholder approval.
The Fund:
1. May not with respect to 75% of its total assets, purchase the securities
of any issuer (except securities issued or guaranteed by the U.S.
government or its agencies or instrumentalities) if, as a result, (i) more
than 5% of the Fund's total assets would be invested in the securities of
that issuer, or (ii) the Fund would hold more than 10% of the outstanding
voting securities of that issuer.
2. May (i) borrow money from banks and (ii) make other investments or engage
in other transactions permissible under the Investment Company Act of 1940
(the "1940 Act") which may involve a borrowing, provided that the
combination of (i) and (ii) shall not exceed 33 1/3% of the value of the
Fund's total assets (including the amount borrowed), less the Fund's
liabilities (other than borrowings), except that the Fund may borrow up to
an additional 5% of its total assets (not including the amount borrowed)
from a bank for temporary or emergency purposes (but not for leverage or
the purchase of investments). The Fund may also borrow money from the
other Strong Funds or other persons to the extent permitted by applicable
law.
3. May not issue senior securities, except as permitted under the 1940 Act.
4. May not act as an underwriter of another issuer's securities, except to
the extent that the Fund may be deemed to be an underwriter within the
meaning of the Securities Act of 1933 in connection with the purchase and
sale of portfolio securities.
5. May not purchase or sell physical commodities unless acquired as a result
of ownership of securities or other instruments (but this shall not
prevent the Fund from purchasing or selling options, futures contracts, or
other derivative instruments, or from investing in securities or other
instruments backed by physical commodities).
6. May not make loans if, as a result, more than 33 1/3% of the Fund's total
assets would be lent to other persons, except through (i) purchases of
debt securities or other debt instruments, or (ii) engaging in repurchase
agreements.
7. May not purchase the securities of any issuer if, as a result, more than
25% of the Fund's total assets would be invested in the securities of
issuers, the principal business activities of which are in the same
industry.
8. May not purchase or sell real estate unless acquired as a result of
ownership of securities or other instruments (but this shall not prohibit
the Fund from purchasing or selling securities or other instruments backed
by real estate or of issuers engaged in real estate activities).
9. May, notwithstanding any other fundamental investment policy or
restriction, invest all of its assets in the securities of a single
open-end management investment company with substantially the same
fundamental investment objective, policies, and restrictions as the Fund.
3
<PAGE> 328
The following are the Fund's non-fundamental operating policies which may
be changed by the Board of Directors of the Corporation without shareholder
approval.
The Fund may not:
1. Sell securities short, unless the Fund owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short, or
unless it covers such short sale as required by the current rules and
positions of the Securities and Exchange Commission or its staff, and
provided that transactions in options, futures contracts, options on
futures contracts, or other derivative instruments are not deemed to
constitute selling securities short.
2. Purchase securities on margin, except that the Fund may obtain such
short-term credits as are necessary for the clearance of transactions; and
provided that margin deposits in connection with futures contracts,
options on futures contracts, or other derivative instruments shall not
constitute purchasing securities on margin.
3. Invest in illiquid securities if, as a result of such investment, more
than 15% of its net assets would be invested in illiquid securities, or
such other amounts as may be permitted under the 1940 Act.
4. Purchase securities of other investment companies except in compliance
with the 1940 Act and applicable state law.
5. Invest all of its assets in the securities of a single open-end
investment management company with substantially the same fundamental
investment objective, restrictions and policies as the Fund.
6. Engage in futures or options on futures transactions which are
impermissible pursuant to Rule 4.5 under the Commodity Exchange Act and,
in accordance with Rule 4.5, will use futures or options on futures
transactions solely for bona fide hedging transactions (within the meaning
of the Commodity Exchange Act), provided, however, that the Fund may, in
addition to bona fide hedging transactions, use futures and options on
futures transactions if the aggregate initial margin and premiums required
to establish such positions, less the amount by which any such options
positions are in the money (within the meaning of the Commodity Exchange
Act), do not exceed 5% of the Fund's net assets.
7. Borrow money except (i) from banks or (ii) through reverse repurchase
agreements or mortgage dollar rolls, and will not purchase securities when
bank borrowings exceed 5% of its total assets.
8. Make any loans other than loans of portfolio securities, except through
(i) purchases of debt securities or other debt instruments, or (ii)
engaging in repurchase agreements.
Except for the fundamental investment limitations listed above and the
Fund's investment objective, the other investment policies described in the
Prospectus and this Statement of Additional Information are not fundamental and
may be changed with approval of the Corporation's Board of Directors. Unless
noted otherwise, if a percentage restriction is adhered to at the time of
investment, a later increase or decrease in percentage resulting from a change
in the Fund's assets (i.e., due to cash inflows or redemptions) or in market
value of the investment or the Fund's assets will not constitute a violation of
that restriction.
INVESTMENT POLICIES AND TECHNIQUES
The following information supplements the discussion of the Fund's
investment objective, policies, and techniques that are described in detail in
the Prospectus under the captions "Investment Objective and Policies" and
"Implementation of Policies and Risks."
4
<PAGE> 329
BORROWING
The Fund may borrow money from banks and make other investments or engage
in other transactions permissible under the 1940 Act which may be considered a
borrowing (such as mortgage dollar rolls and reverse repurchase agreements) as
discussed under "Investment Restrictions." However, the Fund may not purchase
securities when bank borrowings exceed 5% of the Fund's total assets.
Presently, the Fund only intends to borrow from banks for temporary or
emergency purposes.
The Fund has established a line-of-credit (LOC) with certain banks by
which they may borrow funds for temporary or emergency purposes. A borrowing
is presumed to be for temporary or emergency purposes if it is repaid by the
Fund within sixty days and is not extended or renewed. The Fund intends to use
the LOC to meet large or unexpected redemptions that would otherwise force the
Fund to liquidate securities under circumstances which are unfavorable to the
Fund's remaining shareholders. The Fund pays a commitment fee to the banks for
the LOC.
CONVERTIBLE SECURITIES
The Fund may invest in convertible securities, which are bonds,
debentures, notes, preferred stocks, or other securities that may be converted
into or exchanged for a specified amount of common stock of the same or a
different issuer within a particular period of time at a specified price or
formula. A convertible security entitles the holder to receive interest
normally paid or accrued on debt or the dividend paid on preferred stock until
the convertible security matures or is redeemed, converted, or exchanged.
Convertible securities have unique investment characteristics in that they
generally (i) have higher yields than common stocks, but lower yields than
comparable non-convertible securities, (ii) are less subject to fluctuation in
value than the underlying stock since they have fixed income characteristics,
and (iii) provide the potential for capital appreciation if the market price of
the underlying common stock increases. Most convertible securities currently
are issued by U.S. companies, although a substantial Eurodollar convertible
securities market has developed, and the markets for convertible securities
denominated in local currencies are increasing.
The value of a convertible security is a function of its "investment
value" (determined by its yield in comparison with the yields of other
securities of comparable maturity and quality that do not have a conversion
privilege) and its "conversion value" (the security's worth, at market value,
if converted into the underlying common stock). The investment value of a
convertible security is influenced by changes in interest rates, with
investment value declining as interest rates increase and increasing as
interest rates decline. The credit standing of the issuer and other factors
also may have an effect on the convertible security's investment value. The
conversion value of a convertible security is determined by the market price of
the underlying common stock. If the conversion value is low relative to the
investment value, the price of the convertible security is governed principally
by its investment value. Generally, the conversion value decreases as the
convertible security approaches maturity. To the extent the market price of
the underlying common stock approaches or exceeds the conversion price, the
price of the convertible security will be increasingly influenced by its
conversion value. A convertible security generally will sell at a premium over
its conversion value by the extent to which investors place value on the right
to acquire the underlying common stock while holding a fixed income security.
A convertible security may be subject to redemption at the option of the
issuer at a price established in the convertible security's governing
instrument. If a convertible security held by the Fund is called for
redemption, the Fund will be required to permit the issuer to redeem the
security, convert it into the underlying common stock, or sell it to a third
party.
DEBT OBLIGATIONS
The Fund may invest a portion of its assets in debt obligations. Issuers
of debt obligations have a contractual obligation to pay interest at a
specified rate on specified dates and to repay principal on a specified
maturity date. Certain debt obligations (usually intermediate- and long-term
bonds) have provisions that allow the issuer to redeem or "call" a bond before
its maturity. Issuers are most likely to call such securities during periods
of falling interest rates and the Fund may have to replace such securities with
lower yielding securities, which could result in a lower return for the Fund.
5
<PAGE> 330
PRICE VOLATILITY. The market value of debt obligations is affected
primarily by changes in prevailing interest rates. The market value of a debt
obligation generally reacts inversely to interest-rate changes, meaning, when
prevailing interest rates decline, an obligation's price usually rises, and
when prevailing interest rates rise, an obligation's price usually declines.
MATURITY. In general, the longer the maturity of a debt obligation, the
higher its yield and the greater its sensitivity to changes in interest rates.
Conversely, the shorter the maturity, the lower the yield but the greater the
price stability. Commercial paper is generally considered the shortest form of
debt obligation.
CREDIT QUALITY. The values of debt obligations may also be affected by
changes in the credit rating or financial condition of their issuers.
Generally, the lower the quality rating of a security, the higher the degree of
risk as to the payment of interest and return of principal. To compensate
investors for taking on such increased risk, those issuers deemed to be less
creditworthy generally must offer their investors higher interest rates than do
issuers with better credit ratings.
In conducting its credit research and analysis, the Advisor considers both
qualitative and quantitative factors to evaluate the creditworthiness of
individual issuers. The Advisor also relies, in part, on credit ratings
compiled by a number of Nationally Recognized Statistical Rating Organizations
("NRSROs"). Refer to the Appendix for a discussion of securities ratings.
DEPOSITARY RECEIPTS
The Fund may invest in foreign securities by purchasing depositary
receipts, including American Depositary Receipts ("ADRs") and European
Depositary Receipts ("EDRs"), or other securities convertible into securities
of foreign issuers. These securities may not necessarily be denominated in the
same currency as the securities into which they may be converted. Generally,
ADRs, in registered form, are denominated in U.S. dollars and are designed for
use in the U.S. securities markets, while EDRs, in bearer form, may be
denominated in other currencies and are designed for use in the European
securities markets. ADRs are receipts typically issued by a U.S. bank or
trust company evidencing ownership of the underlying securities. EDRs are
European receipts evidencing a similar arrangement. For purposes of the Fund's
investment policies, ADRs and EDRs are deemed to have the same classification
as the underlying securities they represent, except that ADRs and EDRs shall be
treated as indirect foreign investments. Thus, an ADR or EDR representing
ownership of common stock will be treated as common stock. ADR and EDR
depositary receipts do not eliminate all of the risks associated with directly
investing in the securities of foreign issuers.
ADR facilities may be established as either "unsponsored" or "sponsored."
While ADRs issued under these two types of facilities are in some respects
similar, there are distinctions between them relating to the rights and
obligations of ADR holders and the practices of market participants.
A depositary may establish an unsponsored facility without participation
by (or even necessarily the acquiescence of) the issuer of the deposited
securities, although typically the depositary requests a letter of
non-objection from such issuer prior to the establishment of the facility.
Holders of unsponsored ADRs generally bear all the costs of such facilities.
The depositary usually charges fees upon the deposit and withdrawal of the
deposited securities, the conversion of dividends into U.S. dollars, the
disposition of non-cash distributions, and the performance of other services.
The depositary of an unsponsored facility frequently is under no obligation to
pass through voting rights to ADR holders in respect of the deposited
securities. In addition, an unsponsored facility is generally not obligated to
distribute communications received from the issuer of the deposited securities
or to disclose material information about such issuer in the U.S. and thus
there may not be a correlation between such information and the market value of
the depositary receipts.
Sponsored ADR facilities are created in generally the same manner as
unsponsored facilities, except that the issuer of the deposited securities
enters into a deposit agreement with the depositary. The deposit agreement
sets out the rights and responsibilities of the issuer, the depositary, and the
ADR holders. With sponsored facilities, the issuer of the deposited securities
generally will bear some of the costs relating to the facility (such as
dividend payment fees of the depositary), although ADR holders continue to bear
certain other costs (such as deposit and withdrawal fees). Under the terms of
most sponsored arrangements, depositories agree to distribute notices of
shareholder meetings and voting instructions, and to provide shareholder
communications and other information to the ADR holders at the request of the
issuer of the deposited securities.
6
<PAGE> 331
DERIVATIVE INSTRUMENTS
IN GENERAL. The Fund may use derivative instruments for any lawful
purpose consistent with the Fund's investment objective such as hedging or
managing risk. Derivative instruments are commonly defined to include
securities or contracts whose values depend on (or "derive" from) the value of
one or more other assets, such as securities, currencies, or commodities.
These "other assets" are commonly referred to as "underlying assets.
A derivative instrument generally consists of, is based upon, or exhibits
characteristics similar to options or forward contracts. Options and forward
contracts are considered to be the basic "building blocks" of derivatives. For
example, forward-based derivatives include forward contracts, swap contracts,
as well as exchange-traded futures. Option-based derivatives include privately
negotiated, over-the-counter (OTC) options (including caps, floors, collars,
and options on forward and swap contracts) and exchange-traded options on
futures. Diverse types of derivatives may be created by combining options or
forward contracts in different ways, and by applying these structures to a wide
range of underlying assets.
An option is a contract in which the "holder" (the buyer) pays a certain
amount (the "premium") to the "writer" (the seller) to obtain the right, but
not the obligation, to buy from the writer (in a "call") or sell to the writer
(in a "put") a specific asset at an agreed upon price at or before a certain
time. The holder pays the premium at inception and has no further financial
obligation. The holder of an option-based derivative generally will benefit
from favorable movements in the price of the underlying asset but is not
exposed to corresponding losses due to adverse movements in the value of the
underlying asset. The writer of an option-based derivative generally will
receive fees or premiums but generally is exposed to losses due to changes in
the value of the underlying asset.
A forward is a sales contract between a buyer (holding the "long"
position) and a seller (holding the "short" position) for an asset with
delivery deferred until a future date. The buyer agrees to pay a fixed price
at the agreed future date and the seller agrees to deliver the asset. The
seller hopes that the market price on the delivery date is less than the agreed
upon price, while the buyer hopes for the contrary. The change in value of a
forward-based derivative generally is roughly proportional to the change in
value of the underlying asset.
HEDGING. The Fund may use derivative instruments to protect against
possible adverse changes in the market value of securities held in, or are
anticipated to be held in, the Fund's portfolio. Derivatives may also be used
by the Fund to "lock-in" the Fund's realized but unrecognized gains in the
value of its portfolio securities. Hedging strategies, if successful, can
reduce the risk of loss by wholly or partially offsetting the negative effect
of unfavorable price movements in the investments being hedged. However,
hedging strategies can also reduce the opportunity for gain by offsetting the
positive effect of favorable price movements in the hedged investments.
MANAGING RISK. The Fund may also use derivative instruments to manage the
risks of the Fund's portfolio. Risk management strategies include, but are not
limited to, facilitating the sale of portfolio securities, managing the
effective maturity or duration of debt obligations in the Fund's portfolio,
establishing a position in the derivatives markets as a substitute for buying
or selling certain securities, or creating or altering exposure to certain
asset classes, such as equity, debt, and foreign securities. The use of
derivative instruments may provide a less expensive, more expedient or more
specifically focused way for the Fund to invest than "traditional" securities
(i.e., stocks or bonds) would.
EXCHANGE OR OTC DERIVATIVES. Derivative instruments may be
exchange-traded or traded in OTC transactions between private parties.
Exchange-traded derivatives are standardized options and futures contracts
traded in an auction on the floor of a regulated exchange. Exchange contracts
are generally very liquid. The exchange clearinghouse is the counterparty of
every contract. Thus, each holder of an exchange contract bears the credit
risk of the clearinghouse (and has the benefit of its financial strength)
rather than that of a particular counterparty. Over-the-counter transactions
are subject to additional risks, such as the credit risk of the counterparty to
the instrument and are less liquid than exchange-traded derivatives since they
often can only be closed out with the other party to the transaction
RISKS AND SPECIAL CONSIDERATIONS. The use of derivative instruments
involves risks and special considerations as described below. Risks pertaining
to particular derivative instruments are described in the sections that follow.
7
<PAGE> 332
(1) MARKET RISK. The primary risk of derivatives is the same as the risk
of the underlying assets, namely that the value of the underlying asset may go
up or down. Adverse movements in the value of an underlying asset can expose
the Fund to losses. Derivative instruments may include elements of leverage
and, accordingly, the fluctuation of the value of the derivative instrument in
relation to the underlying asset may be magnified. The successful use of
derivative instruments depends upon a variety of factors, particularly Strong
Capital Management, Inc.'s (the "Advisor") ability to predict movements of the
securities, currencies, and commodity markets, which requires different skills
than predicting changes in the prices of individual securities. There can be
no assurance that any particular strategy adopted will succeed. The Advisor's
decision to engage in a derivative instrument will reflect the Advisor's
judgment that the derivative transaction will provide value to the Fund and its
shareholders and is consistent with the Fund's objectives, investment
limitations, and operating policies. In making such a judgment, the Advisor
will analyze the benefits and risks of the derivative transaction and weigh
them in the context of the Fund's entire portfolio and investment objective.
(2) CREDIT RISK. The Fund will be subject to the risk that a loss may be
sustained by the Fund as a result of the failure of a counterparty to comply
with the terms of a derivative instrument. The counterparty risk for
exchange-traded derivative instruments is generally less than for
privately-negotiated or OTC derivative instruments, since generally a clearing
agency, which is the issuer or counterparty to each exchange-traded instrument,
provides a guarantee of performance. For privately-negotiated instruments,
there is no similar clearing agency guarantee. In all transactions, the Fund
will bear the risk that the counterparty will default, and this could result in
a loss of the expected benefit of the derivative transaction and possibly other
losses to the Fund. The Fund will enter into transactions in derivative
instruments only with counterparties that the Advisor reasonably believes are
capable of performing under the contract.
(3) CORRELATION RISK. When a derivative transaction is used to completely
hedge another position, changes in the market value of the combined position
(the derivative instrument plus the position being hedged) result from an
imperfect correlation between the price movements of the two instruments. With
a perfect hedge, the value of the combined position remains unchanged for any
change in the price of the underlying asset. With an imperfect hedge, the
values of the derivative instrument and its hedge are not perfectly correlated.
Correlation risk is the risk that there might be imperfect correlation, or
even no correlation, between price movements of an instrument and price
movements of investments being hedged. For example, if the value of a
derivative instruments used in a short hedge (such as writing a call option,
buying a put option, or selling a futures contract) increased by less than the
decline in value of the hedged investments, the hedge would not be perfectly
correlated. Such a lack of correlation might occur due to factors unrelated to
the value of the investments being hedged, such as speculative or other
pressures on the markets in which these instruments are traded. The
effectiveness of hedges using instruments on indices will depend, in part, on
the degree of correlation between price movements in the index and price
movements in the investments being hedged.
(4) LIQUIDITY RISK. Derivatives are also subject to liquidity risk.
Liquidity risk is the risk that a derivative instrument cannot be sold, closed
out, or replaced quickly at or very close to its fundamental value. Generally,
exchange contracts are very liquid because the exchange clearinghouse is the
counterparty of every contract. OTC transactions are less liquid than
exchange-traded derivatives since they often can only be closed out with the
other party to the transaction. The Fund might be required by applicable
regulatory requirement to maintain assets as "cover," maintain segregated
accounts, and/or make margin payments when it takes positions in derivative
instruments involving obligations to third parties (i.e., instruments other
than purchased options). If the Fund was unable to close out its positions in
such instruments, it might be required to continue to maintain such assets or
accounts or make such payments until the position expired, matured, or was
closed out. The requirements might impair the Fund's ability to sell a
portfolio security or make an investment at a time when it would otherwise be
favorable to do so, or require that the Fund sell a portfolio security at a
disadvantageous time. The Fund's ability to sell or close out a position in an
instrument prior to expiration or maturity depends on the existence of a liquid
secondary market or, in the absence of such a market, the ability and
willingness of the counterparty to enter into a transaction closing out the
position. Therefore, there is no assurance that any derivatives position can
be sold or closed out at a time and price that is favorable to the Fund.
(5) LEGAL RISK. Legal risk is the risk of loss caused by the legal
unenforcibility of a party's obligations under the derivative. While a party
seeking price certainty agrees to surrender the potential upside in exchange
for downside protection, the party taking the risk is looking for a positive
payoff. Despite this voluntary assumption of risk, a counterparty that has
lost money in a derivative transaction may try to avoid payment by exploiting
various legal uncertainties about certain derivative products.
8
<PAGE> 333
(6) SYSTEMIC OR "INTERCONNECTION" RISK. Interconnection risk is the risk
that a disruption in the financial markets will cause difficulties for all
market participants. In other words, a disruption in one market will spill
over into other markets, perhaps creating a chain reaction. Much of the OTC
derivatives market takes place among the OTC dealers themselves, thus creating
a large interconnected web of financial obligations. This interconnectedness
raises the possibility that a default by one large dealer could create losses
at other dealers and destabilize the entire market for OTC derivative
instruments.
GENERAL LIMITATIONS. The use of derivative instruments is subject to
applicable regulations of the Securities and Exchange Commission (the "SEC"),
the several options and futures exchanges upon which they may be traded, the
Commodity Futures Trading Commission ("CFTC"), and various state regulatory
authorities. In addition, the Fund's ability to use derivative instruments may
be limited by certain tax considerations. For a discussion of the federal
income tax treatment of the Fund's derivative instruments, see "Taxes -
Derivative Instruments."
The Fund has filed a notice of eligibility for exclusion from the
definition of the term "commodity pool operator" with the CFTC and the National
Futures Association, which regulate trading in the futures markets. In
accordance with Rule 4.5 of the regulations under the Commodity Exchange Act
(the "CEA"), the notice of eligibility for the Fund includes representations
that the Fund will use futures contracts and related options solely for bona
fide hedging purposes within the meaning of CFTC regulations, provided that the
Fund may hold other positions in futures contracts and related options that do
not qualify as a bona fide hedging position if the aggregate initial margin
deposits and premiums required to establish these positions, less the amount by
which any such futures contracts and related options positions are "in the
money," do not exceed 5% of the Fund's net assets. Adherence to these
guidelines does not limit the Fund's risk to 5% of the Fund's assets.
The SEC has identified certain trading practices involving derivative
instruments that involve the potential for leveraging the Fund's assets in a
manner that raises issues under the 1940 Act. In order to limit the potential
for the leveraging of the Fund's assets, as defined under the 1940 Act, the SEC
has stated that the Fund may use coverage or the segregation of the Fund's
assets. To the extent required by SEC guidelines, the Fund will not enter into
any such transactions unless it owns either: (i) an offsetting ("covered")
position in securities, options, futures, or derivative instruments; or (ii)
cash or liquid securities positions with a value sufficient at all times to
cover its potential obligations to the extent that the position is not
"covered". The Fund will also set aside cash and/or appropriate liquid assets
in a segregated custodial account if required to do so by the SEC and CFTC
regulations. Assets used as cover or held in a segregated account cannot be
sold while the derivative position is open, unless they are replaced with
similar assets. As a result, the commitment of a large portion of the Fund's
assets to segregated accounts could impede portfolio management or the Fund's
ability to meet redemption requests or other current obligations.
In some cases the Fund may be required to maintain or limit exposure to a
specified percentage of its assets to a particular asset class. In such cases,
when the Fund uses a derivative instrument to increase or decrease exposure to
an asset class and is required by applicable SEC guidelines to set aside liquid
assets in a segregated account to secure its obligations under the derivative
instruments, the Advisor may, where reasonable in light of the circumstances,
measure compliance with the applicable percentage by reference to the nature of
the economic exposure created through the use of the derivative instrument and
not by reference to the nature of the exposure arising from the liquid assets
set aside in the segregated account (unless another interpretation is specified
by applicable regulatory requirements).
OPTIONS. The Fund may use options for any lawful purpose consistent with
the Fund's investment objective such as hedging or managing risk. An option is
a contract in which the "holder" (the buyer) pays a certain amount (the
"premium") to the "writer" (the seller) to obtain the right, but not the
obligation, to buy from the writer (in a "call") or sell to the writer (in a
"put") a specific asset at an agreed upon price (the "strike price" or
"exercise price") at or before a certain time (the "expiration date"). The
holder pays the premium at inception and has no further financial obligation.
The holder of an option will benefit from favorable movements in the price of
the underlying asset but is not exposed to corresponding losses due to adverse
movements in the value of the underlying asset. The writer of an option will
receive fees or premiums but is exposed to losses due to changes in the value
of the underlying asset. The Fund may buy or write (sell) put and call options
on assets, such as securities, currencies, commodities, and indices of debt and
equity securities ("underlying assets") and enter into closing
9
<PAGE> 334
transactions with respect to such options to terminate an existing position.
Options used by the Fund may include European, American, and Bermuda style
options. If an option is exercisable only at maturity, it is a "European"
option; if it is also exercisable prior to maturity, it is an "American"
option. If it is exercisable only at certain times, it is a "Bermuda" option.
The Fund may purchase (buy) and write (sell) put and call options
underlying assets and enter into closing transactions with respect to such
options to terminate an existing position. The purchase of call options serves
as a long hedge, and the purchase of put options serves as a short hedge.
Writing put or call options can enable the Fund to enhance income by reason of
the premiums paid by the purchaser of such options. Writing call options
serves as a limited short hedge because declines in the value of the hedged
investment would be offset to the extent of the premium received for writing
the option. However, if the security appreciates to a price higher than the
exercise price of the call option, it can be expected that the option will be
exercised and the Fund will be obligated to sell the security at less than its
market value or will be obligated to purchase the security at a price greater
than that at which the security must be sold under the option. All or a
portion of any assets used as cover for OTC options written by the Fund would
be considered illiquid to the extent described under "Investment Policies and
Techniques -- Illiquid Securities." Writing put options serves as a limited
long hedge because increases in the value of the hedged investment would be
offset to the extent of the premium received for writing the option. However,
if the security depreciates to a price lower than the exercise price of the put
option, it can be expected that the put option will be exercised and the Fund
will be obligated to purchase the security at more than its market value.
The value of an option position will reflect, among other things, the
historical price volatility of the underlying investment, the current market
value of the underlying investment, the time remaining until expiration, the
relationship of the exercise price to the market price of the underlying
investment, and general market conditions.
The Fund may effectively terminate its right or obligation under an option
by entering into a closing transaction. For example, the Fund may terminate
its obligation under a call or put option that it had written by purchasing an
identical call or put option; this is known as a closing purchase transaction.
Conversely, the Fund may terminate a position in a put or call option it had
purchased by writing an identical put or call option; this is known as a
closing sale transaction. Closing transactions permit the Fund to realize the
profit or limit the loss on an option position prior to its exercise or
expiration.
The Fund may purchase or write both exchange-traded and OTC options.
Exchange-traded options are issued by a clearing organization affiliated with
the exchange on which the option is listed that, in effect, guarantees
completion of every exchange-traded option transaction. In contrast, OTC
options are contracts between the Fund and the other party to the transaction
("counter party") (usually a securities dealer or a bank) with no clearing
organization guarantee. Thus, when the Fund purchases or writes an OTC option,
it relies on the counter party to make or take delivery of the underlying
investment upon exercise of the option. Failure by the counter party to do so
would result in the loss of any premium paid by the Fund as well as the loss of
any expected benefit of the transaction.
The Fund's ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The Fund intends to
purchase or write only those exchange-traded options for which there appears to
be a liquid secondary market. However, there can be no assurance that such a
market will exist at any particular time. Closing transactions can be made for
OTC options only by negotiating directly with the counter party, or by a
transaction in the secondary market if any such market exists. Although the
Fund will enter into OTC options only with counter parties that are expected to
be capable of entering into closing transactions with the Fund, there is no
assurance that the Fund will in fact be able to close out an OTC option at a
favorable price prior to expiration. In the event of insolvency of the counter
party, the Fund might be unable to close out an OTC option position at any time
prior to its expiration. If the Fund were unable to effect a closing
transaction for an option it had purchased, it would have to exercise the
option to realize any profit.
The Fund may engage in options transactions on indices in much the same
manner as the options on securities discussed above, except the index options
may serve as a hedge against overall fluctuations in the securities market in
general.
The writing and purchasing of options is a highly specialized activity
that involves investment techniques and risks different from those associated
with ordinary portfolio securities transactions. Imperfect correlation between
the options and securities markets may detract from the effectiveness of
attempted hedging.
10
<PAGE> 335
SPREAD TRANSACTIONS. The Fund may use spread transactions for any lawful
purpose consistent with the Fund's investment objective such as hedging or
managing risk. The Fund may purchase covered spread options from securities
dealers. Such covered spread options are not presently exchange-listed or
exchange-traded. The purchase of a spread option gives the Fund the right to
put, or sell, a security that it owns at a fixed dollar spread or fixed yield
spread in relationship to another security that the Fund does not own, but
which is used as a benchmark. The risk to the Fund in purchasing covered
spread options is the cost of the premium paid for the spread option and any
transaction costs. In addition, there is no assurance that closing
transactions will be available. The purchase of spread options will be used to
protect the Fund against adverse changes in prevailing credit quality spreads,
i.e., the yield spread between high quality and lower quality securities. Such
protection is only provided during the life of the spread option.
FUTURES CONTRACTS. The Fund may use futures contracts for any lawful
purpose consistent with the Fund's investment objective such as hedging or
managing risk. The Fund may enter into futures contracts, including interest
rate, index, and currency futures. The Fund may also purchase put and call
options, and write covered put and call options, on futures in which it is
allowed to invest. The purchase of futures or call options thereon can serve
as a long hedge, and the sale of futures or the purchase of put options thereon
can serve as a short hedge. Writing covered call options on futures contracts
can serve as a limited short hedge, and writing covered put options on futures
contracts can serve as a limited long hedge, using a strategy similar to that
used for writing covered options in securities. The Fund's hedging may include
purchases of futures as an offset against the effect of expected increases in
currency exchange rates and securities prices and sales of futures as an offset
against the effect of expected declines in currency exchange rates and
securities prices. The Fund may also write put options on futures contracts
while at the same time purchasing call options on the same futures contracts in
order to create synthetically a long futures contract position. Such options
would have the same strike prices and expiration dates. The Fund will engage
in this strategy only when the Advisor believes it is more advantageous to the
Fund than is purchasing the futures contract.
To the extent required by regulatory authorities, the Fund only enters
into futures contracts that are traded on national futures exchanges and are
standardized as to maturity date and underlying financial instrument. Futures
exchanges and trading are regulated under the CEA by the CFTC. Although
techniques other than sales and purchases of futures contracts could be used to
reduce the Fund's exposure to market, currency, or interest rate fluctuations,
the Fund may be able to hedge its exposure more effectively and perhaps at a
lower cost through using futures contracts.
An interest rate futures contract provides for the future sale by one
party and purchase by another party of a specified amount of a specific
financial instrument (e.g., debt security) or currency for a specified price at
a designated date, time, and place. An index futures contract is an agreement
pursuant to which the parties agree to take or make delivery of an amount of
cash equal to the difference between the value of the index at the close of the
last trading day of the contract and the price at which the index futures
contract was originally written. Transaction costs are incurred when a futures
contract is bought or sold and margin deposits must be maintained. A futures
contract may be satisfied by delivery or purchase, as the case may be, of the
instrument, the currency or by payment of the change in the cash value of the
index. More commonly, futures contracts are closed out prior to delivery by
entering into an offsetting transaction in a matching futures contract.
Although the value of an index might be a function of the value of certain
specified securities, no physical delivery of those securities is made. If the
offsetting purchase price is less than the original sale price, the Fund
realizes a gain; if it is more, the Fund realizes a loss. Conversely, if the
offsetting sale price is more than the original purchase price, the Fund
realizes a gain; if it is less, the Fund realizes a loss. The transaction
costs must also be included in these calculations. There can be no assurance,
however, that the Fund will be able to enter into an offsetting transaction
with respect to a particular futures contract at a particular time. If the
Fund is not able to enter into an offsetting transaction, the Fund will
continue to be required to maintain the margin deposits on the futures
contract.
No price is paid by the Fund upon entering into a futures contract.
Instead, at the inception of a futures contract, the Fund is required to
deposit in a segregated account with its custodian, in the name of the futures
broker through whom the transaction was effected, "initial margin" consisting
of cash and/or other appropriate liquid assets in an amount generally equal to
10% or less of the contract value. Margin must also be deposited when writing
a call or put option on a futures contract, in accordance with applicable
exchange rules. Unlike margin in securities transactions, initial margin on
futures contracts does not represent a borrowing, but rather is in the nature
of a performance bond or good-faith deposit that is returned to the Fund at the
termination of the transaction if all contractual obligations have been
satisfied. Under certain circumstances, such as periods of high volatility,
the Fund may be required by an exchange to increase the level of its initial
margin payment, and initial margin requirements might be increased generally in
the future by regulatory action.
11
<PAGE> 336
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of the Fund's obligations to or from a futures
broker. When the Fund purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast, when the Fund purchases
or sells a futures contract or writes a call or put option thereon, it is
subject to daily variation margin calls that could be substantial in the event
of adverse price movements. If the Fund has insufficient cash to meet daily
variation margin requirements, it might need to sell securities at a time when
such sales are disadvantageous. Purchasers and sellers of futures positions
and options on futures can enter into offsetting closing transactions by
selling or purchasing, respectively, an instrument identical to the instrument
held or written. Positions in futures and options on futures may be closed
only on an exchange or board of trade that provides a secondary market. The
Fund intends to enter into futures transactions only on exchanges or boards of
trade where there appears to be a liquid secondary market. However, there can
be no assurance that such a market will exist for a particular contract at a
particular time.
Under certain circumstances, futures exchanges may establish daily limits
on the amount that the price of a future or option on a futures contract can
vary from the previous day's settlement price; once that limit is reached, no
trades may be made that day at a price beyond the limit. Daily price limits do
not limit potential losses because prices could move to the daily limit for
several consecutive days with little or no trading, thereby preventing
liquidation of unfavorable positions.
If the Fund were unable to liquidate a futures or option on a futures
contract position due to the absence of a liquid secondary market or the
imposition of price limits, it could incur substantial losses. The Fund would
continue to be subject to market risk with respect to the position. In
addition, except in the case of purchased options, the Fund would continue to
be required to make daily variation margin payments and might be required to
maintain the position being hedged by the future or option or to maintain cash
or securities in a segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or options on futures contracts
might not correlate perfectly with movements in the prices of the investments
being hedged. For example, all participants in the futures and options on
futures contracts markets are subject to daily variation margin calls and might
be compelled to liquidate futures or options on futures contracts positions
whose prices are moving unfavorably to avoid being subject to further calls.
These liquidations could increase price volatility of the instruments and
distort the normal price relationship between the futures or options and the
investments being hedged. Also, because initial margin deposit requirements in
the futures markets are less onerous than margin requirements in the securities
markets, there might be increased participation by speculators in the future
markets. This participation also might cause temporary price distortions. In
addition, activities of large traders in both the futures and securities
markets involving arbitrage, "program trading" and other investment strategies
might result in temporary price distortions.
FOREIGN CURRENCIES. The Fund may purchase and sell foreign currency on a
spot basis, and may use currency-related derivatives instruments such as
options on foreign currencies, futures on foreign currencies, options on
futures on foreign currencies and forward currency contracts (i.e., an
obligation to purchase or sell a specific currency at a specified future date,
which may be any fixed number of days from the contract date agreed upon by the
parties, at a price set at the time the contract is entered into). The Fund
may use these instruments for hedging or any other lawful purpose consistent
with its investment objective, including transaction hedging, anticipatory
hedging, cross hedging, proxy hedging, and position hedging. The Fund's use of
currency-related derivative instruments will be directly related to the Fund's
current or anticipated portfolio securities, and the Fund may engage in
transactions in currency-related derivative instruments as a means to protect
against some or all of the effects of adverse changes in foreign currency
exchange rates on its portfolio investments. In general, if the currency in
which a portfolio investment is denominated appreciates against the U.S.
dollar, the dollar value of the security will increase. Conversely, a decline
in the exchange rate of the currency would adversely affect the value of the
portfolio investment expressed in U.S. dollars.
For example, the Fund might use currency-related derivative instruments to
"lock in" a U.S. dollar price for a portfolio investment, thereby enabling the
Fund to protect itself against a possible loss resulting from an adverse change
in the relationship between the U.S. dollar and the subject foreign currency
during the period between the date the security is purchased or sold and the
date on which payment is made or received. The Fund also might use
currency-related derivative instruments when the Advisor believes that one
currency may experience a substantial movement against another currency,
12
<PAGE> 337
including the U.S. dollar, and it may use currency-related derivative
instruments to sell or buy the amount of the former foreign currency,
approximating the value of some or all of the Fund's portfolio securities
denominated in such foreign currency. Alternatively, where appropriate, the
Fund may use currency-related derivative instruments to hedge all or part of
its foreign currency exposure through the use of a basket of currencies or a
proxy currency where such currency or currencies act as an effective proxy for
other currencies. The use of this basket hedging technique may be more
efficient and economical than using separate currency-related derivative
instruments for each currency exposure held by the Fund. Furthermore,
currency-related derivative instruments may be used for short hedges - for
example, the Fund may sell a forward currency contract to lock in the U.S.
dollar equivalent of the proceeds from the anticipated sale of a security
denominated in a foreign currency.
In addition, the Fund may use a currency-related derivative instrument to
shift exposure to foreign currency fluctuations from one foreign country to
another foreign country where the Advisor believes that the foreign currency
exposure purchased will appreciate relative to the U.S. dollar and thus better
protect the Fund against the expected decline in the foreign currency exposure
sold. For example, if the Fund owns securities denominated in a foreign
currency and the Advisor believes that currency will decline, it might enter
into a forward contract to sell an appropriate amount of the first foreign
currency, with payment to be made in a second foreign currency that the Advisor
believes would better protect the Fund against the decline in the first
security than would a U.S. dollar exposure. Hedging transactions that use two
foreign currencies are sometimes referred to as "cross hedges." The effective
use of currency-related derivative instruments by the Fund in a cross hedge is
dependent upon a correlation between price movements of the two currency
instruments and the underlying security involved, and the use of two currencies
magnifies the risk that movements in the price of one instrument may not
correlate or may correlate unfavorably with the foreign currency being hedged.
Such a lack of correlation might occur due to factors unrelated to the value of
the currency instruments used or investments being hedged, such as speculative
or other pressures on the markets in which these instruments are traded.
The Fund also might seek to hedge against changes in the value of a
particular currency when no hedging instruments on that currency are available
or such hedging instruments are more expensive than certain other hedging
instruments. In such cases, the Fund may hedge against price movements in that
currency by entering into transactions using currency-related derivative
instruments on another foreign currency or a basket of currencies, the values
of which the Advisor believes will have a high degree of positive correlation
to the value of the currency being hedged. The risk that movements in the
price of the hedging instrument will not correlate perfectly with movements in
the price of the currency being hedged is magnified when this strategy is used.
The use of currency-related derivative instruments by the Fund involves a
number of risks. The value of currency-related derivative instruments depends
on the value of the underlying currency relative to the U.S. dollar. Because
foreign currency transactions occurring in the interbank market might involve
substantially larger amounts than those involved in the use of such derivative
instruments, the Fund could be disadvantaged by having to deal in the 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 (generally consisting of transactions of greater than $1 million).
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis.
Quotation information generally is representative of very large transactions in
the interbank market and thus might not reflect odd-lot transactions where
rates might be less favorable. The interbank market in foreign currencies is a
global, round-the-clock market. To the extent the U.S. options or futures
markets are closed while the markets for the underlying currencies remain open,
significant price and rate movements might take place in the underlying markets
that cannot be reflected in the markets for the derivative instruments until
they re-open.
Settlement of transactions in currency-related derivative instruments
might be required to take place within the country issuing the underlying
currency. Thus, the Fund might be required to accept or make delivery of the
underlying foreign currency in accordance with any U.S. or foreign regulations
regarding the maintenance of foreign banking arrangements by U.S. residents
and might be required to pay any fees, taxes and charges associated with such
delivery assessed in the issuing country.
13
<PAGE> 338
When the Fund engages in a transaction in a currency-related derivative
instrument, it relies on the counterparty to make or take delivery of the
underlying currency at the maturity of the contract or otherwise complete the
contract. In other words, the Fund will be subject to the risk that a loss may
be sustained by the Fund as a result of the failure of the counterparty to
comply with the terms of the transaction. The counterparty risk for
exchange-traded instruments is generally less than for privately-negotiated or
OTC currency instruments, since generally a clearing agency, which is the
issuer or counterparty to each instrument, provides a guarantee of performance.
For privately-negotiated instruments, there is no similar clearing agency
guarantee. In all transactions, the Fund will bear the risk that the
counterparty will default, and this could result in a loss of the expected
benefit of the transaction and possibly other losses to the Fund. The Fund
will enter into transactions in currency-related derivative instruments only
with counterparties that the Advisor reasonably believes are capable of
performing under the contract.
Purchasers and sellers of currency-related derivative instruments may
enter into offsetting closing transactions by selling or purchasing,
respectively, an instrument identical to the instrument purchased or sold.
Secondary markets generally do not exist for forward currency contracts, with
the result that closing transactions generally can be made for forward currency
contracts only by negotiating directly with the counterparty. Thus, there can
be no assurance that the Fund will in fact be able to close out a forward
currency contract (or any other currency-related derivative instrument) at a
time and price favorable to the Fund. In addition, in the event of insolvency
of the counterparty, the Fund might be unable to close out a forward currency
contract at any time prior to maturity. In the case of an exchange-traded
instrument, the Fund will be able to close the position out only on an exchange
which provides a market for the instruments. The ability to establish and
close out positions on an exchange is subject to the maintenance of a liquid
market, and there can be no assurance that a liquid market will exist for any
instrument at any specific time. In the case of a privately-negotiated
instrument, the Fund will be able to realize the value of the instrument only
by entering into a closing transaction with the issuer or finding a third party
buyer for the instrument. While the Fund will enter into privately-negotiated
transactions only with entities who are expected to be capable of entering into
a closing transaction, there can be no assurance that the Fund will in fact be
able to enter into such closing transactions.
The precise matching of currency-related derivative instrument amounts and
the value of the portfolio securities involved generally will not be possible
because the value of such securities, measured in the foreign currency, will
change after the currency-related derivative instrument position has been
established. Thus, the Fund might need to purchase or sell foreign currencies
in the spot (cash) market. The projection of short-term currency market
movements is extremely difficult, and the successful execution of a short-term
hedging strategy is highly uncertain.
Permissible foreign currency options will include options traded primarily
in the OTC market. Although options on foreign currencies are traded primarily
in the OTC market, the Fund will normally purchase or sell OTC options on
foreign currency only when the Advisor reasonably believes a liquid secondary
market will exist for a particular option at any specific time.
There will be a cost to the Fund of engaging in transactions in
currency-related derivative instruments that will vary with factors such as the
contract or currency involved, the length of the contract period and the market
conditions then prevailing. The Fund using these instruments may have to pay a
fee or commission or, in cases where the instruments are entered into on a
principal basis, foreign exchange dealers or other counterparties will realize
a profit based on the difference ("spread") between the prices at which they
are buying and selling various currencies. Thus, for example, a dealer may
offer to sell a foreign currency to the Fund at one rate, while offering a
lesser rate of exchange should the Fund desire to resell that currency to the
dealer.
When required by the SEC guidelines, the Fund will set aside permissible
liquid assets in segregated accounts or otherwise cover its potential
obligations under currency-related derivatives instruments. To the extent the
Fund's assets are so set aside, they cannot be sold while the corresponding
currency position is open, unless they are replaced with similar assets. As a
result, if a large portion of the Fund's assets are so set aside, this could
impede portfolio management or the Fund's ability to meet redemption requests
or other current obligations.
14
<PAGE> 339
The Advisor's decision to engage in a transaction in a particular
currency-related derivative instrument will reflect the Advisor's judgment that
the transaction will provide value to the Fund and its shareholders and is
consistent with the Fund's objectives and policies. In making such a judgment,
the Advisor will analyze the benefits and risks of the transaction and weigh
them in the context of the Fund's entire portfolio and objectives. The
effectiveness of any transaction in a currency-related derivative instrument is
dependent on a variety of factors, including the Advisor's skill in analyzing
and predicting currency values and upon a correlation between price movements
of the currency instrument and the underlying security. There might be
imperfect correlation, or even no correlation, between price movements of an
instrument and price movements of investments being hedged. Such a lack of
correlation might occur due to factors unrelated to the value of the
investments being hedged, such as speculative or other pressures on the markets
in which these instruments are traded. In addition, the Fund's use of
currency-related derivative instruments is always subject to the risk that the
currency in question could be devalued by the foreign government. In such a
case, any long currency positions would decline in value and could adversely
affect any hedging position maintained by the Fund.
The Fund's dealing in currency-related derivative instruments will
generally be limited to the transactions described above. However, the Fund
reserves the right to use currency-related derivatives instruments for
different purposes and under different circumstances. Of course, the Fund is
not required to use currency-related derivatives instruments and will not do so
unless deemed appropriate by the Advisor. It also should be realized that use
of these instruments does not eliminate, or protect against, price movements in
the Fund's securities that are attributable to other (i.e., non-currency
related) causes. Moreover, while the use of currency-related derivatives
instruments may reduce the risk of loss due to a decline in the value of a
hedged currency, at the same time the use of these instruments tends to limit
any potential gain which may result from an increase in the value of that
currency.
SWAP AGREEMENTS. The Fund may enter into interest rate, securities index,
commodity, or security and currency exchange rate swap agreements for any
lawful purpose consistent with the Fund's investment objective, such as for the
purpose of attempting to obtain or preserve a particular desired return or
spread at a lower cost to the Fund than if the Fund had invested directly in an
instrument that yielded that desired return or spread. The Fund also may enter
into swaps in order to protect against an increase in the price of, or the
currency exchange rate applicable to, securities that the Fund anticipates
purchasing at a later date. Swap agreements are two-party contracts entered
into primarily by institutional investors for periods ranging from a few weeks
to several years. In a standard "swap" transaction, two parties agree to
exchange the returns (or differentials in rates of return) earned or realized
on particular predetermined investments or instruments. The gross returns to
be exchanged or "swapped" between the parties are calculated with respect to a
"notional amount," i.e., the return on or increase in value of a particular
dollar amount invested at a particular interest rate, in a particular foreign
currency, or in a "basket" of securities representing a particular index. Swap
agreements may include interest rate caps, under which, in return for a
premium, one party agrees to make payments to the other to the extent that
interest rates exceed a specified rate, or "cap;" interest rate floors, under
which, in return for a premium, one party agrees to make payments to the other
to the extent that interest rates fall below a specified level, or "floor;" and
interest rate collars, under which a party sells a cap and purchases a floor,
or vice versa, in an attempt to protect itself against interest rate movements
exceeding given minimum or maximum levels.
The "notional amount" of the swap agreement is the agreed upon basis for
calculating the obligations that the parties to a swap agreement have agreed to
exchange. Under most swap agreements entered into by the Fund, the obligations
of the parties would be exchanged on a "net basis." Consequently, the Fund's
obligation (or rights) under a swap agreement will generally be equal only to
the net amount to be paid or received under the agreement based on the relative
values of the positions held by each party to the agreement (the "net amount").
The Fund's obligation under a swap agreement will be accrued daily (offset
against amounts owed to the Fund) and any accrued but unpaid net amounts owed
to a swap counterparty will be covered by the maintenance of a segregated
account consisting of cash, or liquid high grade debt obligations.
Whether the Fund's use of swap agreements will be successful in furthering
its investment objective will depend, in part, on the Advisor's ability to
predict correctly whether certain types of investments are likely to produce
greater returns than other investments. Swap agreements may be considered to
be illiquid. Moreover, the Fund bears the risk of loss of the amount expected
to be received under a swap agreement in the event of the default or bankruptcy
of a swap agreement counterparty. Certain restrictions imposed on the Fund by
the Internal Revenue Code may limit the Fund's ability to use swap agreements.
The swaps market is largely unregulated.
15
<PAGE> 340
The Fund will enter swap agreements only with counterparties that the
Advisor reasonably believes are capable of performing under the swap
agreements. If there is a default by the other party to such a transaction,
the Fund will have to rely on its contractual remedies (which may be limited by
bankruptcy, insolvency or similar laws) pursuant to the agreements related to
the transaction.
ADDITIONAL DERIVATIVE INSTRUMENTS AND STRATEGIES. In addition to the
derivative instruments and strategies described above and in the Fund's
Prospectus, the Advisor expects to discover additional derivative instruments
and other hedging or risk management techniques. The Advisor may utilize these
new derivative instruments and techniques to the extent that they are
consistent with the Fund's investment objective and permitted by the Fund's
investment limitations, operating policies, and applicable regulatory
authorities.
FOREIGN INVESTMENT COMPANIES
The Fund may invest, to a limited extent, in foreign investment
companies. Some of the countries in which the Fund invests may not permit
direct investment by outside investors. Investments in such countries may
only be permitted through foreign government-approved or -authorized
investment vehicles, which may include other investment companies. In
addition, it may be less expensive and more expedient for the Fund to invest
in a foreign investment company in a country which permits direct foreign
investment. Investing through such vehicles may involve frequent or layered
fees or expenses and may also be subject to limitation under the 1940 Act.
Under the 1940 Act, the Fund may invest up to 10% of its assets in shares of
other investment companies and up to 5% of its assets in any one investment
company as long as the investment does not represent more than 3% of the
voting stock of the acquired investment company. The Fund does not intend to
invest in such investment companies unless, in the judgment of the Advisor,
the potential benefits of such investments justify the payment of any
associated fees and expenses.
FOREIGN SECURITIES
Investing in foreign securities involves a series of risks not present in
investing in U.S. securities. Many of the foreign securities held by the Fund
will not be registered with the Securities and Exchange Commission (the "SEC"),
nor will the foreign issuers be subject to SEC reporting requirements.
Accordingly, there may be less publicly available information concerning
foreign issuers of securities held by the Fund than is available concerning
U.S. companies. Disclosure and regulatory standards in many respects are less
stringent in emerging market countries than in the U.S. and other major
markets. There also may be a lower level of monitoring and regulation of
emerging markets and the activities of investors in such markets, and
enforcement of existing regulations may be extremely limited. Foreign
companies, and in particular, companies in smaller and emerging capital markets
are not generally subject to uniform accounting, auditing and financial
reporting standards, or to other regulatory requirements comparable to those
applicable to U.S. companies. The Fund's net investment income and capital
gains from its foreign investment activities may be subject to non-U.S.
withholding taxes.
The costs attributable to foreign investing that the Fund must bear
frequently are higher than those attributable to domestic investing; this is
particularly true with respect to emerging capital markets. For example, the
cost of maintaining custody of foreign securities exceeds custodian costs for
domestic securities, and transaction and settlement costs of foreign investing
also frequently are higher than those attributable to domestic investing.
Costs associated with the exchange of currencies also make foreign investing
more expensive than domestic investing. Investment income on certain foreign
securities in which the Fund may invest may be subject to foreign withholding
or other government taxes that could reduce the return of these securities.
Tax treaties between the United States and foreign countries, however, may
reduce or eliminate the amount of foreign tax to which the Fund would be
subject.
Foreign markets also have different clearance and settlement procedures,
and in certain markets there have been times when settlements have failed to
keep pace with the volume of securities transactions, making it difficult to
conduct such transactions. Delays in settlement could result in temporary
periods when assets of the Fund are uninvested and no return is earned thereon.
The inability of the Fund to make intended security purchases due to
settlement problems could cause the Fund to miss investment opportunities.
Inability to dispose of a portfolio security due to settlement problems could
result either in losses to the Fund due to subsequent declines in the value of
such portfolio security or, if the Fund has entered into a contract to sell the
security, could result in possible liability to the purchaser.
16
<PAGE> 341
HIGH-YIELD (HIGH-RISK) SECURITIES
IN GENERAL. The Fund may invest up to 5% of its net assets in
non-investment grade debt obligations. Non-investment grade debt obligations
(hereinafter referred to as "lower-quality securities") include (i) bonds rated
as low as C by Moody's Investors Service, Inc. ("Moody's"), Standard & Poor's
Ratings Group ("S&P"), or Fitch Investors Service, Inc. ("Fitch"), or CCC by
Duff & Phelps, Inc. ("D&P"); (ii) commercial paper rated as low as C by S&P,
Not Prime by Moody's, or Fitch 4 by Fitch; and (iii) unrated debt obligations
of comparable quality. Lower-quality securities, while generally offering
higher yields than investment grade securities with similar maturities, involve
greater risks, including the possibility of default or bankruptcy. They are
regarded as predominantly speculative with respect to the issuer's capacity to
pay interest and repay principal. The special risk considerations in
connection with investments in these securities are discussed below. Refer to
the Appendix for a discussion of securities ratings.
EFFECT OF INTEREST RATES AND ECONOMIC CHANGES. The lower-quality and
comparable unrated security market is relatively new and its growth has
paralleled a long economic expansion. As a result, it is not clear how this
market may withstand a prolonged recession or economic downturn. Such
conditions could severely disrupt the market for and adversely affect the value
of such securities.
All interest-bearing securities typically experience appreciation when
interest rates decline and depreciation when interest rates rise. The market
values of lower-quality and comparable unrated securities tend to reflect
individual corporate developments to a greater extent than do higher rated
securities, which react primarily to fluctuations in the general level of
interest rates. Lower-quality and comparable unrated securities also tend to
be more sensitive to economic conditions than are higher-rated securities. As
a result, they generally involve more credit risks than securities in the
higher-rated categories. During an economic downturn or a sustained period of
rising interest rates, highly leveraged issuers of lower-quality and comparable
unrated securities may experience financial stress and may not have sufficient
revenues to meet their payment obligations. The issuer's ability to service
its debt obligations may also be adversely affected by specific corporate
developments, the issuer's inability to meet specific projected business
forecasts or the unavailability of additional financing. The risk of loss due
to default by an issuer of these securities is significantly greater than
issuers of higher-rated securities because such securities are generally
unsecured and are often subordinated to other creditors. Further, if the
issuer of a lower-quality or comparable unrated security defaulted, the Fund
might incur additional expenses to seek recovery. Periods of economic
uncertainty and changes would also generally result in increased volatility in
the market prices of these securities and thus in the Fund's net asset value.
As previously stated, the value of a lower-quality or comparable unrated
security will decrease in a rising interest rate market and accordingly, so
will the Fund's net asset value. If the Fund experiences unexpected net
redemptions in such a market, it may be forced to liquidate a portion of its
portfolio securities without regard to their investment merits. Due to the
limited liquidity of lower-quality and comparable unrated securities (discussed
below), the Fund may be forced to liquidate these securities at a substantial
discount. Any such liquidation would force the Fund to sell the more liquid
portion of its portfolio.
PAYMENT EXPECTATIONS. Lower-quality and comparable unrated securities
typically contain redemption, call or prepayment provisions which permit the
issuer of such securities containing such provisions to, at its discretion,
redeem the securities. During periods of falling interest rates, issuers of
these securities are likely to redeem or prepay the securities and refinance
them with debt securities with a lower interest rate. To the extent an issuer
is able to refinance the securities, or otherwise redeem them, the Fund may
have to replace the securities with a lower yielding security, which would
result in a lower return for the Fund.
CREDIT RATINGS. Credit ratings issued by credit rating agencies are
designed to evaluate the safety of principal and interest payments of rated
securities. They do not, however, evaluate the market value risk of
lower-quality securities and, therefore, may not fully reflect the true risks
of an investment. In addition, credit rating agencies may or may not make
timely changes in a rating to reflect changes in the economy or in the
condition of the issuer that affect the market value of the security.
Consequently, credit ratings are used only as a preliminary indicator of
investment quality. Investments in lower-quality and comparable unrated
obligations will be more dependent on the Advisor's credit analysis than would
be the case with
17
<PAGE> 342
investments in investment-grade debt obligations. The Advisor employs its own
credit research and analysis, which includes a study of existing debt, capital
structure, ability to service debt and to pay dividends, the issuer's
sensitivity to economic conditions, its operating history and the current trend
of earnings. The Advisor continually monitors the investments in the Fund's
portfolio and carefully evaluates whether to dispose of or to retain
lower-quality and comparable unrated securities whose credit ratings or credit
quality may have changed.
LIQUIDITY AND VALUATION. The Fund may have difficulty disposing of
certain lower-quality and comparable unrated securities because there may be a
thin trading market for such securities. Because not all dealers maintain
markets in all lower-quality and comparable unrated securities, there is no
established retail secondary market for many of these securities. The Fund
anticipates that such securities could be sold only to a limited number of
dealers or institutional investors. To the extent a secondary trading market
does exist, it is generally not as liquid as the secondary market for
higher-rated securities. The lack of a liquid secondary market may have an
adverse impact on the market price of the security. As a result, the Fund's
asset value and ability to dispose of particular securities, when necessary to
meet the Fund's liquidity needs or in response to a specific economic event,
may be impacted. The lack of a liquid secondary market for certain securities
may also make it more difficult for the Fund to obtain accurate market
quotations for purposes of valuing the Fund's portfolio. Market quotations are
generally available on many lower-quality and comparable unrated issues only
from a limited number of dealers and may not necessarily represent firm bids of
such dealers or prices for actual sales. During periods of thin trading, the
spread between bid and asked prices is likely to increase significantly. In
addition, adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of lower-quality
and comparable unrated securities, especially in a thinly traded market.
LEGISLATION. Legislation may be adopted, from time to time designed to
limit the use of certain lower-quality and comparable unrated securities by
certain issuers. It is anticipated that if additional legislation is enacted
or proposed, it could have a material affect on the value of these securities
and the existence of a secondary trading market for the securities.
ILLIQUID SECURITIES
The Fund may invest in illiquid securities (i.e., securities that are not
readily marketable). However, the Fund will not acquire illiquid securities
if, as a result, they would comprise more than 15% of the value of the Fund's
net assets (or such other amounts as may be permitted under the 1940 Act).
However, as a matter of internal policy, the Advisor intends to limit the
Fund's investments in illiquid securities to 10% of its net assets.
The Board of Directors of the Fund, or its delegate, has the ultimate
authority to determine, to the extent permissible under the federal securities
laws, which securities are illiquid for purposes of this limitation. Certain
securities exempt from registration or issued in transactions exempt from
registration under the Securities Act of 1933, as amended (the "Securities
Act"), such as securities that may be resold to institutional investors under
Rule 144A under the Securities Act and Section 4(2) commercial paper, may be
considered liquid under guidelines adopted by the Fund's Board of Directors.
The Board of Directors of the Fund has delegated to the Advisor the
day-to-day determination of the liquidity of a security, although it has
retained oversight and ultimate responsibility for such determinations. The
Board of Directors has directed the Advisor to look to such factors as (i) the
frequency of trades or quotes for a security, (ii) the number of dealers
willing to purchase or sell the security and number of potential buyers, (iii)
the willingness of dealers to undertake to make a market in the security, (iv)
the nature of the security and nature of the marketplace trades, such as the
time needed to dispose of the security, the method of soliciting offers, and
the mechanics of transfer, (v) the likelihood that the security's marketability
will be maintained throughout the anticipated holding period, and (vi) any
other relevant factors. The Advisor may determine 4(2) commercial paper to be
liquid if (i) the 4(2) commercial paper is not traded flat or in default as to
principal and interest, (ii) the 4(2) commercial paper is rated in one of the
two highest rating categories by at least two nationally rated statistical
rating organizations ("NRSRO"), or if only one NRSRO rates the security, by
that NRSRO, or is determined by the Advisor to be of equivalent quality, and
(iii) the Advisor considers the trading market for the specific security taking
into account all relevant factors. With respect to the Fund's foreign
holdings, a foreign security may be considered liquid by the Advisor (despite
its restricted nature under the Securities Act) if the security can be freely
traded in a foreign securities market and all the facts and circumstances
support a finding of liquidity.
18
<PAGE> 343
Restricted securities may be sold only in privately negotiated
transactions or in a public offering with respect to which a registration
statement is in effect under the Securities Act. Where registration is
required, the Fund may be obligated to pay all or part of the registration
expenses and a considerable period may elapse between the time of the decision
to sell and the time the Fund may be permitted to sell a security under an
effective registration statement. If, during such a period, adverse market
conditions were to develop, the Fund might obtain a less favorable price than
prevailed when it decided to sell. Restricted securities will be priced at
fair value as determined in good faith by the Board of Directors of the Fund.
If through the appreciation of restricted securities or the depreciation of
unrestricted securities, the Fund should be in a position where more than 15%
of the value of its net assets are invested in illiquid securities, including
restricted securities which are not readily marketable (except for 144A
Securities and 4(2) commercial paper deemed to be liquid by the Advisor), the
Fund will take such steps as is deemed advisable, if any, to protect liquidity.
The Fund may sell over-the-counter ("OTC") options and, in connection
therewith, segregate assets or cover its obligations with respect to OTC
options written by the Fund. The assets used as cover for OTC options written
by the Fund will be considered illiquid unless the OTC options are sold to
qualified dealers who agree that the Fund may repurchase any OTC option it
writes at a maximum price to be calculated by a formula set forth in the option
agreement. The cover for an OTC option written subject to this procedure would
be considered illiquid only to the extent that the maximum repurchase price
under the formula exceeds the intrinsic value of the option.
LENDING OF PORTFOLIO SECURITIES
The Fund is authorized to lend up to 33 1/3% of the total value of its
portfolio securities to broker-dealers or institutional investors that the
Advisor deems qualified, but only when the borrower maintains with the Fund's
custodian bank collateral either in cash or money market instruments in an
amount at least equal to the market value of the securities loaned, plus
accrued interest and dividends, determined on a daily basis and adjusted
accordingly. Although the Fund is authorized to lend, the Fund does not
presently intend to engage in lending. In determining whether to lend
securities to a particular broker-dealer or institutional investor, the Advisor
will consider, and during the period of the loan will monitor, all relevant
facts and circumstances, including the creditworthiness of the borrower. The
Fund will retain authority to terminate any loans at any time. The Fund may
pay reasonable administrative and custodial fees in connection with a loan and
may pay a negotiated portion of the interest earned on the cash or money market
instruments held as collateral to the borrower or placing broker. The Fund
will receive reasonable interest on the loan or a flat fee from the borrower
and amounts equivalent to any dividends, interest or other distributions on the
securities loaned. The Fund will retain record ownership of loaned securities
to exercise beneficial rights, such as voting and subscription rights and
rights to dividends, interest or other distributions, when retaining such
rights is considered to be in the Fund's interest.
MORTGAGE- AND ASSET-BACKED SECURITIES
Mortgage-backed securities represent direct or indirect participations in,
or are secured by and payable from, mortgage loans secured by real property,
and include single- and multi-class pass-through securities and collateralized
mortgage obligations. Such securities may be issued or guaranteed by U.S.
government agencies or instrumentalities, such as the Government National
Mortgage Association and the Federal National Mortgage Association, or by
private issuers, generally originators and investors in mortgage loans,
including savings associations, mortgage bankers, commercial banks, investment
bankers, and special purpose entities (collectively, "private lenders").
Mortgage-backed securities issued by private lenders may be supported by pools
of mortgage loans or other mortgage-backed securities that are guaranteed,
directly or indirectly, by the U.S. government or one of its agencies or
instrumentalities, or they may be issued without any governmental guarantee of
the underlying mortgage assets but with some form of non-governmental credit
enhancement.
Asset-backed securities have structural characteristics similar to
mortgage-backed securities. Asset-backed debt obligations represent direct or
indirect participation in, or secured by and payable from, assets such as motor
vehicle installment sales contracts, other installment loan contracts, home
equity loans, leases of various types of property, and receivables from credit
card or other revolving credit arrangements. The credit quality of most
asset-backed securities depends primarily on the credit quality of the assets
underlying such securities, how well the entity issuing the security is
insulated from the credit risk of the originator or any other affiliated
entities, and the amount and quality of any credit enhancement of the
securities. Payments or distributions of principal and interest on
asset-backed debt obligations may be supported by non-governmental credit
19
<PAGE> 344
enhancements including letters of credit, reserve funds, overcollateralization,
and guarantees by third parties. The market for privately issued asset-backed
debt obligations is smaller and less liquid than the market for government
sponsored mortgage-backed securities.
The rate of principal payment on mortgage- and asset-backed securities
generally depends on the rate of principal payments received on the underlying
assets which in turn may be affected by a variety of economic and other
factors. As a result, the yield on any mortgage- and asset-backed security is
difficult to predict with precision and actual yield to maturity may be more or
less than the anticipated yield to maturity. The yield characteristics of
mortgage- and asset-backed securities differ from those of traditional debt
securities. Among the principal differences are that interest and principal
payments are made more frequently on mortgage-and asset-backed securities,
usually monthly, and that principal may be prepaid at any time because the
underlying mortgage loans or other assets generally may be prepaid at any time.
As a result, if the Fund purchases these securities at a premium, a prepayment
rate that is faster than expected will reduce yield to maturity, while a
prepayment rate that is slower than expected will have the opposite effect of
increasing the yield to maturity. Conversely, if the Fund purchases these
securities at a discount, a prepayment rate that is faster than expected will
increase yield to maturity, while a prepayment rate that is slower than
expected will reduce yield to maturity. Amounts available for reinvestment by
a Fund are likely to be greater during a period of declining interest rates
and, as a result, are likely to be reinvested at lower interest rates than
during a period of rising interest rates. Accelerated prepayments on
securities purchased by the Fund at a premium also impose a risk of loss of
principal because the premium may not have been fully amortized at the time the
principal is prepaid in full. The market for privately issued mortgage-and
asset-backed securities is smaller and less liquid than the market for
government-sponsored mortgage-backed securities.
While many mortgage- and asset-backed securities are issued with only one
class of security, many are issued in more than one class, each with different
payment terms. Multiple class mortgage- and asset-backed securities are issued
for two main reasons. First, multiple classes may be used as a method of
providing credit support. This is accomplished typically through creation of
one or more classes whose right to payments on the security is made subordinate
to the right to such payments of the remaining class or classes. Second,
multiple classes may permit the issuance of securities with payment terms,
interest rates, or other characteristics differing both from those of each
other and from those of the underlying assets. Examples include so-called
"strips" (mortgage - and asset-backed securities entitling the holder to
disproportionate interests with respect to the allocation of interest and
principal of the assets backing the security), and securities with class or
classes having characteristics which mimic the characteristics of non-mortgage-
or asset-backed securities, such as floating interest rates (i.e., interest
rates which adjust as a specified benchmark changes) or scheduled amortization
of principal.
The Fund may invest in stripped mortgage- or asset-backed securities,
which receive differing proportions of the interest and principal payments from
the underlying assets. The market value of such securities generally is more
sensitive to changes in prepayment and interest rates than is the case with
traditional mortgage- and asset-backed securities, and in some cases such
market value may be extremely volatile. With respect to certain stripped
securities, such as interest only and principal only classes, a rate of
prepayment that is faster or slower than anticipated may result in the Fund
failing to recover all or a portion of its investment, even though the
securities are rated investment grade.
Mortgage- and asset-backed securities backed by assets, other than as
described above, or in which the payment streams on the underlying assets are
allocated in a manner different than those described above may be issued in the
future. The Fund may invest in such securities if such investment is otherwise
consistent with its investment objectives and policies and with the investment
restrictions of the Fund.
MORTGAGE DOLLAR ROLLS AND REVERSE REPURCHASE AGREEMENTS
The Fund may engage in reverse repurchase agreements to facilitate
portfolio liquidity, a practice common in the mutual fund industry, or for
arbitrage transactions discussed below. In a reverse repurchase agreement, the
Fund would sell a security and enter into an agreement to repurchase the
security at a specified future date and price. The Fund generally retains the
right to interest and principal payments on the security. Since the Fund
receives cash upon entering into a reverse repurchase agreement, it may be
considered a borrowing. (See "Borrowing".) When required by guidelines of the
SEC, the Fund will set aside permissible liquid assets in a segregated account
to secure its obligations to repurchase the security.
20
<PAGE> 345
The Fund may also enter into mortgage dollar rolls, in which the Fund
would sell mortgage-backed securities for delivery in the current month and
simultaneously contract to purchase substantially similar securities on a
specified future date. While the Fund would forego principal and interest paid
on the mortgage-backed securities during the roll period, the Fund would be
compensated by the difference between the current sales price and the lower
price for the future purchase as well as by any interest earned on the proceeds
of the initial sale. The Fund also could be compensated through the receipt of
fee income equivalent to a lower forward price. At the time the Fund would
enter into a mortgage dollar roll, it would set aside permissible liquid assets
in a segregated account to secure its obligation for the forward commitment to
buy mortgage-backed securities. Mortgage dollar roll transactions may be
considered a borrowing by the Fund. (See "Borrowing".)
The mortgage dollar rolls and reverse repurchase agreements entered into
by the Fund may be used as arbitrage transactions in which the Fund will
maintain an offsetting position in investment grade debt obligations or
repurchase agreements that mature on or before the settlement date on the
related mortgage dollar roll or reverse repurchase agreements. Since the Fund
will receive interest on the securities or repurchase agreements in which it
invests the transaction proceeds, such transactions may involve leverage.
However, since such securities or repurchase agreements will be high quality
and will mature on or before the settlement date of the mortgage dollar roll or
reverse repurchase agreement, the Advisor believes that such arbitrage
transactions do not present the risks to the Fund that are associated with
other types of leverage.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with certain banks or
non-bank dealers. In a repurchase agreement, the Fund buys a security at one
price, and at the time of sale, the seller agrees to repurchase the obligation
at a mutually agreed upon time and price (usually within seven days). The
repurchase agreement, thereby, determines the yield during the purchaser's
holding period, while the seller's obligation to repurchase is secured by the
value of the underlying security. The Advisor will monitor, on an ongoing
basis, the value of the underlying securities to ensure that the value always
equals or exceeds the repurchase price plus accrued interest. Repurchase
agreements could involve certain risks in the event of a default or insolvency
of the other party to the agreement, including possible delays or restrictions
upon the Fund's ability to dispose of the underlying securities. Although no
definitive creditworthiness criteria are used, the Advisor reviews the
creditworthiness of the banks and non-bank dealers with which the Fund enters
into repurchase agreements to evaluate those risks. The Fund may, under
certain circumstances, deem repurchase agreements collateralized by U.S.
government securities to be investments in U.S. government securities.
SHORT SALES AGAINST THE BOX
The Fund may sell securities short against the box to hedge unrealized
gains on portfolio securities. Selling securities short against the box
involves selling a security that the Fund owns or has the right to acquire, for
delivery at a specified date in the future. If the Fund sells securities short
against the box, it may protect unrealized gains, but will lose the opportunity
to profit on such securities if the price rises.
SMALL AND MEDIUM COMPANIES
The Fund may invest a substantial portion of its assets in small and
medium companies. While small and medium companies generally have the
potential for rapid growth, investments in small and medium companies often
involve greater risks than investments in larger, more established companies
because small and medium companies may lack the management experience,
financial resources, product diversification, and competitive strengths of
larger companies. In addition, in many instances the securities of small and
medium companies are traded only over-the-counter or on a regional securities
exchange, and the frequency and volume of their trading is substantially less
than is typical of larger companies. Therefore, the securities of small and
medium companies may be subject to greater and more abrupt price fluctuations.
When making large sales, the Fund may have to sell portfolio holdings at
discounts from quoted prices or may have to make a series of small sales over
an extended period of time due to the trading volume of small and medium
company securities. Investors should be aware that, based on the foregoing
factors, an investment in the Fund may be subject to greater price
fluctuations than an investment in a fund that invests primarily in larger,
more established companies. The
21
<PAGE> 346
Advisor's research efforts may also play a greater role in selecting
securities for the Fund than in a fund that invests in larger, more established
companies.
TEMPORARY DEFENSIVE POSITION
When the Advisor determines that market conditions warrant a temporary
defensive position, the Fund may invest without limitation in cash and
short-term fixed income securities, including U.S. government securities,
commercial paper, banker's acceptances, certificates of deposit, and time
deposits.
WARRANTS
The Fund may acquire warrants. Warrants are securities giving the holder
the right, but not the obligation, to buy the stock of an issuer at a given
price (generally higher than the value of the stock at the time of issuance)
during a specified period or perpetually. Warrants may be acquired separately
or in connection with the acquisition of securities. Warrants do not carry
with them the right to dividends or voting rights with respect to the
securities that they entitle their holder to purchase, and they do not
represent any rights in the assets of the issuer. As a result, warrants may be
considered to have more speculative characteristics than certain other types of
investments. In addition, the value of a warrant does not necessarily change
with the value of the underlying securities, and a warrant ceases to have value
if it is not exercised prior to its expiration date.
WHEN-ISSUED SECURITIES
The Fund may purchase securities on a "when-issued" basis. The price of
debt obligations purchased on a when-issued basis, which may be expressed in
yield terms, generally is fixed at the time the commitment to purchase is made,
but delivery and payment for the securities take place at a later date.
Normally, the settlement date occurs within 45 days of the purchase although in
some cases settlement may take longer. During the period between the purchase
and settlement, no payment is made by the Fund to the issuer and no interest on
the debt obligations accrues to the Fund. Forward commitments 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 value of
the Fund's other assets. While when-issued securities may be sold prior to the
settlement date, the Fund intends to purchase such securities with the purpose
of actually acquiring them unless a sale appears desirable for investment
reasons. At the time the Fund makes the commitment to purchase a security on a
when-issued basis, it will record the transaction and reflect the value of the
security in determining its net asset value. The Fund does not believe that
its net asset value will be adversely affected by purchases of securities on a
when-issued basis.
To the extent required by the SEC, the Fund will maintain cash and
marketable securities equal in value to commitments for when-issued securities.
Such segregated securities either will mature or, if necessary, be sold on or
before the settlement date. When the time comes to pay for when-issued
securities, the Fund will meet its obligations from then-available cash flow,
sale of the securities held in the separate account, described above, sale of
other securities or, although it would not normally expect to do so, from the
sale of the when-issued securities themselves (which may have a market value
greater or less than the Fund's payment obligation).
ZERO-COUPON, STEP-COUPON AND PAY-IN-KIND SECURITIES
The Fund may invest in zero-coupon, step-coupon, and pay-in-kind
securities. These securities are debt securities that do not make regular cash
interest payments. Zero-coupon and step-coupon securities are sold at a deep
discount to their face value. Pay-in-kind securities pay interest through the
issuance of additional securities. Because such securities do not pay current
cash income, the price of these securities can be volatile when interest rates
fluctuate. While these securities do not pay current cash income, federal
income tax law requires the holders of zero-coupon, step-coupon, and
pay-in-kind securities to include in income each year the portion of the
original issue discount (or deemed discount) and other non-cash income on such
securities accruing that year. In order to continue to qualify as a "regulated
investment company" under the Internal Revenue Code and avoid a certain excise
tax, the Fund may be required to distribute a portion of such discount and
income and may be required to dispose of other portfolio securities, which may
occur in periods of adverse market prices, in order to generate cash to meet
these distribution requirements.
22
<PAGE> 347
DIRECTORS AND OFFICERS OF THE CORPORATION
Directors and officers of the Corporation, together with information as to
their principal business occupations during the last five years, and other
information are shown below. Each director who is deemed an "interested
person," as defined in the 1940 Act, is indicated by an asterisk (*). Each
officer and director holds the same position with the 25 registered open-end
management investment companies consisting of 38 mutual funds, which are
managed by the Advisor (the "Strong Funds"). The Strong Funds, in the
aggregate, pays each Director who is not a director, officer, or employee of
the Advisor, or any affiliated company (a "disinterested director") an annual
fee of $50,000, plus $100 per Board meeting for each Strong Fund. In addition,
each disinterested director is reimbursed by the Strong Funds for travel and
other expenses incurred in connection with attendance at such meetings. Other
officers and directors of the Strong Funds receive no compensation or expense
reimbursement from the Strong Funds.
*RICHARD S. STRONG (DOB 5/12/42), Chairman of the Board and Director of the
Corporation.
Prior to August 1985, Mr. Strong was Chief Executive Officer of the
Advisor, which he founded in 1974. Since August 1985, Mr. Strong has been a
Security Analyst and Portfolio Manager of the Advisor. In October 1991, Mr.
Strong also became the Chairman of the Advisor. Mr. Strong is a director of
the Advisor. Mr. Strong has been in the investment management business since
1967. Mr. Strong has served the Corporation as a director since December 1990
and as Chairman of the Board since January 1992.
MARVIN E. NEVINS (DOB 7/9/18), Director of the Corporation.
Private Investor. From 1945 to 1980, Mr. Nevins was Chairman of Wisconsin
Centrifugal Inc.; a foundry. From July 1983 to December 1986, he was Chairman
of General Casting Corp., Waukesha, Wisconsin, a foundry. Mr. Nevins is a
former Chairman of the Wisconsin Association of Manufacturers & Commerce. He
was also a regent of the Milwaukee School of Engineering and a member of the
Board of Trustees of the Medical College of Wisconsin. Mr. Nevins has served
the Corporation as a director since December 1990.
WILLIE D. DAVIS (DOB 7/24/34), Director of the Corporation.
Mr. Davis has been director of Alliance Bank Since 1980, Sara Lee
Corporation (a food/consumer products company) since 1983, KMart Corporation (a
discount consumer products company) since 1985, YMCA Metropolitan - Los Angeles
since 1985, Dow Chemical Company since 1988, MGM Grand, Inc. (an
entertainment/hotel company) since 1990, WICOR, Inc. (a utility company) since
1990, Johnson Controls, Inc. (an industrial company) since 1992, L.A. Gear (a
footwear/sportswear company) since 1992, and Rally's Hamburger, Inc. since
1994. Mr. Davis has been a trustee of the University of Chicago since 1980,
Marquette University since 1988, and Occidental College since 1990. Since
1977, Mr. Davis has been President and Chief Executive Officer of All Pro
Broadcasting, Inc. Mr. Davis was a director of the Fireman's Fund (an
insurance company) from 1975 until 1990. Mr. Davis has served the Corporation
as a director since July 1994.
*JOHN DRAGISIC (DOB 11/26/40), President and Director of the Corporation.
Mr. Dragisic has been President of the Advisor since October 1995, and a
director of the Advisor since July 1994. Mr. Dragisic served as Vice Chairman
of the Advisor from July 1994 until October 1995. Mr. Dragisic was the
President and Chief Executive Officer of Grunau Company, Inc. (a mechanical
contracting and engineering firm), Milwaukee, Wisconsin from 1987 until July
1994. From 1981 to 1987, he was an Executive Vice President with Grunau
Company, Inc. From 1969 until 1973, Mr. Dragisic worked for the InterAmerican
Development Bank. Mr. Dragisic received his Ph.D. in Economics in 1971 from
the University of Wisconsin - Madison and his B.A. degree in Economics in 1962
from Lake Forest College. Mr. Dragisic has served the Corporation as Vice
Chairman from July 1994 until October 1995; as President since October 1995;
and as a director from July 1991 until July 1994, and since April 1995.
23
<PAGE> 348
STANLEY KRITZIK (DOB 1/9/30), Director of the Corporation.
Mr. Kritzik has been a Partner of Metropolitan Associates since 1962, a
Director of Aurora Health Care since 1987, and Health Network Ventures, Inc.
since 1992. Mr. Kritzik has served the Corporation as a director since April
1995.
WILLIAM F. VOGT (DOB 7/19/47), Director of the Corporation.
Mr. Vogt has been the President of Vogt Management Consulting, Inc. since
1990. From 1982 until 1990, he served as Executive Director of University
Physicians of the University of Colorado. Mr. Vogt is the Past President of
the Medical Group Management Association and a Fellow of the American College
of Medical Practice Executives. Mr. Vogt has served the Corporation as a
director since April 1995.
LAWRENCE A. TOTSKY (DOB 5/6/59), C.P.A., Vice President of the Corporation.
Mr. Totsky has been Senior Vice President of the Advisor since December
1994. Mr. Totsky acted as the Advisor's Manager of Shareholder Accounting and
Compliance from June 1987 to June 1991 when he was named Director of Mutual
Fund Administration. Mr. Totsky has served the Corporation as a Vice President
since May 1993.
THOMAS P. LEMKE (DOB 7/30/54), Vice President of the Corporation.
Mr. Lemke has been Senior Vice President, Secretary, and General Counsel
of the Advisor since September 1994. For two years prior to joining the
Advisor, Mr. Lemke acted as Resident Counsel for Funds Management at J.P.
Morgan & Co., Inc. From February 1989 until April 1992, Mr. Lemke acted as
Associate General Counsel to Sanford C. Bernstein Co., Inc. For two years
prior to that, Mr. Lemke was Of Counsel at the Washington, D.C. law firm of Tew
Jorden & Schulte, a successor of Finley, Kumble & Wagner. From August 1979
until December 1986, Mr. Lemke worked at the Securities and Exchange
Commission, most notably as the Chief Counsel to the Division of Investment
Management (November 1984 - December 1986), and as Special Counsel to the
Office of Insurance Products, Division of Investment Management (April 1982 -
October 1984). Mr. Lemke has served the Corporation as a Vice President since
October 1994.
STEPHEN J. SHENKENBERG (DOB 6/14/58), Vice President and Secretary of the
Corporation.
Mr. Shenkenberg has been Deputy General Counsel to the Advisor since
November 1996. From December 1992 until November 1996, Mr. Shenkenberg acted
as Associate Counsel to the Advisor. From June 1987 until December 1992, Mr.
Shenkenberg was an attorney for Godfrey & Kahn, S.C., a Milwaukee law firm.
Mr. Shenkenberg has served the Corporation as a Vice President since April 1996
and as Secretary since October 1996.
JOHN S. WEITZER (10/31/67), Vice President of the Corporation.
Mr. Weitzer has been an Associate Counsel of the Advisor since July 1993.
Mr. Weitzer has served the Corporation as a Vice President since January 1996.
Except for Messrs. Nevins, Davis, Kritzik and Vogt, the address of all of
the above persons is P.O. Box 2936, Milwaukee, Wisconsin 53201. Mr. Nevins'
address is 6075 Pelican Bay Boulevard, Naples, Florida 34108. Mr. Davis'
address is 161 North La Brea, Inglewood, California 90301. Mr. Kritzik's
address is 1123 North Astor Street, P.O. Box 92547, Milwaukee, Wisconsin
53202-0547. Mr. Vogt's address is 2830 East Third Avenue, Denver, Colorado
80206.
In addition to the positions listed above, the following individuals also
hold the following positions with Strong Holdings, Inc. ("Holdings"), a
Wisconsin corporation and subsidiary of the Advisor; Strong Funds Distributors,
Inc., the Fund's underwriter ("Distributors"), Heritage Reserve Development
Corporation ("Heritage"), and Strong Service Corporation ("SSC"), each of which
is a Wisconsin corporation and subsidiary of Holdings; Fussville Real Estate
Holdings
24
<PAGE> 349
L.L.C. ("Real Estate Holdings") and Sherwood Development L.L.C. ("Sherwood"),
each of which is a Wisconsin Limited Liability Company and subsidiary of the
Advisor and Heritage; and Fussville Development L.L.C. ("Fussville
Development"), a Wisconsin Limited Liability Company and subsidiary of the
Advisor and Real Estate Holdings:
RICHARD S. STRONG:
CHAIRMAN AND A DIRECTOR - Holdings and Distributors (since October 1993);
Heritage (since January 1994); and SSC (since November 1995).
CHAIRMAN AND A MEMBER OF THE MANAGING BOARD - Real Estate Holdings and
Fussville Development (since December 1995 and February 1994,
respectively); and Sherwood (since October 1994).
JOHN DRAGISIC:
PRESIDENT AND A DIRECTOR - Holdings (since December 1995 and July 1994,
respectively); Distributors (since September 1996 and July 1994,
respectively); Heritage (since May 1994 and August 1994, respectively);
and SSC (since November 1995).
VICE CHAIRMAN AND A MEMBER OF THE MANAGING BOARD - Real Estate and
Fussville Development (since December 1995 and August 1994,
respectively); and Sherwood (since October 1994).
THOMAS P. LEMKE:
VICE PRESIDENT - Holdings, Heritage, Real Estate Holdings, and Fussville
Development (since December 1995); Distributors (since October 1996);
Sherwood (since October 1994); and SSC (since November 1995).
STEPHEN J. SHENKENBERG:
VICE PRESIDENT AND SECRETARY - Distributors (since December 1995).
SECRETARY - Holdings, Heritage, Fussville Development, Real Estate
Holdings, and Sherwood (since December 1995); and SSC (since November
1995).
As of March 31, 1997, the officers and directors of the Corporation in the
aggregate beneficially owned 35,775 shares of common stock of the Fund which
was 100% of the Fund's then outstanding shares.
PRINCIPAL SHAREHOLDERS
As of March 31, 1997, the Advisor, 100 Heritage Reserve, Menomonee Falls,
WI 53051, owned of record and beneficially 23,275 shares of common stock of the
Fund which was 65.06% of the Fund's then outstanding shares. As of March 31,
1997, Strong Funds Distributors, Inc., 100 Heritage Reserve, Menomonee Falls,
WI 53051, owned of record and beneficially 12,500 shares of common stock of the
Fund which was 34.94% of the Fund's outstanding shares.
INVESTMENT ADVISOR AND DISTRIBUTOR
The Advisor to the Fund is Strong Capital Management, Inc. Mr. Richard S.
Strong controls the Advisor. Mr. Strong is the Chairman and a director of the
Advisor, Mr. Dragisic is the President and a director of the Advisor, Mr.
Totsky is a Senior Vice President of the Advisor, Mr. Lemke is a Senior Vice
President, Secretary, and General Counsel of the Advisor, Mr. Shenkenberg is
Vice President, Assistant Secretary, and Deputy General Counsel of the Advisor,
and Mr. Weitzer is an Associate Counsel of the Advisor. A brief description of
the Fund's investment advisory agreement ("Advisory Agreement") is set forth in
the Prospectus under "Management."
25
<PAGE> 350
The Fund's Advisory Agreement is dated July 10, 1995, and will remain in
effect as to the Fund for a period of two years. The Advisory Agreement was
approved by the Fund's initial shareholder on its first day of operations.
Thereafter, the Advisory Agreement is required to be approved annually by the
Board of Directors of the Corporation or by vote of a majority of the Fund's
outstanding voting securities (as defined in the 1940 Act). In either case,
each annual renewal must also be approved by the vote of a majority of the
Corporation's directors who are not parties to the Advisory Agreement or
interested persons of any such party, cast in person at a meeting called for
the purpose of voting on such approval. The Advisory Agreement is terminable,
without penalty, on 60 days' written notice by the Board of Directors of the
Corporation, by vote of a majority of the Fund's outstanding voting securities,
or by the Advisor. In addition, the Advisory Agreement will terminate
automatically in the event of its assignment.
Under the terms of the Advisory Agreement, the Advisor manages the Fund's
investments subject to the supervision of the Corporation's Board of Directors.
The Advisor is responsible for investment decisions and supplies investment
research and portfolio management. At its expense, the Advisor provides office
space and all necessary office facilities, equipment, and personnel for
servicing the investments of the Fund. The Advisor places all orders for the
purchase and sale of the Fund's securities at its expense.
Except for expenses assumed by the Advisor, as set forth above, or by the
Distributor, as described below with respect to the distribution of the Fund's
shares, the Fund is responsible for all its other expenses, including, without
limitation, interest charges, taxes, brokerage commissions and similar
expenses; organizational expenses; expenses of issue, sale, repurchase or
redemption of shares; expenses of registering or qualifying shares for sale
with the states and the SEC; expenses for printing and distributing
Prospectuses and quarterly financial statements to existing shareholders;
charges of custodians, transfer agent fees (including the printing and mailing
of reports and notices to shareholders), registrars, auditing and legal
services, clerical services related to recordkeeping and shareholder relations,
and printing of stock certificates; and fees for directors who are not
"interested persons" of the Advisor; and its allocable share of the
Corporation's expenses.
As compensation for its services, the Fund pays to the Advisor a monthly
management fee at the annual rate of 1.00% of the Fund's average daily net
asset value. (See "Additional Information - Calculation of Net Asset Value" in
the Prospectus.) From time to time, the Advisor may voluntarily waive all or a
portion of its management fee for the Fund. The organizational expenses of the
Fund which were $11,544, were advanced by the Advisor and will be reimbursed by
the Fund for a period of not more than 60 months from the Fund's date of
inception.
The Advisory Agreement requires the Advisor to reimburse the Fund in the
event that the expenses and charges payable by the Fund in any fiscal year,
including the management fee but excluding taxes, interest, brokerage
commissions, and similar fees and to the extent permitted extraordinary
expenses, exceed two percent (2%) of the average net asset value of the Fund
for such year, as determined by valuations made as of the close of each
business day of the year. Reimbursement of expenses in excess of the
applicable limitation will be made on a monthly basis and will be paid to the
Fund by reduction of the Advisor's fee, subject to later adjustment month by
month for the remainder of the Fund's fiscal year. The Advisor may from time
to time absorb expenses for the Fund in addition to the reimbursement of
expenses in excess of applicable limitations.
On July 12, 1994, the Securities and Exchange Commission (the "SEC") filed
an administrative action (the "Order" against the Advisor, Mr. Strong, and
another employee of the Advisor in connection with conduct that occurred
between 1987 and early 1990. In re Strong/Corneliuson Capital Management,
Inc.; et al. Admin. Proc. File No. 3-8411. The proceeding was settled by
consent without admitting or denying the allegations in the Order. The Order
found that the Advisor and Mr. Strong aided and abetted violations of Section
17(a) of the 1940 Act by effecting trades between mutual funds, and between
mutual funds and Harbour Investments Ltd. ("Harbour"), without complying with
the exemptive provisions of SEC Rule 17a-7 or otherwise obtaining an exemption.
It further found that the Advisor violated, and Mr. Strong aided and abetted
violations of, the disclosure provisions of the 1940 Act and the Investment
Advisers Act of 1940 by misrepresenting the Advisor's policy on personal
trading and by failing to disclose trading by Harbour, an entity in which
principals of the Advisor owned between 18 and 25 percent of the voting stock.
As part of the settlement, the respondents agreed to a censure and a cease and
desist order and the Advisor agreed to various undertakings, including adoption
of certain procedures and a limitation for six months on accepting certain
types of new advisory clients.
On June 6, 1996, the Department of Labor (the "DOL") filed an action
against the Advisor for equitable relief alleging violations of the Employee
Retirement Income Security Act of 1974 ("ERISA") in connection with cross
trades that
26
<PAGE> 351
occurred between 1987 and late 1989 involving certain pension accounts managed
by the Advisor. Contemporaneous with this filing, the Advisor, without
admitting or denying the DOL's allegations, agreed to the entry of a consent
judgment resolving all matters relating to the allegations. Reich v. Strong
Capital Management, Inc., (U.S.D.C. E.D. WI) (the "Consent Judgment"). Under
the terms of the Consent Judgment, the Advisor agreed to reimburse the affected
accounts a total of $5.9 million. The settlement did not have any material
impact on the Advisor's financial position or operations.
The Fund and Advisor have adopted a Code of Ethics (the "Code") which
governs the personal trading activities of all "Access Persons" of the Advisor.
Access Persons include every director and officer of the Advisor and the
investment companies managed by the Advisor, including the Fund, as well as
certain employees of the Advisor who have access to information relating to the
purchase or sale of securities by the Advisor on behalf of accounts managed by
it. The Code is based upon the principal that such Access Persons have a
fiduciary duty to place the interests of the Fund and the Advisor's other
clients ahead of their own.
The Code requires Access Persons (other than Access Persons who are
independent directors of the investment companies managed by the Advisor,
including the Fund) to, among other things, preclear their securities
transactions (with limited exceptions, such as transactions in shares of mutual
funds, direct obligations of the U.S. government, and certain options on
broad-based securities market indexes) and to execute such transactions through
the Advisor's trading department. The Code, which applies to all Access Persons
(other than Access Persons who are independent directors of the investment
companies managed by the Advisor, including the Fund), includes a ban on
acquiring any securities in an initial public offering, other than a new
offering of a registered open-end investment company, and a prohibition from
profiting on short-term trading in securities. In addition, no Access Person
may purchase or sell any security which, is contemporaneously being purchased
or sold, or to the knowledge of the Access Person, is being considered for
purchase or sale, by the Advisor on behalf of any mutual fund or other account
managed by it. Finally, the Code provides for trading "black out" periods or
seven calendar days during which time Access Persons who are portfolio managers
may not trade in securities which have been purchased or sold any mutual fund
or other account managed by the portfolio manager.
From time to time the Advisor votes the shares owned by the Fund according
to its Statement of General Proxy Voting Policy ("Proxy Voting Policy"). The
general principal of the Proxy Voting Policy is to vote any beneficial interest
in an equity security prudently and solely in the best long-term economic
interest of the Fund and its beneficiaries considering all relevant factors and
without undue influence from individuals or groups who may have an economic
interest in the outcome of a proxy vote. Shareholders may obtain a copy of the
Proxy Voting Policy upon request from the Advisor.
The Advisor provides investment advisory services for multiple clients and
may give advice and take action, with respect to any client, that may differ
from the advice given, or the timing or nature of action taken, with respect to
any one account. However, the Advisor will allocate over a period of time, to
the extent practical, investment opportunities to each account on a fair and
equitable basis relative to other similarly-situated client accounts. The
Advisor, its principals and associates (to the extent not prohibited by the
Code), and other clients of the Advisory may have, acquire, increase, decrease,
or dispose of securities or interests therein at or about the same time that
the Advisor is purchasing or selling securities or interests therein for an
account that are or may be deemed to be inconsistent with the actions taken by
such persons.
Under a Distribution Agreement dated July 10, 1995 with the Corporation
(the "Distribution Agreement"), Strong Funds Distributors, Inc.
("Distributor"), a subsidiary of the Advisor, acts as underwriter of the Fund's
shares. The Distribution Agreement provides that the Distributor will use its
best efforts to distribute the Fund's shares. Shares are only offered and sold
to the separate accounts of certain insurance companies. Since the Fund is a
"no-load" fund, no sales commissions are charged on the purchase of Fund
shares. Certain sales charges may apply to the variable annuity or life
insurance contract, which should be described in the prospectus of the
insurance company's separate account. The Distribution Agreement further
provides that the Distributor will bear the additional costs of printing
prospectuses and shareholder reports which are used for selling purposes, as
well as advertising and other costs attributable to the distribution of the
Fund's shares. The Distributor is an indirect subsidiary of the Advisor and
controlled by the Advisor and Richard S. Strong. The Distribution Agreement is
subject to the same termination and renewal provisions as are described above
with respect to the Advisory Agreement.
27
<PAGE> 352
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Advisor is responsible for decisions to buy and sell securities for
the Fund and for the placement of the Fund's investment business and the
negotiation of the commissions to be paid on such transactions. It is the
policy of the Advisor to seek the best execution at the best security price
available with respect to each transaction, in light of the overall quality of
brokerage and research services provided to the Advisor or the Fund. In
over-the-counter transactions, orders are placed directly with a principal
market maker unless it is believed that a better price and execution can be
obtained using a broker. The best price to the Fund means the best net price
without regard to the mix between purchase or sale price and commission, if
any. In selecting broker-dealers and in negotiating commissions, the Advisor
considers a variety of factors, including best price and execution, the full
range of brokerage services provided by the broker, as well as its capital
strength and stability, and the quality of the research and research services
provided by the broker. Brokerage will not be allocated based on the sale of
any shares of the Strong Funds.
The Advisor has adopted procedures that provide generally for the Advisor
to seek to bunch orders for the purchase or sale of the same security for the
Fund, other mutual funds managed by the Advisor, and other advisory clients
(collectively, the "client accounts"). The Advisor will bunch orders when it
deems it to be appropriate and in the best interest of the client accounts.
When a bunched order is filled in its entirety, each participating client
account will participate at the average share price for the bunched order on
the same business day, and transaction costs shall be shared pro rata based on
each client's participation in the bunched order. When a bunched order is only
partially filled, the securities purchased will be allocated on a pro rata
basis to each client account participating in the bunched order based upon the
initial amount requested for the account, subject to certain exceptions, and
each participating account will participate at the average share price for the
bunched order on the same business day.
Section 28(e) of the Securities Exchange Act of 1934 ("Section 28(e)")
permits an investment advisor, under certain circumstances, to cause an account
to pay a broker or dealer a commission for effecting a transaction in excess of
the amount of commission another broker or dealer would have charged for
effecting the transaction in recognition of the value of the brokerage and
research services provided by the broker or dealer. Brokerage and research
services include (a) furnishing advice as to the value of securities, the
advisability of investing in, purchasing or selling securities, and the
availability of securities or purchasers or sellers of securities; (b)
furnishing analyses and reports concerning issuers, industries, securities,
economic factors and trends, portfolio strategy, and the performance of
accounts; and (c) effecting securities transactions and performing functions
incidental thereto (such as clearance, settlement, and custody).
In carrying out the provisions of the Advisory Agreement, the Advisor may
cause the Fund to pay a broker, which provides brokerage and research services
to the Advisor, a commission for effecting a securities transaction in excess
of the amount another broker would have charged for effecting the transaction.
The Advisor believes it is important to its investment decision-making process
to have access to independent research. The Advisory Agreement provides that
such higher commissions will not be paid by the Fund unless (a) the Advisor
determines in good faith that the amount is reasonable in relation to the
services in terms of the particular transaction or in terms of the Advisor's
overall responsibilities with respect to the accounts as to which it exercises
investment discretion; (b) such payment is made in compliance with the
provisions of Section 28(e), other applicable state and federal laws, and the
Advisory Agreement; and (c) in the opinion of the Advisor, the total
commissions paid by the Fund will be reasonable in relation to the benefits to
the Fund over the long term. The investment management fee paid by the Fund
under the Advisory Agreement is not reduced as a result of the Advisor's
receipt of research services.
Generally, research services provided by brokers may include information
on the economy, industries, groups of securities, individual companies,
statistical information, accounting and tax law interpretations, political
developments, legal developments affecting portfolio securities, technical
market action, pricing and appraisal services, credit analysis, risk
measurement analysis, performance analysis, and analysis of corporate
responsibility issues. Such research services are received primarily in the
form of written reports, telephone contacts, and personal meetings with
security analysts. In addition, such research services may be provided in the
form of access to various computer-generated data, computer hardware and
software, and meetings arranged with corporate and industry spokespersons,
economists, academicians, and government representatives. In some cases,
research services are generated by third parties but are provided to the
Advisor by or through brokers. Such brokers may pay for all or a portion of
computer hardware and software costs relating to the pricing of securities.
28
<PAGE> 353
Where the Advisor itself receives both administrative benefits and
research and brokerage services from the services provided by brokers, it makes
a good faith allocation between the administrative benefits and the research
and brokerage services, and will pay for any administrative benefits with cash.
In making good faith allocations of costs between administrative benefits and
research and brokerage services, a conflict of interest may exist by reason of
the Advisor's allocation of the costs of such benefits and services between
those that primarily benefit the Advisor and those that primarily benefit the
Fund and other advisory clients.
From time to time, the Advisor may purchase new issues of securities for
the Fund in a fixed price offering. In these situations, the seller may be a
member of the selling group that will, in addition to selling the securities to
the Fund and other advisory clients, provide the Advisor with research. The
National Association of Securities Dealers has adopted rules expressly
permitting these types of arrangements under certain circumstances. Generally,
the seller will provide research "credits" in these situations at a rate that
is higher than that which is available for typical secondary market
transactions. These arrangements may not fall within the safe harbor of Section
28(e).
Each year, the Advisor considers the amount and nature of research and
research services provided by brokers, as well as the extent to which such
services are relied upon, and attempts to allocate a portion of the brokerage
business of the Fund and other advisory clients on the basis of that
consideration. In addition, brokers may suggest a level of business they would
like to receive in order to continue to provide such services. The actual
brokerage business received by a broker may be more or less than the suggested
allocations, depending upon the Advisor's evaluation of all applicable
considerations.
The Advisor has informal arrangements with various brokers whereby, in
consideration for providing research services and subject to Section 28(e), the
Advisor allocates brokerage to those firms, provided that their brokerage and
research services were satisfactory to the Advisor and their execution
capabilities were compatible with the Advisor's policy of seeking best
execution at the best security price available, as discussed above. In no case
will the Advisor make binding commitments as to the level of brokerage
commissions it will allocate to a broker, nor will it commit to pay cash if any
informal targets are not met. The Advisor anticipates it will continue to
enter into such brokerage arrangements.
The Advisor may direct the purchase of securities on behalf of the Fund
and other advisory clients in secondary market transactions, in public
offerings directly from an underwriter, or in privately negotiated transactions
with an issuer. When the Advisor believes the circumstances so warrant,
securities purchased in public offerings may be resold shortly after
acquisition in the immediate aftermarket for the security in order to take
advantage of price appreciation from the public offering price or for other
reasons. Short-term trading of securities acquired in public offerings, or
otherwise, may result in higher portfolio turnover and associated brokerage
expenses.
The Advisor places portfolio transactions for other advisory accounts,
including other mutual funds managed by the Advisor. Research services
furnished by firms through which the Fund effects its securities transactions
may be used by the Advisor in servicing all of its accounts; not all of such
services may be used by the Advisor in connection with the Fund. In the
opinion of the Advisor, it is not possible to measure separately the benefits
from research services to each of the accounts (including the Fund) managed by
the Advisor. Because the volume and nature of the trading activities of the
accounts are not uniform, the amount of commissions in excess of those charged
by another broker paid by each account for brokerage and research services will
vary. However, in the opinion of the Advisor, such costs to the Fund will not
be disproportionate to the benefits received by the Fund on a continuing basis.
The Advisor seeks to allocate portfolio transactions equitably whenever
concurrent decisions are made to purchase or sell securities by the Fund and
another advisory account. In some cases, this procedure could have an adverse
effect on the price or the amount of securities available to the Fund. In
making such allocations between the Fund and other advisory accounts, the main
factors considered by the Advisor are the respective investment objectives, the
relative size of portfolio holdings of the same or comparable securities, the
availability of cash for investment, the size of investment commitments
generally held, and the opinions of the persons responsible for recommending
the investment.
Where consistent with a client's investment objectives, investment
restrictions, and risk tolerance, the Advisor may purchase securities sold in
underwritten public offerings for client accounts, commonly referred to as
"deal" securities. The Advisor has adopted deal allocation procedures (the
"procedures"), summarized below, that reflect the Advisor's overriding
29
<PAGE> 354
policy that deal securities must be allocated among participating client
accounts in a fair and equitable manner and that deal securities may not be
allocated in a manner that unfairly discriminates in favor of certain clients
or types of clients.
The procedures provide that, in determining which client accounts a
portfolio manager team will seek to have purchase deal securities, the team
will consider all relevant factors including, but not limited to, the nature,
size, and expected allocation to the Advisor of deal securities; the size of
the account(s); the accounts' investment objectives and restrictions; the risk
tolerance of the client; the client's tolerance for possibly higher portfolio
turnover; the amount of commissions generated by the account during the past
year; and the number of other deals the client has participated in during the
past year.
Where more than one of the Advisor's portfolio manager team seeks to have
client accounts participate in a deal and the amount of deal securities
allocated to the Advisor by the underwriting syndicate is less than the
aggregate amount ordered by the Advisor (a "reduced allocation"), the deal
securities will be allocated among the portfolio manager teams based on all
relevant factors. The primary factor shall be assets under management,
although other factors that may be considered in the allocation decision
include, but are not limited to, the nature, size, and expected allocation of
the deal; the amount of brokerage commissions or other amounts generated by the
respective participating portfolio manager teams; and which portfolio manager
team is primarily responsible for the Advisor receiving securities in the deal.
Based on the relevant factors, the Advisor has established general allocation
percentages for its portfolio manager teams, and these percentages are reviewed
on a regular basis to determine whether asset growth or other factors make it
appropriate to use different general allocation percentages for reduced
allocations.
When a portfolio manager team receives a reduced allocation of deal
securities, the portfolio manager team will allocate the reduced allocation
among client accounts in accordance with the allocation percentages set forth
in the team's initial allocation instructions for the deal securities, except
where this would result in a de minimis allocation to any client account. On a
regular basis, the Advisor reviews the allocation of deal securities to ensure
that they have been allocated in a fair and equitable manner that does not
unfairly discriminate in favor of certain clients or types of clients.
CUSTODIAN
As custodian of the Fund's assets, Firstar Trust Company, P.O. Box 761,
Milwaukee, Wisconsin 53201, has custody of all securities and cash of the Fund,
delivers and receives payment for securities sold, receives and pays for
securities purchased, collects income from investments, and performs other
duties, all as directed by officers of the Corporation. The custodian is in no
way responsible for any of the investment policies or decisions of the Fund.
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT
The Advisor acts as transfer agent and dividend-disbursing agent for the
Fund at no cost.
ADMINISTRATIVE SERVICES
From time to time the Fund and/or the Advisor may enter into arrangements
under which certain administrative services may be performed by the insurance
companies that purchase shares in the Fund. These administrative services may
include, among other things, responding to ministerial inquiries concerning the
Fund's investment objective, investment program, policies and performance,
transmitting, on behalf of the Fund, proxy statements, annual reports, updated
prospectuses, and other communications regarding the Fund, and providing only
related services as the Fund or its shareholders may reasonably request.
Depending on the arrangements, the Fund and/or Advisor may compensate such
insurance companies or their agents directly or indirectly for the
administrative services. To the extent the Fund compensates the insurance
company for these services, the Fund will pay the insurance company an annual
fee that will vary depending upon the number of contract holders that utilize
the Fund as the funding medium for their contracts. The insurance company may
impose other account or service charges. See the prospectus for the separate
account of the insurance company for additional information regarding such
charges.
30
<PAGE> 355
TAXES
GENERAL
As indicated under "Additional Information - Distributions and Taxes" in
the Prospectus, the Fund intends to continue to qualify annually for treatment
as a regulated investment company ("RIC") under the Internal Revenue Code of
1986, as amended (the "Code"). This qualification does not involve government
supervision of the Fund's management practices or policies.
In order to qualify for treatment as a RIC under the Code, the Fund must
distribute to its shareholders for each taxable year at least 90% of its
investment company taxable income (consisting generally of net investment
income, net short-term capital gain, and net gains from certain foreign
currency transactions) ("Distribution Requirement") and must meet several
additional requirements. Among these requirements are the following: (1) the
Fund must derive at least 90% of its gross income each taxable year from
dividends, interest, payments with respect to securities loans, and gains from
the sale or other disposition of securities or foreign currencies, or other
income (including gains from options, futures, or forward contracts) derived
with respect to its business of investing in securities or those currencies
("Income Requirement"); (2) the Fund must derive less than 30% of its gross
income each taxable year from the sale or other disposition of securities, or
any of the following, that were held for less than three months - options or
futures (other than those on foreign currencies), or foreign currencies (or
options, futures, or forward contracts thereon) that are not directly related
to the Fund's principal business or investing in securities (or options and
futures with respect to securities) ("30% Limitation"); (3) at the close of
each quarter of the Fund's taxable year, at least 50% of the value of its total
assets must be represented by cash and cash items, U.S. government securities,
securities of other RICs, and other securities, with these other securities
limited, in respect of any one issuer, to an amount that does not exceed 5% of
the value of the Fund's total assets and that does not represent more than 10%
of the issuer's outstanding voting securities; and (4) at the close of each
quarter of the Fund's taxable year, not more than 25% of the value of its total
assets may be invested in securities (other than U.S. government securities or
the securities of other RICs) of any one issuer. From time to time the Advisor
may find it necessary to make certain types of investments for the purpose of
ensuring that the Fund continues to qualify for treatment as a RIC under the
Code.
If Fund shares are sold at a loss after being held for six months or less,
the loss will be treated as long-term, instead of short-term, capital loss to
the extent of any capital gain distributions received on those shares.
In addition, the Fund must satisfy the diversification requirements of
Section 817(h) of the Code. In general, for the Fund to meet these investment
diversification requirements, Treasury regulations require that no more than
55% of the total value of the assets of the Fund may be represented by any one
investment, no more than 70% by two investments, no more than 80% by three
investments and no more than 90% by four investments. Generally, for purposes
of the regulations, all securities of the same issuer are treated as a single
investment. With respect to the United States Government securities (including
any security that is issued, guaranteed or insured by the United States or an
instrumentality of the United States), each governmental agency or
instrumentality is treated as a separate issuer. Compliance with the
regulations is tested on the last day of each calendar year quarter. There is
a 30-day period after the end of each calendar year quarter in which to cure
any non-compliance with these requirements.
FOREIGN TRANSACTIONS
Interest and dividends received by the Fund may be subject to income,
withholding, or other taxes imposed by foreign countries and U.S. possessions
that would reduce the yield on its securities. Tax conventions between certain
countries and the United States may reduce or eliminate these foreign taxes,
however, and many foreign countries do not impose taxes on capital gains in
respect of investments by foreign investors.
31
<PAGE> 356
The Fund maintains its accounts and calculates its income in U.S. dollars.
In general, gain or loss (1) from the disposition of foreign currencies and
forward currency contracts, (2) from the disposition of
foreign-currency-denominated debt securities that are attributable to
fluctuations in exchange rates between the date the securities are acquired and
their disposition date, and (3) attributable to fluctuations in exchange rates
between the time the Fund accrues interest or other receivables or expenses or
other liabilities denominated in a foreign currency and the time the Fund
actually collects those receivables or pays those liabilities, will be treated
as ordinary income or loss. A foreign-currency-denominated debt security
acquired by the Fund may bear interest at a high normal rate that takes into
account expected decreases in the value of the principal amount of the security
due to anticipated currency devaluations; in that case, the Fund would be
required to include the interest in income as it accrues but generally would
realize a currency loss with respect to the principal only when the principal
was received (through disposition or upon maturity).
The Fund may invest in the stock of "passive foreign investment companies"
("PFICs"). A PFIC is a foreign corporation that, in general, meets either of
the following tests: (1) at least 75% of its gross income is passive or (2) an
average of at least 50% of its assets produce, or are held for the production
of, passive income. Under certain circumstances, the Fund will be subject to
federal income tax on a portion of any "excess distribution" received on the
stock or of any gain on disposition of the stock (collectively, "PFIC income"),
plus interest thereon, even if the Fund distributes the PFIC income to its
shareholders. The balance of the PFIC income will be included in the Fund's
investment company taxable income and, accordingly, will not be taxable to it
to the extent that income is distributed to its shareholders. If the Fund
invests in a PFIC and elects to treat the PFIC as a "qualified electing fund,"
then in lieu of the foregoing tax and interest obligation, the Fund will be
required to include in income each year its pro rata share of the qualified
electing fund's annual ordinary earnings and net capital gain (the excess of
net long-term capital gain over net short-term capital loss) -- which probably
would have to be distributed to its shareholders to satisfy the Distribution
Requirement -- even if those earnings and gain were not received by the Fund.
In most instances it will be very difficult, if not impossible, to make this
election because of certain requirements thereof.
DERIVATIVE INSTRUMENTS
The use of derivatives strategies, such as purchasing and selling
(writing) options and futures and entering into forward currency contracts,
involves complex rules that will determine for income tax purposes the
character and timing of recognition of the gains and losses the Fund realizes
in connection therewith. Gains from the disposition of foreign currencies
(except certain gains therefrom that may be excluded by future regulations),
and income from transactions in options, futures, and forward currency
contracts derived by the Fund with respect to its business of investing in
securities or foreign currencies, will qualify as permissible income under the
Income Requirement. However, income from the disposition of options and
futures (other than those on foreign currencies) will be subject to the 30%
Limitation if they are held for less than three months. Income from the
disposition of foreign currencies, and options, futures, and forward contracts
on foreign currencies, that are not directly related to the Fund's principal
business of investing in securities (or options and futures with respect to
securities) also will be subject to the 30% Limitation if they are held for
less than three months.
If the Fund satisfies certain requirements, any increase in value of a
position that is part of a "designated hedge" will be offset by any decrease in
value (whether realized or not) of the offsetting hedging position during the
period of the hedge for purposes of determining whether the Fund satisfies the
30% Limitation. Thus, only the net gain (if any) from the designated hedge
will be included in gross income for purposes of that limitation. The Fund
intends that, when it engages in hedging strategies, the hedging transactions
will qualify for this treatment, but at the present time it is not clear
whether this treatment will be available for all of the Fund's hedging
transactions. To the extent this treatment is not available or is not elected
by the Fund, it may be forced to defer the closing out of certain options,
futures, or forward currency contracts beyond the time when it otherwise would
be advantageous to do so, in order for the Fund to continue to qualify as a
RIC.
For federal income tax purposes, the Fund is required to recognize as
income for each taxable year its net unrealized gains and losses on options,
futures, and forward currency contracts that are subject to section 1256 of the
Code ("Section 1256 Contracts") and are held by the Fund as of the end of the
year, as well as gains and losses on Section 1256 Contracts actually realized
during the year. Except for Section 1256 Contracts that are part of a "mixed
straddle" and with respect to which the Fund makes a certain election, any gain
or loss recognized with respect to Section 1256 Contracts is considered to be
60% long-term capital gain or loss and 40% short-term capital gain or loss,
without regard to the holding period of the Section 1256 Contract. Unrealized
gains on Section 1256 Contracts that have been held by the Fund for less than
three months as of the end
32
<PAGE> 357
of its taxable year, and that are recognized for federal income tax purposes as
described above, will not be considered gains on investments held for less than
three months for purposes of the 30% Limitation.
ZERO-COUPON, STEP-COUPON, AND PAY-IN-KIND SECURITIES
The Fund may acquire zero-coupon, step-coupon, or other securities issued
with original issue discount. As a holder of those securities, the Fund must
include in its income the original issue discount that accrues on the
securities during the taxable year, even if the Fund receives no corresponding
payment on the securities during the year. Similarly, the Fund must include in
its income securities it receives as "interest" on pay-in-kind securities.
Because the Fund annually must distribute substantially all of its investment
company taxable income, including any original issue discount and other
non-cash income, to satisfy the Distribution Requirement, it may be required in
a particular year to distribute as a dividend an amount that is greater than
the total amount of cash it actually receives. Those distributions may be made
from the proceeds on sales of portfolio securities, if necessary. The Fund may
realize capital gains or losses from those sales, which would increase or
decrease its investment company taxable income or net capital gain, or both.
In addition, any such gains may be realized on the disposition of securities
held for less than three months. Because of the 30% Limitation, any such gains
would reduce the Fund's ability to sell other securities, or certain options,
futures, or forward currency contracts, held for less that three months that
it might wish to sell in the ordinary course of its portfolio management.
The foregoing federal tax discussion as well as the tax discussion
contained within the Prospectus under "Additional Information - Distributions
and Taxes" is intended to provide you with an overview of the impact of federal
income tax provisions on the Fund or its shareholders. These tax provisions
are subject to change by legislative or administrative action at the federal,
state, or local level, and any changes may be applied retroactively. Any such
action that limits or restricts the Fund's current ability to pass-through
earnings without taxation at the Fund level, or otherwise materially changes
the Fund's tax treatment, could adversely affect the value of a shareholder's
investment in the Fund. Because the Fund's taxes are a complex matter, you
should consult your tax adviser for more detailed information concerning the
taxation of the Fund and the federal, state, and local tax consequences to
shareholders of an investment in the Fund.
DETERMINATION OF NET ASSET VALUE
A more complete discussion of the Fund's determination of net asset value
is contained in the Prospectus. Generally, the net asset value of the Fund
will be determined as of the close of trading on each day the New York Stock
Exchange (the "NYSE") is open for trading. The NYSE is open for trading Monday
through Friday except New Year's Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
Additionally, if any of the aforementioned holidays falls on a Saturday, the
NYSE will not be open for trading on the preceding Friday, and when any such
holiday falls on a Sunday, the NYSE will not be open for trading on the
succeeding Monday, unless unusual business conditions exist, such as the ending
of a monthly or the yearly accounting period.
Debt securities are valued by a pricing service that utilizes electronic
data processing techniques to determine values for normal institutional-sized
trading units of debt securities without regard to sale or bid prices when
such values are believed to more accurately reflect the fair market value for
such securities. Otherwise, sale or bid prices are used. Any securities or
other assets for which market quotations are not readily available are valued
at fair value as determined in good faith by the Board of Directors of the
Corporation. Debt securities having remaining maturities of 60 days or less
are valued by the amortized cost method when the Corporation's Board of
Directors determines that the fair value of such securities is their amortized
cost. Under this method of valuation, a security is initially valued at its
acquisition cost, and thereafter, amortization of any discount or premium is
assumed each day, regardless of the impact of the fluctuating rates on the
market value of the instrument.
33
<PAGE> 358
ADDITIONAL SHAREHOLDER INFORMATION
The Fund has elected to be governed by Rule 18f-1 under the 1940 Act,
which obligates it to redeem shares in cash, with respect to any one
shareholder during any 90-day period, up to the lesser of $250,000 or 1% of the
assets of the Fund. If the Advisor determines that existing conditions make
cash payments undesirable, redemption payments may be made in whole or in part
in securities or other financial assets, valued for this purpose as they are
valued in computing the NAV for the Fund's shares (a "redemption-in-kind").
Shareholders receiving securities or other financial assets in a
redemption-in-kind may realize a gain or loss for tax purposes, and will incur
any costs of sale, as well as the associated inconveniences. If you expect to
make a redemption in excess of the lesser of $250,000 or 1% of the Fund's
assets during any 90-day period and would like to avoid any possibility of
being paid with securities in-kind, you may do so by providing Strong Funds
with an unconditional instruction to redeem at least 15 calendar days prior to
the date on which the redemption transaction is to occur, specifying the dollar
amount or number of shares to be redeemed and the date of the transaction
(please call 1-800-368-3863). This will provide the Fund with sufficient time
to raise the cash in an orderly manner to pay the redemption and thereby
minimize the effect of the redemption on the interests of the Fund's remaining
shareholders. Redemption checks in excess of the lesser of $250,000 or 1% of
the Fund's assets during any 90-day period may not be honored by the Fund if
the Advisor determines that existing conditions make cash payments undesirable.
FUND ORGANIZATION
The Fund is a series of Strong Variable Insurance Funds, Inc., a Wisconsin
corporation (the "Corporation"). The Corporation (formerly known as Strong
Discovery Fund II, Inc., formerly known as Strong D Fund, Inc.) was organized
on December 28, 1990 and is authorized to issue an indefinite shares of common
stock and series and classes of series of shares of common stock, with a par
value of $.00001 per share. The Corporation is authorized to issue an
indefinite shares of common stock of the Fund. Each share of the Corporation
has one vote, and all shares of a series participate equally in dividends and
other capital gains distributions and in the residual assets of that Fund in
the event of liquidation. Fractional shares have the same rights
proportionately as do full shares. Shares of the Corporation have no
preemptive, conversion, or subscription rights. The Corporation currently has
seven series of common stock outstanding. The assets belonging to each series
of shares is held separately by the custodian, and in effect each series is a
separate fund. All holders of shares of the Corporation would vote on each
matter presented to shareholders for action except with respect to any matter
which affects only one or more series or classes, in which case only the shares
of the affected series or class shall be entitled to vote. Because of current
federal securities law requirements the Corporation expects that its
shareholders will offer to owners of variable annuity and variable life
insurance contracts the opportunity to instruct them as to how shares allocable
to their contracts will be voted with respect to certain matters, such as
approval of changes to the investment advisory agreement.
PERFORMANCE INFORMATION
As described under "Additional Information - Performance Information" in
the Prospectus, the Fund's historical performance or return may be shown in the
form of "average annual total return," "total return," and "cumulative total
return." From time to time, the Advisor may voluntarily waive all or a portion
of its management fee and/or absorb certain expenses for the Fund. Total
returns contained in advertisements include the effect of deducting the Fund's
expenses, but may not include charges and expenses attributable to any
particular insurance product. Since shares may only be purchased by the
separate accounts of certain insurance companies, contracts owners should
carefully review the prospectus of the separate account for information on fees
and expenses. Excluding such fees and expenses from the Fund's total return
quotations has the effect of increasing the performance quoted.
AVERAGE ANNUAL TOTAL RETURN
The Fund's average annual total return quotation is computed in accordance
with a standardized method prescribed by rules of the SEC. The average annual
total return for the Fund for a specific period is found by first taking a
hypothetical $10,000 investment ("initial investment") in the Fund's shares on
the first day of the period and computing the "redeemable value" of that
investment at the end of the period. The redeemable value is then divided by
the initial investment, and this quotient is taken to the Nth root (N
representing the number of years in the period) and one is subtracted from the
result, which
34
<PAGE> 359
is then expressed as a percentage. The calculation assumes that all income and
capital gains dividends paid by the Fund have been reinvested at net asset
value on the reinvestment dates during the period.
TOTAL RETURN
Calculation of the Fund's total return is not subject to a standardized
formula. Total return performance for a specific period is calculated by first
taking an investment (assumed below to be $10,000) ("initial investment") in
the Fund's shares on the first day of the period and computing the "ending
value" of that investment at the end of the period. The total return
percentage is then determined by subtracting the initial investment from the
ending value and dividing the remainder by the initial investment and
expressing the result as a percentage. The calculation assumes that all income
and capital gains dividends paid by the Fund have been reinvested at net asset
value on the reinvestment dates during the period. Total return may also be
shown as the increased dollar value of the hypothetical investment over the
period.
CUMULATIVE TOTAL RETURN
Calculation of the Fund's cumulative total return is not subject to a
standardized formula and represents the simple change in value of an investment
over a stated period and may be quoted as a percentage or as a dollar amount.
Total returns and cumulative total returns may be broken down into their
components of income and capital (including capital gains and changes in share
price) in order to illustrate the relationship between these factors and their
contributions to total return.
The Fund's performance figures are based upon historical results and do
not represent future performance. The Fund's shares are sold at net asset
value per share. The Fund's returns and net asset value will fluctuate and
shares are redeemable at the then current net asset value of the Fund, which
may be more or less than original cost. Factors affecting the Fund's
performance include general market conditions, operating expenses, and
investment management. Any additional fees charged by an insurance company or
other financial services firm would reduce the returns described in this
section.
The Fund's total return for the three months ending March 31, 1997, was
- -2.80%.
COMPARISONS
(1) U.S. TREASURY BILLS, NOTES, OR BONDS
Investors may also wish to compare the performance of the Fund to that of
United States Treasury bills, notes, or bonds, which are issued by the U.S.
government, because such instruments represent alternative income producing
products. Treasury obligations are issued in selected denominations. Rates of
Treasury obligations are fixed at the time of issuance and payment of principal
and interest is backed by the full faith and credit of the United States
Treasury. The market value of such instruments will generally fluctuate
inversely with interest rates prior to maturity and will equal par value at
maturity.
(2) CERTIFICATES OF DEPOSIT
Investors may wish to compare the Fund's performance to that of
certificates of deposit offered by banks and other depositary institutions.
Certificates of deposit represent an alternative income producing product.
Certificates of deposit may offer fixed or variable interest rates and
principal is guaranteed and may be insured. Withdrawal of the deposits prior to
maturity normally will be subject to a penalty. Rates offered by banks and
other depositary institutions are subject to change at any time specified by
the issuing institution.
(3) MONEY MARKET FUNDS
Investors may also want to compare performance of the Fund to that of
money market funds. Money market fund yields will fluctuate and an investment
in money market fund shares is neither insured nor guaranteed by the U.S.
government, but share values usually remain stable.
(4) LIPPER ANALYTICAL SERVICES, INC. ("LIPPER") AND OTHER INDEPENDENT RANKING
ORGANIZATIONS
From time to time, in marketing and other fund literature, the Fund's
performance may be compared to the performance of other mutual funds in general
or to the performance of particular types of mutual funds, with similar
investment goals, as tracked by independent organizations. Among these
organizations, Lipper, a widely used independent research firm which ranks
mutual funds by overall performance, investment objectives, and assets, may be
cited. Lipper performance figures
35
<PAGE> 360
are based on changes in net asset value, with all income and capital gain
dividends reinvested. Such calculations do not include the effect of any sales
charges imposed by other funds. The Fund will be compared to Lipper's
appropriate fund category, that is, by fund objective and portfolio holdings.
(5) MORNINGSTAR, INC.
The Fund's performance may also be compared to the performance of other
mutual funds by Morningstar, Inc. which rates funds on the basis of historical
risk and total return. Morningstar's ratings range from five stars (highest)
to one star (lowest) and represent Morningstar's assessment of the historical
risk level and total return of the Fund as a weighted average for 3, 5, and 10
year periods. Ratings are not absolute and do not represent future results.
(6) VARDS REPORT
The Fund's performance may also be compared to the performance of other
variable annuity products in general or to the performance of particular types
of variable annuity products, with similar investment goals, as tracked by the
VARDS Report (Variable Annuity Research and Data Service Report) produced by
Financial Planning Resources, Inc. The VARDS Report is a monthly performance
analysis of the variable annuity industry.
(7) INDEPENDENT SOURCES
Evaluations of Fund performance made by independent sources may also be
used in advertisements concerning the Fund, including reprints of, or
selections from, editorials or articles about the Fund, especially those with
similar objectives. Sources for Fund performance information and articles
about the Fund may include publications such as Money, Forbes, Kiplinger's,
Smart Money, Morningstar, Inc., Financial World, Business Week, U.S. News and
World Report, The Wall Street Journal, Barron's, and a variety of investment
newsletters.
(8) INDICES
The Fund may compare its performance to a wide variety of indices
including the following:
(a) Consumer Price Index
(b) Dow Jones Average of 30 Industrials
(c) NASDAQ Over-the-Counter Composite Index
(d) Standard & Poor's 500 Stock Index
(e) Standard & Poor's 400 Mid-Cap Stock Index
(f) Standard & Poor's 600 Small-Cap Index
(g) Wilshire 4500 Index
(h) Wilshire 5000 Index
(i) Wilshire Small Cap Index
(j) Wilshire Small Cap Growth Index
(k) Wilshire Small Cap Value Index
(l) Wilshire Midcap 750 Index
(m) Wilshire Midcap Growth Index
(n) Wilshire Midcap Value Index
(o) Wilshire Large Cap Growth Index
(p) Russell 1000 Index
(q) Russell 1000 Growth Index
(r) Russell 2000 Index
(s) Russell 2000 Small Stock Index
(t) Russell 2000 Growth Index
(u) Russell 2000 Value Index
(v) Russell 2500 Index
(w) Russell 3000 Stock Index
(x) Russell MidCap Index
(y) Russell MidCap Growth Index
(z) Russell MidCap Value Index
(aa) Value Line Index
36
<PAGE> 361
(bb) Morgan Stanley Capital International EAFE(R) Index (Net
Dividend, Gross Dividend, and Price-Only). In addition, the Fund may
compare its performance to certain other indices that measure stock
market performance in geographic areas in which the Fund may invest.
The market prices and yields of the stocks in these indexes will
fluctuate. The Fund may also compare its portfolio weighting to the
EAFE Index weighting, which represents the relative capitalization
of the major overseas markets on a dollar-adjusted basis
(cc) Morgan Stanley Capital International World Index
There are differences and similarities between the investments that the
Fund may purchase for its portfolio and the investments measured by these
indicies.
(9) HISTORICAL ASSET CLASS RETURNS
From time to time, marketing materials may portray the historical returns
of various asset classes. Such presentations will typically compare the
average annual rates of return of inflation, U.S. Treasury bills, bonds, common
stocks, and small stocks. There are important differences between each of these
investments that should be considered in viewing any such comparison. The
market value of stocks will fluctuate with market conditions, and small-stock
prices generally will fluctuate more than large-stock prices. Stocks are
generally more volatile than bonds. In return for this volatility, stocks have
generally performed better than bonds or cash over time. Bond prices generally
will fluctuate inversely with interest rates and other market conditions, and
the prices of bonds with longer maturities generally will fluctuate more than
those of shorter-maturity bonds. Interest rates for bonds may be fixed at the
time of issuance, and payment of principal and interest may be guaranteed by
the issuer and, in the case of U.S. Treasury obligations, backed by the full
faith and credit of the U.S. Treasury.
(10) STRONG VARIABLE INSURANCE FUNDS
The Strong Variable Insurance Funds offer a range of investment options.
All of the members of the Strong Variable Insurance Funds and their investment
objectives are listed below. The Funds are listed in ascending order of risk
and return, as determined by the Funds' Advisor.
FUND NAME INVESTMENT OBJECTIVE
<TABLE>
<CAPTION>
FUND NAME INVESTMENT OBJECTIVE
- -----------------------------------------------------------------------------------------------------------
<S> <C>
Strong Advantage Fund II Current income with a very low degree of share-price fluctuation.
- -----------------------------------------------------------------------------------------------------------
Strong Government Securities Fund II Total return by investing for a high level of current income with a
moderate degree of share-price fluctuation.
- -----------------------------------------------------------------------------------------------------------
Strong Asset Allocation Fund II High total return consistent with reasonable risk over the long term.
- -----------------------------------------------------------------------------------------------------------
Strong Special Fund II Capital growth.
- -----------------------------------------------------------------------------------------------------------
Strong Growth Fund II Capital growth.
- -----------------------------------------------------------------------------------------------------------
Strong Discovery Fund II Capital growth.
- -----------------------------------------------------------------------------------------------------------
Strong International Stock Fund II Capital growth.
- -----------------------------------------------------------------------------------------------------------
</TABLE>
Each Fund may from time to time be compared to the other Funds in the
Strong Variable Insurance Funds based on a risk/reward spectrum. In general,
the amount of risk associated with any investment product is commensurate with
that product's potential level of reward. The Strong Variable Insurance Funds'
risk/reward continuum or any Fund's position on the continuum may be described
or diagrammed in marketing materials. The Strong Variable Insurance Funds'
risk/reward continuum positions the risk and reward potential of each Fund
relative to the other Strong Variable Insurance Funds, but is not intended to
position any Fund relative to other mutual funds or investment products.
Marketing materials may also discuss the relationship between risk and reward
as it relates to an individual investor's portfolio. Financial goals vary from
person to person. You may choose one or more of the Strong Variable Insurance
Funds to help you reach your financial goals.
The Advisor also serves as advisor to the Strong Family of Funds, which is
a retail fund complex composed of 25 open-end management investment companies.
37
<PAGE> 362
ADDITIONAL FUND INFORMATION
(1) PORTFOLIO CHARACTERISTICS
In order to present a more complete picture of the Fund's portfolio,
marketing materials may include various actual or estimated portfolio
characteristics, including but not limited to median market capitalizations,
earnings per share, alphas, betas, price/earnings ratios, returns on equity,
dividend yields, capitalization ranges, growth rates, price/book ratios, top
holdings, sector breakdowns, asset allocations, quality breakdowns, and
breakdowns by geographic region.
(2) MEASURES OF VOLATILITY AND RELATIVE PERFORMANCE
Occasionally statistics may be used to specify Fund volatility or risk.
The general premise is that greater volatility connotes greater risk undertaken
in achieving performance. Measures of volatility or risk are generally used to
compare the Fund's net asset value or performance relative to a market index.
One measure of volatility is beta. Beta is the volatility of a fund relative
to the total market as represented by the Standard & Poor's 500 Stock Index. A
beta of more than 1.00 indicates volatility greater than the market, and a beta
of less than 1.00 indicates volatility less than the market. Another measure
of volatility or risk is standard deviation. Standard deviation is a
statistical tool that measures the degree to which a fund's performance has
varied from its average performance during a particular time period.
Standard deviation is calculated using the following formula:
2
Standard deviation = the square root of E(x - x )
i m
----------
n-1
where E = "the sum of",
x = each individual return during the time period,
i
x = the average return over the time period, and
m
n = the number of individual returns during the time period.
Statistics may also be used to discuss the Fund's relative performance.
One such measure is alpha. Alpha measures the actual return of a fund compared
to the expected return of a fund given its risk (as measured by beta). The
expected return is based on how the market as a whole performed, and how the
particular fund has historically performed against the market. Specifically,
alpha is the actual return less the expected return. The expected return is
computed by multiplying the advance or decline in a market representation by
the fund's beta. A positive alpha quantifies the value that the fund manager
has added, and a negative alpha quantifies the value that the fund manager has
lost.
Other measures of volatility and relative performance may be used as
appropriate. However, all such measures will fluctuate and do not represent
future results.
GENERAL INFORMATION
BUSINESS PHILOSOPHY
The Advisor is an independent, Midwestern-based investment advisor, owned
by professionals active in its management. Recognizing that investors are the
focus of its business, the Advisor strives for excellence both in investment
management and in the service provided to investors. This commitment affects
many aspects of the business, including professional staffing, product
development, investment management, and service delivery.
The increasing complexity of the capital markets requires specialized
skills and processes for each asset class and style. Therefore, the Advisor
believes that active management should produce greater returns than a passively
managed index. The Advisor has brought together a group of top-flight
investment professionals with diverse product expertise, and each concentrates
on their investment specialty. The Advisor believes that people are the firm's
most important asset. For this reason, continuity of professionals is critical
to the firm's long-term success.
38
<PAGE> 363
INVESTMENT ENVIRONMENT
Discussions of economic, social, and political conditions and their impact
on the Fund may be used in advertisements and sales materials. Such factors
that may impact the Fund include, but are not limited to, changes in interest
rates, political developments, the competitive environment, consumer behavior,
industry trends, technological advances, macroeconomic trends, and the supply
and demand of various financial instruments. In addition, marketing materials
may cite the portfolio management's views or interpretations of such factors.
EIGHT BASIC PRINCIPLES FOR SUCCESSFUL MUTUAL FUND INVESTING
These common sense rules are followed by many successful investors. They
make sense for beginners, too. If you have a question on these principles, or
would like to discuss them with us, please contact us at 1-800-368-3863.
1. Have a plan - even a simple plan can help you take control of your
financial future. Review your plan once a year, or if your circumstances
change.
2. Start investing as soon as possible. Make time a valuable ally. Let it
put the power of compounding to work for you, while helping to reduce your
potential investment risk.
3. Diversify your portfolio. By investing in different asset classes -
stocks, bonds, and cash - you help protect against poor performance in one
type of investment while including investments most likely to help you
achieve your important goals.
4. Invest regularly. Investing is a process, not a one-time event. By
investing regularly over the long term, you reduce the impact of
short-term market gyrations, and you attend to your long-term plan before
you're tempted to spend those assets on short-term needs.
5. Maintain a long-term perspective. For most individuals, the best
discipline is staying invested as market conditions change. Reactive,
emotional investment decisions are all too often a source of regret - and
principal loss.
6. Consider stocks to help achieve major long-term goals. Over time, stocks
have provided the more powerful returns needed to help the value of your
investments stay well ahead of inflation.
7. Keep a comfortable amount of cash in your portfolio. To meet current
needs, including emergencies, use a money market fund or a bank account -
not your long-term investment assets.
8. Know what you're buying. Make sure you understand the potential risks and
rewards associated with each of your investments. Ask questions... request
information...make up your own mind. And choose a fund company that helps
you make informed investment decisions.
PORTFOLIO MANAGEMENT
The portfolio manager works with a team of analysts, traders, and
administrative personnel. From time to time, marketing materials may discuss
various members of the team, including their education, investment experience,
and other credentials.
Conventional wisdom often divides fund managers into two schools -- growth
and value. Growth-style managers look for companies that exhibit
faster-than-average gains in earnings and profits. Value-style managers
generally concentrate more on the price side of the equation, looking for
companies that are undervalued and selling at a discount to what they believe
is their intrinsic value.
39
<PAGE> 364
The style of the portfolio manager for the Fund, Mr. Ronald C. Ognar,
leans more toward growth, although he keeps an eye on valuations. The Fund's
core investments tend to be growth stocks at reasonable prices. These core
holdings are supplemented by stocks that have strong growth prospects. The
Advisor looks for growth of both sales and earnings. The Advisor believes
that, in general, good growth companies exhibit accelerating sales and
earnings, high return on equity, and, typically, low debt. They offer products
or services that should show strong future growth, and their market share is
expanding. Other characteristics that the Advisor looks for in companies
include low cost production, innovative products, and strong fundamentals
versus an index. In short, they offer some unique, sustainable competitive
advantage. These advantages can be found in companies of all market
capitalizations. However, the Advisor believes that the key is the management.
Mr. Ognar meets face-to-face with the management of many companies, which
helps him get to know and trust a company and the people in charge of it.
Currently, the Advisor is focusing on some companies that are undergoing
positive change. Oftentimes, a new product, a new technology, or a change in
management can positively affect a company's earnings growth prospects. Themes
also play a part in the investment strategy. Some examples would be the aging
population, telecommunications, and the rapid development of foreign economies
where U.S. companies have strong revenue growth.
The Advisor believes that, in the '90s, growth investors need to have both
large and small companies because core holdings with growing dividends are
usually found in larger companies, but faster growth should continue in medium
and small companies. Therefore, the Advisor utilizes a broad range of equity
market capitalizations.
The Advisor seeks to manage risk by adhering to price disciplines,
diversifying holdings across sectors, and, when appropriate, building cash
reserves.
INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P., 411 East Wisconsin Avenue, Milwaukee, Wisconsin
53202, have been selected as the independent accountants for the Fund,
providing audit services and assistance and consultation with respect to the
preparation of filings with the SEC.
LEGAL COUNSEL
Godfrey & Kahn, S.C., 780 North Water Street, Milwaukee, Wisconsin 53202,
acts as outside legal counsel for the Fund.
FINANCIAL STATEMENTS
The unaudited financial statements for the fiscal period from January 1,
1997 to March 31, 1997 attached hereto contain the following information:
(a) Schedule of Investments in Securities.
(b) Statements of Operations.
(c) Statements of Assets and Liabilities.
(d) Statements of Changes in Net Assets.
(e) Notes to Financial Statements.
(f) Financial Highlights.
40
<PAGE> 365
APPENDIX
BOND RATINGS
STANDARD & POOR'S DEBT RATINGS
A Standard & Poor's corporate or municipal debt rating is a current
assessment of the creditworthiness of an obligor with respect to a specific
obligation. This assessment may take into consideration obligors such as
guarantors, insurers, or lessees.
The debt rating is not a recommendation to purchase, sell, or hold a
security, inasmuch as it does not comment as to market price or suitability for
a particular investor.
The ratings are based on current information furnished by the issuer or
obtained by S&P from other sources it considers reliable. S&P does not perform
an audit in connection with any rating and may, on occasion, rely on unaudited
financial information. The ratings may be changed, suspended, or withdrawn as
a result of changes in, or unavailability of, such information, or based on
other circumstances.
The ratings are based, in varying degrees, on the following
considerations:
1. Likelihood of default capacity and willingness of
the obligor as to the timely payment of interest and repayment
of principal in accordance with the terms of the obligation.
2. Nature of and provisions of the obligation.
3. Protection afforded by, and relative position of,
the obligation in the event of bankruptcy, reorganization, or
other arrangement under the laws of bankruptcy and other laws
affecting creditors' rights.
INVESTMENT GRADE
AAA Debt rated 'AAA' has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA Debt rated 'AA' has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree.
A Debt rated 'A' has a strong capacity to pay interest and repay
principal, although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher-rated
categories.
BBB Debt rated 'BBB' is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
SPECULATIVE GRADE
Debt rated 'BB', 'B', 'CCC', 'CC' and 'C' is regarded as having
predominantly speculative characteristics with respect to capacity to pay
interest and repay principal. 'BB' indicates the least degree of speculation
and 'C' the highest. While such debt will likely have some quality and
protective characteristics, these are outweighed by large uncertainties or
major exposures to adverse conditions.
BB Debt rated 'BB' has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The 'BB'
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied 'BBB-' rating.
A-1
<PAGE> 366
B Debt rated 'B' has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial, or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The 'B' rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied 'BB' or 'BB-' rating.
CCC Debt rated 'CCC' has a currently identifiable vulnerability to
default, and is dependent upon favorable business, financial, and economic
conditions to meet timely payment of interest and repayment of principal. In
the event of adverse business, financial, or economic conditions, it is not
likely to have the capacity to pay interest and repay principal. The 'CCC'
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied 'B' or 'B-' rating.
CC Debt rated 'CC' typically is applied to debt subordinated to senior
debt that is assigned an actual or implied 'CCC' rating.
C Debt rated 'C' typically is applied to debt subordinated to senior debt
which is assigned an actual or implied 'CCC-' rating. The 'C' rating may be
used to cover a situation where a bankruptcy petition has been filed, but debt
service payments are continued.
CI The rating 'CI' is reserved for income bonds on which no interest is
being paid.
D Debt rated 'D' is in payment default. The 'D' rating category is used
when interest payments or principal payments are not made on the date due, even
if the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grade period. The 'D' rating also will be
used upon the filing of a bankruptcy petition if debt service payments are
jeopardized.
MOODY'S LONG-TERM DEBT RATINGS
Aaa - Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edged". Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa - Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risk appear somewhat larger than in Aaa
securities.
A - Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper-medium grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may be
present which suggest a susceptibility to impairment some time in the future.
Baa - Bonds which are rated Baa are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest
payments and principal security appear adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable over
any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba - Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate, and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
maintenance of other terms of the contract over any long period of time may be
small.
A-2
<PAGE> 367
Caa - Bonds which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to principal
or interest.
Ca - Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other marked
shortcomings.
C - Bonds which are rated C are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
FITCH INVESTORS SERVICE, INC. BOND RATINGS
Fitch investment grade bond and preferred stock ratings provide a guide to
investors in determining the credit risk associated with a particular security.
The ratings represent Fitch's assessment of the issuer's ability to meet the
obligations of a specific debt or preferred issue in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the
issuer's future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided
by insurance policies or financial guaranties unless otherwise indicated.
Bonds and preferred stock carrying the same rating are of similar but not
necessarily identical credit quality since the rating categories do not fully
reflect small differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for other reasons.
AAA Bonds and preferred stock considered to be investment grade
and of the highest credit quality. The obligor has an exceptionally
strong ability to pay interest and/or dividends and repay principal,
which is unlikely to be affected by reasonably foreseeable events.
AA Bonds and preferred stock considered to be investment grade
and of very high credit quality. The obligor's ability to pay
interest and/or dividends and repay principal is very strong,
although not quite as strong as bonds rated 'AAA'. Because bonds
and preferred stock rated in the 'AAA' and 'AA' categories are not
significantly vulnerable to foreseeable future developments,
short-term debt of the issuers is generally rated 'F-1+'.
A Bonds and preferred stock considered to be investment grade
and of high credit quality. The obligor's ability to pay interest
and/or dividends and repay principal is considered to be strong,
but may be more vulnerable to adverse changes in economic
conditions and circumstances than debt or preferred securities with
higher ratings.
BBB Bonds and preferred stock considered to be investment grade
and of satisfactory credit quality. The obligor's ability to pay
interest or dividends and repay principal is considered to be
adequate. Adverse changes in economic conditions and circumstances,
however, are more likely to have adverse impact on these securities
and, therefore, impair timely payment. The likelihood that the
ratings of these bonds or preferred will fall below investment grade
is higher than for securities with higher ratings.
A-3
<PAGE> 368
Fitch speculative grade bond or preferred stock ratings provide a guide to
investors in determining the credit risk associated with a particular security.
The ratings ('BB' to 'C') represent Fitch's assessment of the likelihood of
timely payment of principal and interest or dividends in accordance with the
terms of obligation for issues not in default. For defaulted bonds or
preferred stock, the rating ('DDD' to 'D') is an assessment of the ultimate
recovery value through reorganization or liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer or possible recovery value in
bankruptcy, the current and prospective financial condition and operating
performance of the issuer and any guarantor, as well as the economic and
political environment that might affect the issuer's future financial strength.
Bonds or preferred stock that have the same rating are of similar but not
necessarily identical credit quality since the rating categories cannot fully
reflect the differences in the degrees of credit risk.
BB Bonds or preferred stock are considered speculative. The
obligor's ability to pay interest or dividends and repay principal
may be affected over time by adverse economic changes. However,
business and financial alternatives can be identified, which could
assist the obligor in satisfying its debt service requirements.
B Bonds or preferred stock are considered highly speculative.
While bonds in this class are currently meeting debt service
requirements or paying dividends, the probability of continued
timely payment of principal and interest reflects the obligor's
limited margin of safety and the need for reasonable business and
economic activity throughout the life of the issue.
CCC Bonds or preferred stock have certain identifiable
characteristics that, if not remedied, may lead to default. The
ability to meet obligations requires an advantageous business and
economic environment.
CC Bonds or preferred stock are minimally protected. Default
in payment of interest and/or principal seems probable over time.
C Bonds are in imminent default in payment of interest or
principal or suspension of preferred stock dividends is imminent.
DDD,
DD,
and D Bonds are in default on interest and/or principal payments
or preferred stock dividends are suspended. Such securities are
extremely speculative and should be valued on the basis of their
ultimate recovery value in liquidation or reorganization of the
obligor. 'DDD' represents the highest potential for recovery of
these securities, and 'D' represents the lowest potential for
recovery.
DUFF & PHELPS, INC. LONG-TERM DEBT RATINGS
These ratings represent a summary opinion of the issuer's long-term
fundamental quality. Rating determination is based on qualitative and
quantitative factors which may vary according to the basic economic and
financial characteristics of each industry and each issuer. Important
considerations are vulnerability to economic cycles as well as risks related to
such factors as competition, government action, regulation, technological
obsolescence, demand shifts, cost structure, and management depth and
expertise. The projected viability of the obligor at the trough of the cycle
is a critical determination.
Each rating also takes into account the legal form of the security, (e.g.,
first mortgage bonds, subordinated debt, preferred stock, etc.). The extent of
rating dispersion among the various classes of securities is determined by
several factors including relative weightings of the different security classes
in the capital structure, the overall credit strength of the issuer, and the
nature of covenant protection. Review of indenture restrictions is important
to the analysis of a company's operating and financial constraints. From time
to time, Duff & Phelps Credit Rating Co. places issuers or security classes on
Rating Watch. The Rating Watch Status results from a need to notify investors
and the issuer that there are conditions present leading us to re-evaluate the
current rating(s). A listing on Rating Watch, however, does not mean a rating
change is inevitable. The Rating Watch Status can either be resolved quickly
or over a longer period of time, depending on the reasons surrounding the
A-4
<PAGE> 369
placement on Rating Watch. The "up" designation means a rating may be
upgraded; the "down" designation means a rating may be downgraded, and the
uncertain designation means a rating may be raised or lowered.
The Credit Rating Committee formally reviews all ratings once per quarter
(more frequently, if necessary). Ratings of 'BBB-' and higher fall within the
definition of investment grade securities, as defined by bank and insurance
supervisory authorities. Structured finance issues, including real estate,
asset-backed and mortgage-backed financings, use this same rating scale with
minor modification in the definitions. Thus, an investor can compare the
credit quality of investment alternatives across industries and structural
types. A "Cash Flow Rating" (as noted for specific ratings) addresses the
likelihood that aggregate principal and interest will equal or exceed the rated
amount under appropriate stress conditions.
<TABLE>
<CAPTION>
RATING SCALE DEFINITION
- -------------------------------------------------------------------------------------------------
<S> <C>
AAA Highest credit quality. The risk factors are negligible, being only slightly more
than for risk-free U.S. Treasury debt.
- -------------------------------------------------------------------------------------------------
AA+ High credit quality. Protection factors are strong. Risk is modest, but may
AA vary slightly from time to time because of economic conditions.
AA-
- -------------------------------------------------------------------------------------------------
A+ Protection factors are average but adequate. However, risk factors are more
A variable and greater in periods of economic stress.
A-
- -------------------------------------------------------------------------------------------------
BBB+ Below-average protection factors but still considered sufficient for prudent
BBB investment. Considerable variability in risk during economic cycles.
BBB-
- -------------------------------------------------------------------------------------------------
BB+ Below investment grade but deemed likely to meet obligations when due.
BB Present or prospective financial protection factors fluctuate according to
BB- industry conditions or company fortunes. Overall quality may move up or
down frequently within this category.
- -------------------------------------------------------------------------------------------------
B+ Below investment grade and possessing risk that obligations will not be met
B when due. Financial protection factors will fluctuate widely according to
B- economic cycles, industry conditions and/or company fortunes. Potential
exists for frequent changes in the rating within this category or into a higher
or lower rating grade.
- -------------------------------------------------------------------------------------------------
CCC Well below investment grade securities. Considerable uncertainty exists as to
timely payment of principal, interest or preferred dividends.
Protection factors are narrow and risk can be substantial with unfavorable
economic/industry conditions, and/or with unfavorable company developments.
- -------------------------------------------------------------------------------------------------
DD Defaulted debt obligations. Issuer failed to meet scheduled principal and/or
interest payments.
DP Preferred stock with dividend arrearages.
</TABLE>
A-5
<PAGE> 370
A-6
<PAGE> 371
IBCA LONG-TERM DEBT RATINGS
AAA - Obligations for which there is the lowest expectation of investment
risk. Capacity for timely repayment of principal and interest is substantial,
such that adverse changes in business, economic or financial conditions are
unlikely to increase investment risk substantially.
AA - Obligations for which there is a very low expectation of investment
risk. Capacity for timely repayment of principal and interest is substantial.
Adverse changes in business, economic or financial conditions may increase
investment risk, albeit not very significantly.
A - Obligations for which there is a low expectation of investment risk.
Capacity for timely repayment of principal and interest is strong, although
adverse changes in business, economic or financial conditions may lead to
increased investment risk.
BBB - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial
conditions are more likely to lead to increased investment risk than for
obligations in other categories.
BB - Obligations for which there is a possibility of investment risk
developing. Capacity for timely repayment of principal and interest exists,
but is susceptible over time to adverse changes in business, economic or
financial conditions.
B - Obligations for which investment risk exists. Timely repayment of
principal and interest is not sufficiently protected against adverse changes in
business, economic or financial conditions.
CCC - Obligations for which there is a current perceived possibility of
default. Timely repayment of principal and interest is dependent on favorable
business, economic or financial conditions.
CC - Obligations which are highly speculative or which have a high risk of
default.
C - Obligations which are currently in default.
Notes: "+" or "-" may be appended to a rating below AAA to denote relative
status within major rating categories. Ratings of BB and below are assigned
where it is considered that speculative characteristics are present.
THOMSON BANKWATCH LONG-TERM DEBT RATINGS
Long-Term Debt Ratings assigned by Thomson BankWatch also weigh heavily
government ownership and support. The quality of both the company's management
and franchise are of even greater importance in the Long-Term Debt Rating
decisions. Long-Term Debt Ratings look out over a cycle and are not adjusted
frequently for what we believe are short-term performance aberrations.
Long-Term Debt Ratings can be restricted to local currency debt - ratings
will be identified by the designation LC. In addition, Long-Term Debt Ratings
may include a plus (+) or minus (-) to indicate where within the category the
issue is placed. BankWatch Long-Term Debt Ratings are based on the following
scale:
Investment Grade
AAA (LC-AAA) - Indicates that the ability to repay principal and interest
on a timely basis is extremely high.
AA (LC-AA) - Indicates a very strong ability to repay principal and
interest on a timely basis, with limited incremental risk compared to issues
rated in the highest category.
A (LC-A) - Indicates the ability to repay principal and interest is
strong. Issues rated A could be more vulnerable to adverse developments (both
internal and external) than obligations with higher ratings.
A-7
<PAGE> 372
BBB (LC-BBB) - The lowest investment-grade category; indicates an
acceptable capacity to repay principal and interest. BBB issues are more
vulnerable to adverse developments (both internal and external) than
obligations with higher ratings.
Non-Investment Grade - may be speculative in the likelihood of timely repayment
of principal and interest
BB (LC-BB) - While not investment grade, the BB rating suggests that the
likelihood of default is considerably less than for lower-rated issues.
However, there are significant uncertainties that could affect the ability to
adequately service debt obligations.
B (LC-B) - Issues rated B show higher degree of uncertainty and therefore
greater likelihood of default than higher-rated issues. Adverse developments
could negatively affect the payment of interest and principal on a timely
basis.
CCC (LC-CCC) - Issues rated CCC clearly have a high likelihood of default,
with little capacity to address further adverse changes in financial
circumstances.
CC (LC-CC) - CC is applied to issues that are subordinate to other
obligations rated CCC and are afforded less protection in the event of
bankruptcy or reorganization.
D (LC-D) - Default.
SHORT-TERM RATINGS
STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt considered short-term in the relevant
market.
Ratings are graded into several categories, ranging from 'A-1' for the
highest quality obligations to 'D' for the lowest. These categories are as
follows:
A-1 This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus sign (+) designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated 'A-1'.
A-3 Issues carrying this designation have adequate capacity for timely
payment. They are, however, more vulnerable to the adverse effects of changes
in circumstances than obligations carrying the higher designations.
B Issues rated 'B' are regarded as having only speculative capacity for
timely payment.
C This rating is assigned to short-term debt obligations with doubtful
capacity for payment.
D Debt rated 'D' is in payment default. The 'D' rating category is used
when interest payments or principal payments are not made on the date due, even
if the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grace period.
STANDARD & POOR'S NOTE RATINGS
An S&P note rating reflects the liquidity factors and market-access risks
unique to notes. Notes maturing in three years or less will likely receive a
note rating. Notes maturing beyond three years will most likely receive a
long-term debt rating.
A-8
<PAGE> 373
The following criteria will be used in making the assessment:
- Amortization schedule - the larger the final maturity
relative to other maturities, the more likely the issue is to be
treated as a note.
- Source of payment - the more the issue depends on the market
for its refinancing, the more likely it is to be treated as a note.
Note rating symbols and definitions are as follows:
SP-1 Strong capacity to pay principal and interest. Issues determined to
possess very strong characteristics are given a plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term of the
notes.
SP-3 Speculative capacity to pay principal and interest.
MOODY'S SHORT-TERM RATINGS
Moody's short-term debt ratings are opinions of the ability of issuers to
repay punctually senior debt obligations. These obligations have an original
maturity not exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment ability of rated issuers:
Issuers rated PRIME-1 (or supporting institutions) have a superior ability
for repayment of senior short-term debt obligations. Prime-1 repayment ability
will often be evidenced by many of the following characteristics: (i) leading
market positions in well-established industries, (ii) high rates of return on
funds employed, (iii) conservative capitalization structure with moderate
reliance on debt and ample asset protection, (iv) broad margins in earnings
coverage of fixed financial charges and high internal cash generation, and (v)
well established access to a range of financial markets and assured sources of
alternate liquidity.
Issuers rated PRIME-2 (or supporting institutions) have a strong ability
for repayment of senior short-term debt obligations. This will normally be
evidenced by many of the characteristics cited above, but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be
more affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated PRIME-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The effect of industry
characteristics and market compositions may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt
protection measurements and may require relatively high financial leverage.
Adequate alternate liquidity is maintained.
Issuers rated NOT PRIME do not fall within any of the Prime rating
categories.
FITCH INVESTORS SERVICE, INC. SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes.
A-9
<PAGE> 374
The short-term rating places greater emphasis than a long-term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
F-1+ Exceptionally Strong Credit Quality. Issues assigned this
rating are regarded as having the strongest degree of assurance for
timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating
reflect an assurance of timely payment only slightly less in degree
than issues rated 'F-1+'.
F-2 Good Credit Quality. Issues assigned this rating have a
satisfactory degree of assurance for timely payment but the margin
of safety is not as great as for issues assigned 'F-1+' and 'F-1'
ratings.
F-3 Fair Credit Quality. Issues assigned this rating have
characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause
these securities to be rated below investment grade.
F-S Weak Credit Quality. Issues assigned this rating have
characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial
and economic conditions.
D Default. Issues assigned this rating are in actual or
imminent payment default.
LOC The symbol LOC indicates that the rating is based on a letter
of credit issued by a commercial bank.
DUFF & PHELPS, INC. SHORT-TERM DEBT RATINGS
Duff & Phelps' short-term ratings are consistent with the rating criteria
used by money market participants. The ratings apply to all obligations with
maturities of under one year, including commercial paper, the uninsured portion
of certificates of deposit, unsecured bank loans, master notes, bankers
acceptances, irrevocable letters of credit, and current maturities of long-term
debt. Asset-backed commercial paper is also rated according to this scale.
Emphasis is placed on liquidity which is defined as not only cash from
operations, but also access to alternative sources of funds including trade
credit, bank lines, and the capital markets. An important consideration is the
level of an obligor's reliance on short-term funds on an ongoing basis.
The distinguishing feature of Duff & Phelps' short-term ratings is the
refinement of the traditional '1' category. The majority of short-term debt
issuers carry the highest rating, yet quality differences exist within that
tier. As a consequence, Duff & Phelps has incorporated gradations of '1+' (one
plus) and '1-' (one minus) to assist investors in recognizing those
differences.
From time to time, Duff & Phelps places issuers or security classes on
Rating Watch. The Rating Watch status results from a need to notify investors
and the issuer that there are conditions present leading us to re-evaluate the
current rating(s). A listing on Rating Watch, however, does not mean a rating
change is inevitable.
The Rating Watch status can either be resolved quickly or over a longer
period of time, depending on the reasons surrounding the placement on Rating
Watch. The "up" designation means a rating may be upgraded; the "down"
designation means a rating may be downgraded, and the "uncertain" designation
means a rating may be raised or lowered.
Rating Scale: Definition
High Grade
A-10
<PAGE> 375
D-1+ Highest certainty of timely payment. Short-Term liquidity,
including internal operating factors and/or access to alternative
sources of funds, is outstanding, and safety is just below risk-free
U.S. Treasury short-term obligations.
D-1 Very high certainty of timely payment. Liquidity factors are
excellent and supported by good fundamental protection factors.
Risk factors are minor.
D-1- High certainty of timely payment. Liquidity factors are
strong and supported by good fundamental protection factors. Risk
factors are very small.
Good Grade
D-2 Good certainty of timely payment. Liquidity factors and
company fundamentals are sound. Although ongoing funding needs may
enlarge total financing requirements, access to capital markets is
good. Risk factors are small.
Satisfactory Grade
D-3 Satisfactory liquidity and other protection factors qualify
issues as to investment grade. Risk factors are larger and subject
to more variation. Nevertheless, timely payment is expected.
Non-Investment Grade
D-4 Speculative investment characteristics. Liquidity is not
sufficient to insure against disruption in debt service. Operating
factors and market access may be subject to a high degree of
variation.
Default
D-5 Issuer failed to meet scheduled principal and/or interest payments.
THOMSON BANKWATCH (TBW) SHORT-TERM RATINGS
The TBW Short-Term Ratings apply, unless otherwise noted, to specific debt
instruments of the rated entities with a maturity of one year or less. TBW
Short-Term Ratings are intended to assess the likelihood of an untimely or
incomplete payments of principal or interest.
TBW-1 The highest category; indicates a very high likelihood that
principal and interest will be paid on a timely basis.
TBW-2 The second highest category; while the degree of safety regarding
timely repayment of principal and interest is strong, the relative degree of
safety is not as high as for issues rated "TBW-1".
TBW-3 The lowest investment-grade category; indicates that while the
obligation is more susceptible to adverse developments (both internal and
external) than those with higher ratings, the capacity to service principal and
interest in a timely fashion is considered adequate.
TBW-4 The lowest rating category; this rating is regarded as
non-investment grade and therefore speculative.
IBCA SHORT-TERM RATINGS
IBCA Short-Term Ratings assess the borrowing characteristics of banks and
corporations, and the capacity for timely repayment of debt obligations. The
Short-Term Ratings relate to debt which has a maturity of less than one year.
A-11
<PAGE> 376
A1 Obligations supported by the highest capacity for timely repayment.
Where issues possess a particularly strong credit feature, a rating of
A1+ is assigned.
A2 Obligations supported by a good capacity for timely repayment.
A3 Obligations supported by a satisfactory capacity for timely repayment.
B Obligations for which there is an uncertainty as to the capacity to
ensure timely repayment.
C Obligations for which there is a high risk of default or which are
currently in default.
A-12
<PAGE> 377
<TABLE>
<CAPTION>
SCHEDULE OF INVESTMENTS IN SECURITIES 3/31/97 (UNAUDITED)
- -------------------------------------------------------------------------
STRONG GROWTH FUND II SHARES OR
PRINCIPAL VALUE
AMOUNT (NOTE 2)
- -------------------------------------------------------------------------
<S> <C> <C>
COMMON STOCK 76.8%
BANK - MONEY CENTER 2.9%
Chase Manhattan Corporation 50 $ 4,681
Citicorp 50 5,412
-------
10,093
BANK - REGIONAL 2.1%
First Bank System, Inc. 100 7,300
BANK - SUPER REGIONAL 1.3%
Norwest Corporation 100 4,625
BROKERAGE & INVESTMENT MANAGEMENT 7.8%
First Union Real Estate Equity & Mortgage Investments
Share Beneficial Interest 500 6,625
Franklin Resources, Inc. 100 5,100
Patriot American Hospitality, Inc. 200 4,850
The Charles Schwab Corporation 100 3,187
Starwood Lodging Trust 200 7,800
-------
27,562
CHEMICAL 2.2%
Monsanto Company 200 7,650
COMMERCIAL SERVICE 0.5%
Romac International, Inc. (b) 100 1,769
COMPUTER SOFTWARE 2.6%
Cisco Systems, Inc. (b) 50 2,406
McAfee Associates, Inc. (b) 50 2,213
Microsoft Corporation (b) 50 4,584
-------
9,203
CONSUMER - MISCELLANEOUS 0.8%
Service Corporation International 100 2,975
DIVERSIFIED OPERATIONS 1.3%
Corning, Inc. 100 4,437
ELECTRONICS - SEMICONDUCTOR/COMPONENT 4.7%
Altera Corporation (b) 50 2,150
Applied Materials, Inc. (b) 100 4,637
Intel Corporation 30 4,174
National Semiconductor Corporation (b) 100 2,750
Teradyne, Inc. (b) 100 2,887
-------
16,598
FINANCE - MISCELLANEOUS 0.7%
Nationwide Financial Services, Inc. Class A (b) 100 2,575
HEALTHCARE - DRUG/DIVERSIFIED 6.1%
Abbott Laboratories 50 2,806
Johnson & Johnson 100 5,287
Merck & Company, Inc. 80 6,740
Pfizer, Inc. 80 6,730
-------
21,563
HEALTHCARE - INSTRUMENTATION 0.9%
Medtronic, Inc. 50 3,112
HEALTHCARE - MEDICAL SUPPLY 4.6%
Amerisource Distribution Corporation Class A (b) 100 4,375
Cardinal Health, Inc. 100 5,437
McKesson Corporation 100 6,400
-------
16,212
</TABLE>
<PAGE> 378
<TABLE>
<S> <C> <C>
HEALTHCARE - PATIENT CARE 2.2%
Healthsouth Corporation (b) 400 $ 7,650
HEALTHCARE - PRODUCT 1.2%
Boston Scientific Corporation (b) 70 4,323
HOUSING RELATED 1.4%
Watsco, Inc. 200 5,100
INSURANCE - DIVERSIFIED 1.4%
Travelers Corporation 100 4,788
INSURANCE - MULTI-LINE 2.0%
MGIC Investment Corporation 100 7,075
INSURANCE - PROPERTY & CASUALTY 1.7%
American International Group, Inc. 50 5,869
LEISURE SERVICE 5.5%
CapStar Hotel Company (b) 200 5,600
Carnival Corporation Class A 100 3,700
Extended Stay America, Inc. (b) 100 1,475
HFS, Inc. (b) 150 8,831
-------
19,606
METAL PRODUCTS & FABRICATION 2.3%
Illinois Tool Works, Inc. 100 8,163
NATURAL GAS DISTRIBUTION 1.3%
The Williams Companies, Inc. 100 4,450
OFFICE AUTOMATION 0.9%
Danka Business Systems PLC Sponsored ADR 100 3,144
OIL WELL EQUIPMENT & SERVICE 1.8%
Global Marine, Inc. (b) 100 2,150
Pride Petroleum Services, Inc. (b) 200 4,150
-------
6,300
PAPER & FOREST PRODUCTS 3.7%
Fort Howard Corporation (b) 100 3,113
Kimberly-Clark Corporation 100 9,938
-------
13,051
PERSONAL & COMMERCIAL LENDING 0.8%
Firstplus Financial Group (b) 100 3,013
RETAIL - DEPARTMENT STORE 1.2%
Kohl's Corporation (b) 100 4,238
RETAIL - DISCOUNT & VARIETY 3.9%
Consolidated Stores Corporation (b) 200 7,050
Dollar General Corporation 100 3,125
Dollar Tree Stores, Inc. (b) 100 3,700
-------
13,875
RETAIL - DRUG STORE 1.2%
Walgreen Company 100 4,188
RETAIL - SPECIALTY 1.5%
CUC International, Inc. (b) 100 2,250
Corporate Express, Inc. (b) 300 3,075
-------
5,325
SAVINGS & LOAN 1.4%
Washington Mutual, Inc. 100 4,831
TELECOMMUNICATION EQUIPMENT 1.0%
Tellabs, Inc. (b) 100 3,613
</TABLE>
<PAGE> 379
<TABLE>
<S> <C> <C>
TELECOMMUNICATION SERVICE 0.6%
WorldCom, Inc. (b) 100 $ 2,200
TELEPHONE 1.3%
Cincinnati Bell, Inc. 80 4,520
--------
Total Common Stocks (Cost $281,006) 270,996
SHORT-TERM INVESTMENTS (a) 15.8%
COMMERCIAL PAPER
INTEREST BEARING, DUE UPON DEMAND
American Family Financial Services, Inc., 5.29% $ 13 13,000
General Mills, Inc., 5.27% 12 12,000
Johnson Controls, Inc., 5.31% 11 10,800
Pitney Bowes Credit Corporation, 5.29% 12 12,000
Sara Lee Corporation, 5.27% 5 5,400
Wisconsin Electric Power Company, 5.33% 3 2,500
--------
TOTAL SHORT-TERM INVESTMENTS (COST $55,700) 55,700
--------
TOTAL INVESTMENTS IN SECURITIES (COST $336,706) 92.6% 326,696
Other Assets and Liabilities, Net 7.4% 26,300
--------
NET ASSETS 100.0% $352,996
========
</TABLE>
<TABLE>
<CAPTION>
PERCENTAGE OF
COUNTRY DIVERSIFICATION NET ASSETS
- -----------------------------------------------------------------------------
<S> <C>
United States . . . . . . . . . . . . . . . . . . . . . . . . . 91.7%
United Kingdom . . . . . . . . . . . . . . . . . . . . . . . . . 0.9%
Other Assets and Liabilities, Net. . . . . . . . . . . . . . . . 7.4%
-----
Total 100.0%
=====
</TABLE>
Legend
(a) Short-term investments include any security which has
a maturity of less than one year.
(b) Non-income producing security.
Percentages are stated as a percent of net assets.
<PAGE> 380
STATEMENT OF OPERATIONS
- -------------------------------------------------------------------------
For the Period Ended March 31, 1997 (Unaudited)
<TABLE>
<S> <C>
INCOME:
Dividends $ 810
Interest 895
--------
Total Income 1,705
EXPENSES:
Investment Advisory Fees 1,102
Custodian Fees 1,381
Reports to Shareholders 160
Other 281
--------
Total Expenses before Waivers 2,924
Voluntary Expense Waivers by Advisor (680)
--------
Expenses, Net 2,244
--------
NET INVESTMENT LOSS (539)
REALIZED AND UNREALIZED GAIN (LOSS):
Net Realized Gain on Investments 7,672
Change in Unrealized Appreciation/Depreciation on Investments (10,010)
--------
NET LOSS (2,338)
--------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS ($2,877)
========
</TABLE>
See notes to financial statements.
<PAGE> 381
STATEMENT OF ASSETS AND LIABILITIES
- -------------------------------------------------------------------
March 31, 1997 (Unaudited)
<TABLE>
<S> <C>
ASSETS:
Investments in Securities, at Value
(Cost of $336,706) $326,696
Receivable from Brokers for Securities and
Forward Foreign Currency Contracts Sold 26,251
Dividends and Interest Receivable 531
Other Assets 12,130
--------
Total Assets 365,608
LIABILITIES:
Accrued Operating Expenses and Other Liabilities 12,612
--------
NET ASSETS $352,996
========
CAPITAL SHARES OUTSTANDING (UNLIMITED NUMBER AUTHORIZED) 36,331
NET ASSET VALUE PER SHARE $ 9.72
========
</TABLE>
See notes to financial statements.
<PAGE> 382
STATEMENT OF CHANGES IN NET ASSETS
- -----------------------------------------------------------------------
<TABLE>
<CAPTION>
PERIOD ENDED
MARCH 31, 1997
(UNAUDITED)
-----------
(NOTE 1)
<S> <C>
Operations:
Net Investment Loss ($539)
Net Realized Gain 7,672
Change in Unrealized Appreciation/Depreciation (10,010)
--------
Decrease in Net Assets Resulting from Operations (2,877)
CAPITAL SHARE TRANSACTIONS 355,873
--------
TOTAL INCREASE IN NET ASSETS 352,996
NET ASSETS:
Beginning of Period ---
--------
End of Period $352,996
========
</TABLE>
See notes to financial statements.
<PAGE> 383
FINANCIAL HIGHLIGHTS
- ------------------------------------------------------------------------
<TABLE>
<CAPTION>
3/31/97(b)
-----------
(UNAUDITED)
<S> <C>
SELECTED PER-SHARE DATA (a)
NET ASSET VALUE, BEGINNING OF PERIOD $ 10.00
INCOME FROM INVESTMENT OPERATIONS:
Net Investment Loss (0.01)
Net Realized and Unrealized Losses on Investments (0.27)
--------
Total from Investment Operations (0.28)
--------
NET ASSET VALUE, END OF PERIOD $ 9.72
========
TOTAL RETURN -2.8%
RATIOS AND SUPPLEMENTAL DATA
Net Assets, End of Period $352,996
Ratio of Expenses to Average Net Assets 2.0% *
Ratio of Expenses to Average Net Assets
Without Waivers and Absorptions 2.6% *
Ratio of Net Investment Income to Average Net Assets (0.5%) *
Portfolio Turnover Rate 119.9%
Average Commission Rate Paid $ 0.0661
</TABLE>
* Calculated on an annualized basis.
(a) Information presented relates to a share of capital stock of the Fund
outstanding for the entire period.
(b) Inception date is 12/31/96.
<PAGE> 384
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
March 31, 1997 (Unaudited)
1. ORGANIZATION
The Strong Growth Fund II commenced operations on December 31, 1996, and is a
diversified series of the Strong Variable Insurance Funds, Inc., an open-end
management investment company registered under the Investment Company Act of
1940.
2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies followed by the
Fund in the preparation of its financial statements.
(A) Security Valuation -- Portfolio securities traded primarily on a
principal securities exchange are valued at the last reported sales
price or the mean between the latest bid and asked prices where no last
sales price is available. Securities traded over-the-counter are valued
at the mean of the latest bid and asked prices or the last reported
sales price. Debt securities not traded on a principal securities
exchange are valued through valuation obtained from a commercial pricing
service, otherwise sale or bid prices are used. Securities for which
market quotations are not readily available when held by the Fund are
valued at fair value as determined in good faith under consistently
applied procedures established by and under the general supervision of
the Board of Directors. Securities which are purchased within 60 days
of their stated maturity are valued at amortized cost, which
approximates current value.
The Fund may own certain investment securities which are restricted as
to resale. These securities are valued after giving due consideration
to pertinent factors, including recent private sales, market conditions
and the issuer's financial performance. The Fund generally bears the
costs, if any, associated with the disposition of restricted securities.
(B) Federal Income and Excise Taxes and Distributions to Shareholders --
It is the Fund's policy to comply with the requirements of the Internal
Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders
in a manner which results in no tax cost to the Fund. Therefore, no
Federal income or excise tax provision is required.
The character of distributions made during the year from net investment
income or net realized gains may differ from the characterization for
Federal income tax purposes due to differences in the recognition of
income and expense items for financial statement and tax purposes.
Where appropriate, reclassifications between net asset accounts are made
for such differences that are permanent in nature.
(C) Realized Gains and Losses on Investment Transactions -- Gains or
losses realized on investment transactions are determined by comparing
the identified cost of the security lot sold with the net sales
proceeds.
(D) Futures -- Upon entering into a futures contract, the Fund pledges to
the broker cash or other investments equal to the minimum "initial
margin" requirements of the exchange. The Fund also receives from or
pays to the broker an amount of cash equal to the daily fluctuation in
the value of the contract. Such receipts or payments are known as
"variation margin," and are recorded as unrealized gains or losses.
When the futures contract is closed, a realized gain or loss is recorded
equal to the difference between the value of the contract at the time it
was opened and the value at the time it was closed.
(E) Options -- Premiums received by the Fund upon writing put or call
options are recorded as an asset with a corresponding liability which is
subsequently adjusted to the current market value of the option. When
an option expires, is exercised, or is closed, the Fund realizes a gain
or loss, and the liability is eliminated. The Fund continues to bear
the risk of adverse movements in the price of the underlying asset
during the period of the option, although any potential loss during the
period would be reduced by the amount of the option premium received.
(F) Foreign Currency Translation -- Investment securities and other
assets and liabilities initially expressed in foreign currencies are
converted to U.S. dollars based upon current exchange rates. Purchases
and sales of foreign investment securities and income are converted to
U.S. dollars based upon currency exchange rates prevailing on the
respective dates of such transactions. The effect of changes in foreign
exchange rates on realized and unrealized security gains or losses is
reflected as a component of such gains or losses.
(G) Forward Foreign Currency Exchange Contracts -- Forward foreign
currency exchange contracts are valued at the forward rate and are
marked-to-market daily. The change in market value is recorded as an
unrealized gain or loss. When the contract is closed, the Fund records
an exchange gain or loss equal to the difference between the value of
the contract at the time it was opened and the value at the time it was
closed.
(H) Additional Investment Risk -- The use of futures contracts, options,
foreign denominated assets, forward foreign currency exchange contracts
and other similar instruments for purposes of hedging the Fund's
investment portfolio involves, to varying degrees, elements of market
risk in excess of the amount recognized in the statement of assets and
liabilities. The predominant risk with futures contracts is an
imperfect correlation between the value of the contracts and the
underlying securities. Foreign denominated assets and forward foreign
currency exchange contracts may involve greater risks than domestic
transactions, including currency, political and economic, regulatory and
market risks.
<PAGE> 385
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
March 31, 1997 (Unaudited)
(I) Use of Estimates -- The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements, and the
reported amounts of increases and decreases in net assets from
operations during the reporting period. Actual results could differ
from those estimates.
(J) Other -- Investment security transactions are recorded as of the
trade date. Dividend income and distributions to shareholders are
recorded on the ex-dividend date. Interest income is recorded on the
accrual basis and includes amortization of premium and discounts.
3. NET ASSETS
Net assets as of March 31, 1997 were as follows:
CAPITAL STOCK $355,873
Undistributed Net Investment Loss (539)
Undistributed Net Realized Gain 7,672
Net Unrealized Depreciation (10,010)
--------
$352,996
========
4. CAPITAL SHARE TRANSACTIONS
Transactions in shares of the Fund for the period ended March 31, 1997 were
as follows:
1997
-----------------
SHARES DOLLARS
------ --------
Shares Sold 50,556 $505,875
Shares Redeemed (14,225) (150,002)
------ --------
36,331 $355,873
====== ========
5. RELATED PARTY TRANSACTIONS
Strong Capital Management, Inc. (the "Advisor"), with whom certain officers
and directors of the Fund are affiliated, provides investment advisory
services to the Fund. Investment advisory fees, which are established by
terms of the Advisory Agreement, are based on an annualized rate of 1.00% of
the average daily net assets of the Fund. Advisory fees are subject to
reimbursement by the Advisor if the Fund's operating expenses exceed certain
levels.
The Fund may invest cash reserves in money market funds sponsored and
managed by Strong Capital Management, Inc., subject to certain limitations.
The terms of such transactions are identical to those of non-related
entities except that, to avoid duplicate investment advisory fees, the
Advisor remits to the Fund an amount equal to all fees otherwise due to the
Fund under its investment advisory agreement for the assets invested in such
money market funds.
The amount payable to the Advisor at March 31, 1997 and unaffiliated
directors' fees, excluding the effect of waivers, for the period ended
March 31, 1997 were $11,583 and $375, respectively.
6. INVESTMENT TRANSACTIONS
The aggregate purchases and sales of long-term securities for the period
ended March 31, 1997 were $712,924 and $441,586, respectively.
<PAGE> 386
STRONG GOVERNMENT SECURITIES FUND II
Strong Government Securities Fund II (the "Fund") is a diversified series of
the Strong Variable Insurance Funds, Inc. (the "Corporation"), an open-end
management investment company, commonly called a mutual fund. The Fund seeks
total return by investing for a high level of current income with a moderate
degree of share-price fluctuation. The Fund normally invests at least 80% of its
net assets in U.S. government securities.
Shares of the Fund are only offered and sold to the separate accounts of
certain insurance companies for the purpose of funding variable annuity and
variable life insurance contracts. This Prospectus should be read together with
the prospectus of the separate account of the specific insurance product which
preceded or accompanies this Prospectus.
This Prospectus contains information that you should consider before you
invest. Please read it carefully and keep it for future reference. A Statement
of Additional Information for the Fund, dated May 1, 1997, which contains
further information, is incorporated by reference into this Prospectus, and has
been filed with the Securities and Exchange Commission ("SEC"). This Statement,
which may be revised from time to time, is available upon request and without
charge by writing to the Fund at P.O. Box 2936, Milwaukee, Wisconsin 53201 or by
calling 1-800-368-1683.
============================================================================
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
- ----------------------------------------------------------------------------
Dated May 1, 1997
-------------------
PROSPECTUS PAGE 1
<PAGE> 387
TABLE OF CONTENTS
<TABLE>
<S> <C>
THE FUND................................. 2
FINANCIAL HIGHLIGHTS..................... 3
INVESTMENT OBJECTIVE AND POLICIES........ 4
FUNDAMENTALS OF FIXED INCOME INVESTING... 4
IMPLEMENTATION OF POLICIES AND RISKS..... 6
SPECIAL CONSIDERATIONS................... 14
MANAGEMENT............................... 16
ADDITIONAL INFORMATION................... 17
APPENDIX................................. A-1
</TABLE>
No person has been authorized to give any information or to make any
representations other than those contained in this Prospectus and the Statement
of Additional Information and, if given or made, such information or
representations may not be relied upon as having been authorized by the Fund.
This Prospectus does not constitute an offer to sell securities to any person in
any state or jurisdiction in which such offering may not lawfully be made.
THE FUND
The Fund is a diversified series of the Corporation, which is an open-end
management investment company. The Fund offers and sells its shares only to
separate accounts of insurance companies for the purpose of funding variable
annuity and variable life insurance contracts. The Fund does not impose any
sales or redemption charges. Strong Capital Management, Inc. (the "Advisor") is
the investment advisor for the Fund.
-------------------
PROSPECTUS PAGE 2
<PAGE> 388
FINANCIAL HIGHLIGHTS
The following annual Financial Highlights for the Fund have been audited by
Coopers & Lybrand L.L.P., independent certified public accountants. Their report
for the fiscal year ended December 31, 1996 is included in the Fund's Annual
Report that is contained in the Fund's Statement of Additional Information. The
Financial Highlights should be read in conjunction with the Financial Statements
and related notes included in the Fund's Annual Report. Additional information
about the performance of the Fund is contained in the Fund's Annual Report,
which may be obtained without charge by calling or writing Strong Funds. Please
note that the total return shown in the Financial Highlights does not reflect
expenses that apply to the separate account or the related insurance policies.
Inclusion of these charges would reduce the total return for the periods shown.
The following presents information relating to a share of common stock
outstanding for the entire period ended as indicated.
<TABLE>
<CAPTION>
12-31-96(1)
-----------
<S> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $10.00
INCOME FROM INVESTMENT OPERATIONS
Net Investment Income 0.34
Net Realized and Unrealized Losses on Investments (0.39)
------
Total from Investment Operations (0.05)
LESS DISTRIBUTIONS:
From Net Investment Income (0.34)
------
Total Distributions (0.34)
------
NET ASSET VALUE, END OF PERIOD $ 9.61
======
TOTAL RETURN -0.4%
RATIOS AND SUPPLEMENTAL DATA
Net Assets, End of Period (In Thousands) $ 199
Ratio of Expenses to Average Net Assets 1.7%*
Ratio of Expenses to Average Net Assets Without Waivers
and Absorptions 3.9%*
Ratio of Net Investment Income to Average Net Assets 3.9%*
Portfolio Turnover Rate 170.9%
</TABLE>
* Calculated on an annualized basis.
(1)Inception date is January 31, 1996. Total return and portfolio turnover rate
are not annualized.
-------------------
PROSPECTUS PAGE 3
<PAGE> 389
INVESTMENT OBJECTIVE AND POLICIES
The Fund has adopted certain fundamental investment restrictions that are set
forth in the Fund's Statement of Additional Information ("SAI"). Those
restrictions, the Fund's investment objective and any other investment policies
identified as "fundamental" cannot be changed without shareholder approval. To
further guide investment activities, the Fund has also instituted a number of
non-fundamental operating policies, which are described throughout this
Prospectus and in the SAI. Although these additional policies may be changed by
the Corporation's Board of Directors without shareholder approval, the Fund will
promptly notify shareholders of any material change in operating policies.
The Fund seeks total return by investing for a high level of current income
with a moderate degree of share-price fluctuation.
The Fund is designed for long-term investors who want to pursue higher income
than shorter-term securities generally provide, who are willing to accept the
fluctuation in principal associated with longer-term securities, and who seek
the low credit risk that U.S. government securities generally carry.
Under normal market conditions, at least 80% of the Fund's net assets will be
invested in U.S. government securities. The balance of the Fund's assets may be
invested in other investment-grade debt obligations. While there are no maturity
restrictions on the portfolio, it is anticipated that the Fund's average
portfolio maturity will normally be between 5 and 10 years. When the Advisor
determines market conditions warrant a temporary defensive position, the Fund
may invest without limitation in cash and short-term fixed income securities.
FUNDAMENTALS OF
FIXED INCOME INVESTING
The Fund may invest in a wide variety of debt obligations and other
securities. See "Implementation of Policies and Risks - Debt Obligations."
Issuers of debt obligations have a contractual obligation to pay interest at
a specified rate ("coupon rate") on specified dates and to repay principal
("face value" or "par value") on a specified maturity date. Certain debt
obligations (usually intermediate- and long-term obligations) have provisions
that allow the issuer to redeem or "call" the obligation before its maturity.
Issuers are most likely to call such debt obligations during periods of falling
interest rates. As a result, the Fund may be required to invest the
unanticipated proceeds of the called obligations at lower interest rates, which
may cause the Fund's income to decline.
-------------------
PROSPECTUS PAGE 4
<PAGE> 390
Although the net asset value of the Fund is expected to fluctuate, the
Advisor actively manages the Fund's portfolio and adjusts its average portfolio
maturity according to the Advisor's interest rate outlook while seeking to avoid
or reduce, to the extent possible, any negative changes in net asset value.
PRICE VOLATILITY
The market value of debt obligations is affected by changes in prevailing
interest rates. The market value of a debt obligation generally reacts inversely
to interest-rate changes, meaning, when prevailing interest rates decline, an
obligation's price usually rises, and when prevailing interest rates rise, an
obligation's price usually declines. A fund portfolio consisting primarily of
debt obligations will react similarly to changes in interest rates.
MATURITY
In general, the longer the maturity of a debt obligation, the higher its
yield and the greater its sensitivity to changes in interest rates. Conversely,
the shorter the maturity, the lower the yield but the greater the price
stability. Commercial paper is generally considered the shortest form of debt
obligation. Notes, whose original maturities are two years or less, are
considered short-term obligations. The term "bond" generally refers to
securities with maturities longer than two years. Bonds with maturities of three
years or less are considered short term, bonds with maturities between three and
seven years are considered intermediate term, and bonds with maturities greater
than seven years are considered long term.
CREDIT QUALITY
The values of debt obligations may also be affected by changes in the credit
rating or financial condition of their issuers. Generally, the lower the quality
rating of an obligation, the higher the degree of risk as to the payment of
interest and return of principal. To compensate investors for taking on such
increased risk, those issuers deemed to be less creditworthy generally must
offer their investors higher interest rates than do issuers with better credit
ratings.
In conducting its credit research and analysis, the Advisor considers both
qualitative and quantitative factors to evaluate the creditworthiness of
individual issuers. The Advisor also relies, in part, on credit ratings compiled
by a number of nationally recognized statistical rating organizations, which
include Standard & Poor's Ratings Group ("S&P"), Moody's Investors Service,
Inc., Fitch Investors Service, Inc., Duff & Phelps Rating Co., Thomson
BankWatch, Inc., and IBCA, Inc. (the "NRSROs"). "Appendix A - Ratings of Debt
Obligations" presents a summary of the ratings of these organizations. Please
refer to
-------------------
PROSPECTUS PAGE 5
<PAGE> 391
the Appendix in the Fund's SAI for a more detailed description of the ratings of
the NRSROs.
INVESTMENT-GRADE DEBT OBLIGATIONS. Debt obligations rated in the highest-
through the medium-quality categories are commonly referred to as
"investment-grade" debt obligations and include the following:
- - U.S. government securities (See "Implementation of Policies and Risks - Debt
Obligations" below);
- - bonds or bank obligations rated in one of the four highest rating categories
(e.g., BBB or higher by S&P);
- - short-term notes rated in one of the two highest rating categories (e.g., SP-2
or higher by S&P);
- - short-term bank obligations rated in one of the three highest rating
categories (e.g., A-3 or higher by S&P), with respect to obligations maturing
in one year or less;
- - commercial paper rated in one of the three highest rating categories (e.g.,
A-3 or higher by S&P);
- - unrated debt obligations determined by the Advisor to be of comparable
quality; and
- - repurchase agreements involving investment-grade debt obligations.
Investment-grade debt obligations are generally believed to have relatively
low degrees of credit risk. All ratings are determined at the time of
investment. Any subsequent rating downgrade of a debt obligation will be
monitored by the Advisor to consider what action, if any, the Fund should take
consistent with its investment objective. For purposes of determining whether a
security is investment grade, the Advisor may use the highest rating assigned to
that security by any NRSRO.
IMPLEMENTATION OF POLICIES AND RISKS
In addition to the Fund's investment policies described above (and subject to
certain restrictions described herein), the Fund may invest in some or all of
the following securities and employ some or all of the following investment
techniques, some of which may present special risks as described below. A more
complete discussion of these securities and investment techniques and their
associated risks is contained in the Fund's SAI.
DEBT OBLIGATIONS
The Fund may invest in any debt obligations. The Fund's authority to invest
in certain types of debt obligations may be restricted or subject to objective
investment criteria. For additional information on these restrictions, see
"Investment Objective and Policies."
-------------------
PROSPECTUS PAGE 6
<PAGE> 392
TYPES OF OBLIGATIONS. Debt obligations include (i) corporate debt securities,
including bonds, debentures, and notes; (ii) bank obligations, such as
certificates of deposit, banker's acceptances, and time deposits of domestic and
foreign banks and their subsidiaries and branches, and domestic savings and loan
associations (in amounts in excess of the insurance coverage (currently $100,000
per account) provided by the Federal Deposit Insurance Corporation); (iii)
commercial paper (including variable-amount master demand notes); (iv)
repurchase agreements; (v) loan interests; (vi) foreign debt obligations issued
by foreign issuers traded either in foreign markets or in domestic markets
through depositary receipts; (vii) convertible securities - debt obligations of
corporations convertible into or exchangeable for equity securities or debt
obligations that carry with them the right to acquire equity securities, as
evidenced by warrants attached to such securities, or acquired as part of units
of the securities; (viii) preferred stocks - securities that represent an
ownership interest in a corporation and that give the owner a prior claim over
common stock on the company's earnings or assets; (ix) trust preferred
securities - certain obligations which have characteristics of both debt and
preferred stock; (x) U.S. government securities; (xi) mortgage-backed
securities, collateralized mortgage obligations, and similar securities; and
(xii) municipal obligations.
GOVERNMENT SECURITIES
U.S. government securities are issued or guaranteed by the U.S. government or
its agencies or instrumentalities. Securities issued by the government include
U.S. Treasury obligations, such as Treasury bills, notes, and bonds. Securities
issued or guaranteed by government agencies or instrumentalities include the
following:
- - the Federal Housing Administration, Farmers Home Administration, Export-Import
Bank of the United States, Small Business Administration, and the Government
National Mortgage Association, including GNMA pass-through certificates, whose
securities are supported by the full faith and credit of the United States;
- - the Federal Home Loan Banks, Federal Intermediate Credit Banks, and the
Tennessee Valley Authority, whose securities are supported by the right of the
agency to borrow from the U.S. Treasury;
- - the Federal National Mortgage Association, whose securities are supported by
the discretionary authority of the U.S. government to purchase certain
obligations of the agency or instrumentality; and
- - the Student Loan Marketing Association, the Interamerican Development Bank,
and International Bank for Reconstruction and Development, whose securities
are supported only by the credit of such agencies.
Although the U.S. government provides financial support to such U.S.
government-sponsored agencies or instrumentalities, no assurance can be given
that it will always do so. The U.S. government and its agencies and
-------------------
PROSPECTUS PAGE 7
<PAGE> 393
instrumentalities do not guarantee the market value of their securities;
consequently, the value of such securities will fluctuate.
MORTGAGE- AND ASSET-BACKED SECURITIES
Mortgage-backed securities represent direct or indirect participation in, or
are secured by and payable from, mortgage loans secured by real property, and
include single- and multi-class pass-through securities and collateralized
mortgage obligations. Such securities may be issued or guaranteed by U.S.
government agencies or instrumentalities or by private issuers, generally
originators in mortgage loans, including savings associations, mortgage bankers,
commercial banks, investment bankers, and special purpose entities
(collectively, "private lenders"). Mortgage-backed securities issued by private
lenders may be supported by pools of mortgage loans or other mortgage-backed
securities that are guaranteed, directly or indirectly, by the U.S. government
or one of its agencies or instrumentalities, or they may be issued without any
governmental guarantee of the underlying mortgage assets but with some form of
non-governmental credit enhancement.
Asset-backed securities have structural characteristics similar to mortgage-
backed securities. However, the underlying assets are not first-lien mortgage
loans or interests therein; rather they include assets such as motor vehicle
installment sales contracts, other installment loan contracts, home equity
loans, leases of various types of property and receivables from credit card or
other revolving credit arrangements. Payments or distributions of principal and
interest on asset-backed securities may be supported by non-governmental credit
enhancements similar to those utilized in connection with mortgage-backed
securities.
The yield characteristics of mortgage- and asset-backed securities differ
from those of traditional debt obligations. Among the principal differences are
that interest and principal payments are made more frequently on mortgage-and
asset-backed securities, usually monthly, and that principal may be prepaid at
any time because the underlying mortgage loans or other assets generally may be
prepaid at any time. As a result, if the Fund purchases these securities at a
premium, a prepayment rate that is faster than expected will reduce yield to
maturity, while a prepayment rate that is slower than expected will have the
opposite effect of increasing the yield to maturity. Conversely, if the Fund
purchases these securities at a discount, a prepayment rate that is faster than
expected will increase yield to maturity, while a prepayment rate that is slower
than expected will reduce yield to maturity. Accelerated prepayments on
securities purchased by the Fund at a premium also impose a risk of loss of
principal because the premium may not have been fully amortized at the time the
principal is prepaid in full. The market for privately issued mortgage- and
asset-backed securities is smaller and less liquid than the market for
government sponsored mortgage-backed securities.
The Fund may invest in stripped mortgage- or asset-backed securities, which
receive differing proportions of the interest and principal payments
-------------------
PROSPECTUS PAGE 8
<PAGE> 394
from the underlying assets. The market value of such securities generally is
more sensitive to changes in prepayment and interest rates than is the case with
traditional mortgage- and asset-backed securities, and in some cases the market
value may be extremely volatile. With respect to certain stripped securities,
such as interest-only ("IO") and principal-only ("PO") classes, a rate of
prepayment that is faster or slower than anticipated may result in the Fund
failing to recover all or a portion of its investment, even though the
securities are rated investment grade.
FOREIGN SECURITIES AND CURRENCIES
The Fund may invest up to 20% of its net assets, directly or indirectly in
foreign securities. The Fund will limit its investments in foreign securities to
those denominated in U.S. dollars. The Fund may invest in U.S. securities
enhanced as to credit quality or liquidity by foreign issuers without regard to
this limitation.
Foreign investments involve special risks, including:
- expropriation, confiscatory taxation, and withholding taxes on dividends
and interest;
- less extensive regulation of foreign brokers, securities markets, and
issuers;
- less publicly available information and different accounting standards;
- possible delays in settlement in foreign securities markets, limitations on
the use or transfer of assets (including suspension of the ability to
transfer currency from a given country), and difficulty of enforcing
obligations in other countries; and
- diplomatic developments and political or social instability.
Foreign economies may differ favorably or unfavorably from the U.S. economy
in various respects, including growth of gross domestic product, rates of
inflation, currency depreciation, capital reinvestment, resource
self-sufficiency, and balance-of-payments positions. Many foreign securities may
be less liquid and their prices more volatile than comparable U.S. securities.
Although the Fund generally invest only in securities that are regularly traded
on recognized exchanges or in over-the-counter markets, from time to time
foreign securities may be difficult to liquidate rapidly without adverse price
effects. Certain costs attributable to foreign investing, such as custody
charges and brokerage costs, may be higher than those attributable to domestic
investing.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with certain banks and non-bank
dealers. In a repurchase agreement, the Fund buys a security at one price, and
at the time of sale, the seller agrees to repurchase the obligation at a
mutually agreed upon time and price (usually within seven days). The repur-
-------------------
PROSPECTUS PAGE 9
<PAGE> 395
chase agreement determines the yield during the purchaser's holding period,
while the seller's obligation to repurchase is secured by the value of the
underlying security. The Fund may enter into repurchase agreements with respect
to any security in which it may invest. The Advisor will monitor, on an ongoing
basis, the value of the underlying securities to ensure that the value always
equals or exceeds the repurchase price plus accrued interest. Repurchase
agreements could involve certain risks in the event of a default or insolvency
of the other party to the agreement, including possible delays or restrictions
upon the Fund's ability to dispose of the underlying securities. Although no
definitive creditworthiness criteria are used, the Advisor reviews the
creditworthiness of the banks and non-bank dealers with which the Fund enters
into repurchase agreements to evaluate those risks. The Fund may, under certain
circumstances, deem repurchase agreements collateralized by U.S. government
securities to be investments in U.S. government securities.
DERIVATIVE INSTRUMENTS
The Fund may use derivative instruments for any lawful purpose consistent
with the Fund's investment objective such as hedging or managing risk.
Derivative instruments are commonly defined to include securities or contracts
whose values depend on (or "derive" from) the value of one or more other assets,
such as securities, currencies, or commodities. These "other assets" are
commonly referred to as "underlying assets."
A derivative instrument generally consists of, is based upon, or exhibits
characteristics similar to options or forward contracts. Options and forward
contracts are considered to be the basic "building blocks" of derivatives. For
example, forward-based derivatives include forward contracts, swap contracts, as
well as exchange-traded futures. Option-based derivatives include privately
negotiated, over-the-counter (OTC) options (including caps, floors, collars, and
options on forward and swap contracts) and exchange-traded options on futures.
Diverse types of derivatives may be created by combining options or forward
contracts in different ways, and by applying these structures to a wide range of
underlying assets.
An option is a contract in which the "holder" (the buyer) pays a certain
amount (the "premium") to the "writer" (the seller) to obtain the right, but not
the obligation, to buy from the writer (in a "call") or sell to the writer (in a
"put") a specific asset at an agreed upon price at or before a certain time. The
holder pays the premium at inception and has no further financial obligation.
The holder of an option-based derivative generally will benefit from favorable
movements in the price of the underlying asset but is not exposed to
corresponding losses due to adverse movements in the value of the underlying
asset. The writer of an option-based derivative generally will receive fees or
premiums but generally is exposed to losses due to changes in the value of the
underlying assets.
---------------------
PROSPECTUS PAGE 10
<PAGE> 396
A forward is a sales contract between a buyer (holding the "long" position)
and a seller (holding the "short" position) for an asset with delivery deferred
until a future date. The buyer agrees to pay a fixed price at the agreed future
date and the seller agrees to deliver the asset. The seller hopes that the
market price on the delivery date is less than the agreed upon price, while the
buyer hopes for the contrary. The change in value of a forward-based derivative
generally is roughly proportional to the change in value of the underlying
asset.
Derivative instruments may include (i) options; (ii) futures; (iii) options
on futures; (iv) short sales against the box, in which the Fund sells a security
it owns for delivery at a future date; (v) swaps, in which two parties agree to
exchange a series of cash flows in the future, such as interest-rate payments;
(vi) interest-rate caps, under which, in return for a premium, one party agrees
to make payments to the other to the extent that interest rates exceed a
specified rate, or "cap"; (vii) interest-rate floors, under which, in return for
a premium, one party agrees to make payments to the other to the extent that
interest rates fall below a specified level, or "floor"; (viii) forward currency
contracts and foreign currency exchange-related securities; and (ix) structured
instruments which combine the foregoing in different ways.
Derivatives may be exchange-traded or traded in OTC transactions between
private parties. OTC transactions are subject to additional risks, such as the
credit risk of the counterparty to the instrument and are less liquid than
exchange-traded derivatives since they often can only be closed out with the
other party to the transaction. Derivative instruments may include elements of
leverage and, accordingly, the fluctuation of the value of the derivative
instrument in relation to the underlying asset may be magnified. When required
by SEC guidelines, the Fund will set aside permissible liquid assets in a
segregated account to secure its obligations under the derivative.
The successful use of derivatives by the Fund is dependent upon a variety of
factors, particularly the Advisor's ability to correctly anticipate trends in
the underlying asset. In a hedging transaction, if the Advisor incorrectly
anticipates trends in the underlying asset, the Fund may be in a worse position
than if no hedging had occurred. In addition, there may be imperfect correlation
between the Fund's derivative transactions and the instruments being hedged. To
the extent that the Fund is engaging in derivative transactions for risk
management, the Fund's successful use of such transactions is more dependent
upon the Advisor's ability to correctly anticipate such trends, since losses in
these transactions may not be offset in gains in the Fund's portfolio or in
lower purchase prices for assets it intends to acquire. The Advisor's prediction
of trends in underlying assets may prove to be inaccurate, which could result in
substantial losses to the Fund.
In addition to the derivative instruments and strategies described above, the
Advisor expects to discover additional derivative instruments and other trading
techniques. The Advisor may utilize these new derivative instruments and
techniques to the extent that they are consistent with the Fund's invest-
---------------------
PROSPECTUS PAGE 11
<PAGE> 397
ment objective and permitted by the Fund's investment limitations, operating
policies, and applicable regulatory authorities.
WHEN-ISSUED SECURITIES
The Fund may invest in securities purchased on a when-issued or delayed-
delivery basis. Although the payment and interest terms of these securities are
established at the time the purchaser enters into the commitment, these
securities may be delivered and paid for at a future date, generally within 45
days. Purchasing when-issued securities allows the Fund to lock in a fixed price
or yield on a security it intends to purchase. However, when the Fund purchases
a when-issued security, it immediately assumes the risk of ownership, including
the risk of price fluctuation.
The greater the Fund's outstanding commitments for these securities, the
greater the exposure to potential fluctuations in the net asset value of the
Fund. Purchasing when-issued securities may involve the additional risk that the
yield available in the market when the delivery occurs may be higher or the
market price lower than that obtained at the time of commitment. Although the
Fund may be able to sell these securities prior to the delivery date, it will
purchase when-issued securities for the purpose of actually acquiring the
securities, unless, after entering into the commitment, a sale appears desirable
for investment reasons. When required by SEC guidelines, the Fund will set aside
permissible liquid assets in a segregated account to secure its outstanding
commitments for when-issued securities.
ILLIQUID SECURITIES
The Fund may invest up to 15% of its net assets in illiquid securities.
Illiquid securities are those securities that are not readily marketable,
including restricted securities and repurchase obligations maturing in more than
seven days. Certain restricted securities which may be resold to institutional
investors under Rule 144A under the Securities Act of 1933 and Section 4(2)
commercial paper may be determined to be liquid under guidelines adopted by the
Corporation's Board of Directors.
ZERO-COUPON, STEP-COUPON, AND PAY-IN-KIND SECURITIES
The Fund may invest in zero-coupon, step-coupon, and pay-in-kind securities.
These securities are debt securities that do not make regular cash interest
payments. Zero-coupon and step-coupon securities are sold at a deep discount to
their face value. Pay-in-kind securities pay interest through the issuance of
additional securities. Because such securities do not pay current cash income,
the price of these securities can be volatile when interest rates fluctuate.
While these securities do not pay current cash income, federal income tax law
requires the holders of zero-coupon, step-coupon, and pay-in-kind securities to
---------------------
PROSPECTUS PAGE 12
<PAGE> 398
include in income each year the portion of the original issue discount (or
deemed discount) and other non-cash income on such securities accrued during
that year.
MORTGAGE DOLLAR ROLLS AND
REVERSE REPURCHASE AGREEMENTS
The Fund may engage in reverse repurchase agreements to facilitate portfolio
liquidity, a practice common in the mutual fund industry, or for arbitrage
transactions discussed below. In a reverse repurchase agreement, the Fund would
sell a security and enter into an agreement to repurchase the security at a
specified future date and price. The Fund generally retains the right to
interest and principal payments on the security. Since the Fund receives cash
upon entering into a reverse repurchase agreement, it may be considered a
borrowing. When required by SEC guidelines, the Fund will set aside permissible
liquid assets in a segregated account to secure its obligation to repurchase the
security.
The Fund may also enter into mortgage dollar rolls, in which the Fund would
sell mortgage-backed securities for delivery in the current month and
simultaneously contract to purchase substantially similar securities on a
specified future date. While the Fund would forego principal and interest paid
on the mortgage-backed securities during the roll period, the Fund would be
compensated by the difference between the current sale price and the lower price
for the future purchase as well as by any interest earned on the proceeds of the
initial sale. The Fund also could be compensated through the receipt of fee
income equivalent to a lower forward price. When required by SEC guidelines, the
Fund would set aside permissible liquid assets in a segregated account to secure
its obligation for the forward commitment to buy mortgage-backed securities.
Mortgage dollar roll transactions may be considered a borrowing by the Fund.
The mortgage dollar rolls and reverse repurchase agreements entered into by
the Fund may be used as arbitrage transactions in which the Fund will maintain
an offsetting position in investment-grade debt obligations or repurchase
agreements that mature on or before the settlement date of the related mortgage
dollar roll or reverse repurchase agreement. Since the Fund will receive
interest on the securities or repurchase agreements in which it invests the
transaction proceeds, such transactions may involve leverage. However, since
such securities or repurchase agreements will be high quality and will mature on
or before the settlement date of the mortgage dollar roll or reverse repurchase
agreement, the Advisor believes that such arbitrage transactions do not present
the risks to the Fund that are associated with other types of leverage.
---------------------
PROSPECTUS PAGE 13
<PAGE> 399
CASH MANAGEMENT
The Fund may invest directly in cash and short-term fixed-income securities,
including, for this purpose, shares of one or more money market funds managed by
the Advisor (collectively, the "Strong Money Funds"). The Strong Money Funds
seek current income, a stable share price of $1.00, and daily liquidity. All
money market instruments can change in value when interest rates or an issuer's
creditworthiness change dramatically. The Strong Money Funds cannot guarantee
that they will always be able to maintain a stable net asset value of $1.00 per
share.
PORTFOLIO TURNOVER
The annual portfolio turnover rate indicates changes in the Fund's portfolio.
The turnover rate may vary from year to year, as well as within a year. It may
also be affected by sales of portfolio securities necessary to meet cash
requirements for redemption of shares. High portfolio turnover in any year will
result in the payment by the Fund of above-average amounts of transaction costs.
The annual portfolio turnover rate for the Fund is expected to be between 200%
and 300%. However, the Fund's portfolio turnover rate may exceed 300% when the
Advisor believes the anticipated benefits of short-term investments outweigh any
increase in transaction costs. This rate should not be considered as a limiting
factor.
SPECIAL CONSIDERATIONS
The Fund is designed as an investment vehicle for variable annuity and
variable life insurance contracts funded by separate accounts of certain
insurance companies. Section 817(h) of the Internal Revenue Code of 1986, as
amended (the "Code") and the regulations thereunder impose certain
diversification standards on the investments underlying variable annuity and
variable life insurance contracts in order for such contracts to be treated for
tax purposes as annuities or life insurance. Section 817(h) of the Code provides
that a variable annuity and variable life insurance contract based on a separate
account shall not be treated as an annuity or life insurance contract for any
period (and any subsequent period) for which the account's investments are not
adequately diversified. These diversification requirements are in addition to
the diversification requirements applicable to the Fund under Subchapter M of
the Code and the Investment Company Act of 1940 (the "1940 Act") and may affect
the composition of the Fund's investments.
Since the shares of the Fund are currently sold to segregated asset accounts
underlying such variable annuity and variable life insurance contracts, the Fund
intends to comply with the diversification requirements as set forth
---------------------
PROSPECTUS PAGE 14
<PAGE> 400
in the regulations. The Secretary of the Treasury may in the future issue
additional regulations or revenue rulings that may prescribe the circumstances
in which a contract owner's control of the investments of a separate account may
cause the contract owner, rather than the insurance company, to be treated as
the owner of assets of the separate account. Failure to comply with Section
817(h) of the Code or any regulation thereunder, or with any future regulations
or revenue rulings on contract owner control, would cause earnings regarding a
contract owner's interest in an insurance company's separate account to be
includible in the contract owner's gross income in the year earned. Such
standards may apply only prospectively, although retroactive application is
possible. In the event that any such regulations or revenue rulings are adopted,
the Fund may not be able to continue to operate as currently described in this
prospectus, or maintain its investment program.
The Fund will be managed in such a manner as to comply with the requirements
of Subchapter L of the Code. It is possible that in order to comply with such
requirements, less desirable investment decisions may be made which would affect
the investment performance of the Fund.
The Fund may sell its shares to the separate accounts of various insurance
companies, which are not affiliated with each other, for the purpose of funding
variable annuity and variable life insurance contracts. The Fund currently does
not foresee any disadvantages to contract owners arising out of the fact that it
offers its shares to separate accounts of various insurance companies, which are
not affiliated with each other, to serve as an investment medium for their
variable products. However, it is theoretically possible that the interests of
owners of various contracts participating in the Fund through the separate
accounts might at some time be in conflict. The Board of Directors of the
Corporation, however, will monitor events in order to identify any material
irreconcilable conflicts which may possibly arise and to determine what action,
if any, should be taken in response to such conflicts. If such a conflict were
to occur, one or more insurance companies' separate accounts might be required
to withdraw its investments in the Fund, and shares of another Fund may be
substituted. This might force the Fund to sell securities at disadvantageous
prices. In addition, the Board of Directors may refuse to sell Fund shares to
any separate account or may suspend or terminate the offering of Fund shares if
such action is required by law or regulatory authority or is in the best
interest of the shareholders of the Fund.
Except for the organizational shares of the Fund, the Fund's shares may be
held of record only by insurance company separate accounts. As of March 31,
1997, Fortis Benefits Insurance Co. owned approximately 52% of the Fund. As of
March 31, 1997, the Advisor owned approximately 48% of the Fund. The Advisor's
share ownership represents the organizational shares of the Fund. Their
ownership of greater than 25% of the Fund's shares may result in them being
deemed to be controlling entities of the Fund. They may continue to be deemed as
such until insurance companies, if any, selling significant numbers
---------------------
PROSPECTUS PAGE 15
<PAGE> 401
of variable annuity and variable life insurance contracts, make substantial
investments in the Fund's shares.
MANAGEMENT
The Board of Directors of the Corporation is responsible for managing the
Fund's business and affairs. The Fund has entered into an investment advisory
agreement (an "Advisory Agreement") with the Advisor. Under the terms of the
Advisory Agreement, the Advisor manages the Fund's investments and business
affairs, subject to the supervision of the Board of Directors.
The Advisor began conducting business in 1974. Since then, its principal
business has been providing continuous investment supervision for individuals
and institutional accounts, such as pension funds and profit-sharing plans, as
well as mutual funds, several of which are funding vehicles for variable
insurance products. As of March 31, 1997, the Advisor had over $23 billion under
management. The Advisor's principal mailing address is P.O. Box 2936, Milwaukee,
Wisconsin 53201. Mr. Richard S. Strong, the Chairman of the Board of the
Corporation, is the controlling shareholder of the Advisor.
As compensation for its services, the Fund pays the Advisor a monthly
management fee. The annual fee is .60% of the average daily net asset value of
the Fund. Under the terms of the Advisory Agreement, the Advisor provides office
space and all necessary office facilities, equipment, and personnel for
servicing the investments of the Fund. From time to time, the Advisor may
voluntarily waive all or a portion of its management fee and/or absorb certain
expenses for the Fund without further notification of the commencement or
termination of any such waiver or absorption. Any such waiver or absorption will
have the effect of lowering the overall expense ratio of the Fund and increasing
the Fund's return to investors at the time such amounts were waived and/or
absorbed.
Except for expenses assumed by the Advisor or Strong Funds Distributors,
Inc., the Fund is responsible for all its other expenses, including, without
limitation, interest charges, taxes, brokerage commissions and similar expenses;
expenses of issue, sale, repurchase, or redemption of shares; expenses of
registering or qualifying shares for sale with the states and the SEC; expenses
of printing and distribution of prospectuses to existing shareholders; charges
of custodians (including fees as custodian for keeping books and similar
services for the Fund), transfer agents (including the printing and mailing of
reports and notices to shareholders), registrars, auditing and legal services,
and clerical services related to recordkeeping and shareholder relations;
printing of stock certificates; fees for directors who are not "interested
persons" of the Advisor; expenses of indemnification; extraordinary expenses;
and costs of shareholder and director meetings.
The Advisor permits portfolio managers and other persons who may have access
to information about the purchase or sale of securities in the Fund's portfolio
("access persons") to purchase and sell securities for their own
---------------------
PROSPECTUS PAGE 16
<PAGE> 402
accounts, subject to the Advisor's policy governing personal investing. The
policy requires access persons to conduct their personal investment activities
in a manner that the Advisor believes is not detrimental to the Fund or to the
Advisor's other advisory clients. Among other things, the policy requires access
persons to obtain preclearance before executing personal trades and prohibits
access persons from keeping profits derived from the purchase or sale of the
same security within 60 calendar days. See the SAI for more information.
PORTFOLIO MANAGER. Mr. Bradley C. Tank joined the Advisor in June 1990. Prior
to that, Mr. Tank spent eight years at Salomon Brothers, Inc., where he was a
fixed income specialist and, for the last six years, a vice president. Mr. Tank
received his B.A. in 1980 from the University of Wisconsin-Eau Claire and his
M.B.A. in 1982 from the University of Wisconsin-Madison, where he also completed
the Applied Securities Analysis Program. Mr. Tank has managed the Fund since its
inception in June 1995 and chairs the Advisor's Fixed Income Investment
Committee.
ADDITIONAL INFORMATION
HOW TO INVEST. Investments in the Fund may only be made by separate accounts
established and maintained by insurance companies for purposes of funding
variable annuity and variable life insurance contracts. For instructions on how
to direct a separate account to purchase shares in the Fund, please refer to the
prospectus of the insurance company's separate account. The Fund does not impose
any sales charge or 12b-1 fee. Certain sales charges may apply to the variable
annuity or variable life insurance contract, which should be described in the
prospectus of the insurance company's separate account. The Fund may decline to
accept a purchase order upon receipt when, in the judgment of the Advisor, it
would not be in the best interest of the existing shareholders to accept the
order. Shares of the Fund will be sold at the net asset value next determined
after receipt by the Fund of a purchase order in proper form placed by an
insurance company investing in the Fund. Certificates for shares in the Fund
will not be issued.
CALCULATION OF NET ASSET VALUE. The net asset value ("NAV") per share for the
Fund is determined as of the close of trading on the New York Stock Exchange
(the "Exchange"), currently 3:00 p.m. Central Time, on days the Exchange is open
for business. The NAV will not be determined for the Fund on days during which
the Fund receives no orders to purchase shares and no shares are tendered for
redemption. The Fund's NAV is calculated by taking the fair value of the Fund's
total assets, subtracting all its liabilities, and dividing by the total number
of shares outstanding. Expenses are accrued and applied daily when determining
the NAV.
---------------------
PROSPECTUS PAGE 17
<PAGE> 403
Debt securities are valued by a pricing service that utilizes electronic data
processing techniques to determine values for normal institutional size trading
units of debt securities without regard to the existence of sale or bid prices
when such values are believed to more accurately reflect the fair market value
of such securities. Otherwise, sale or bid prices are used. Any securities or
other assets for which market quotations are not readily available are valued at
fair value as determined in good faith by the Board of Directors. Debt
securities having remaining maturities of 60 days or less are valued by the
amortized cost method when the Board of Directors determines that the fair value
of such securities is their amortized cost.
HOW TO REDEEM SHARES. Shares of the Fund may be redeemed on any business day.
The price received upon redemption will be the net asset value next determined
after the redemption request in proper form is received by the Fund. (See
"Calculation of Net Asset Value.") Contract owners should refer to the
withdrawal or surrender instructions in the prospectus of the separate account
for instructions on how to redeem shares. Once the redemption request is
received in proper form, the Fund will ordinarily forward payment to the
separate account no later than seven days after receipt.
The right of redemption may be suspended during any period in which: (i)
trading on the Exchange is restricted, as determined by the SEC, or the Exchange
is closed for other than weekends and holidays; (ii) the SEC has permitted such
suspension by order; or (iii) an emergency, as determined by the SEC, exists
which makes disposal of portfolio securities or valuation of net assets of the
Fund not reasonably practicable.
DISTRIBUTIONS AND TAXES. The policy of the Fund is to pay dividends to the
insurance company's separate accounts from net investment income monthly and to
distribute substantially all net realized capital gains, after using any
available capital loss carryovers, annually. All dividends and capital gain
distributions paid to the insurance company's separate accounts will be
automatically reinvested in additional Fund shares.
The Fund intends to continue to qualify for treatment as a Regulated
Investment Company or "RIC" under Subchapter M of the Code and, if so qualified,
will not be liable for federal income tax on earnings and gains distributed to
its shareholders in a timely manner. If the Fund does not so qualify, however,
it would be treated for tax purposes as an ordinary corporation and would
receive no tax deduction for distributions made to its shareholders. For more
information regarding tax implications for owners of variable annuity or
variable life insurance contracts investing in the Fund, please refer to the
prospectus of your insurance company's separate account. See "Special
Considerations" for a discussion of special tax considerations relating to the
Fund's compliance with Subchapter L of the Code, as an investment vehicle for
variable annuity and variable life insurance contracts of certain insurance
companies.
---------------------
PROSPECTUS PAGE 18
<PAGE> 404
This section is not intended to be a full discussion of present or proposed
federal income tax law and its effect on the Fund and investors. (See the SAI
for a further discussion.) Investors are urged to consult their own tax adviser.
ORGANIZATION. The Fund is a series of common stock of the Corporation, which
is a Wisconsin corporation. The Corporation is authorized to issue an indefinite
number of shares of common stock and series and classes of series of shares of
common stock. All holders of shares of the Corporation would vote on each matter
presented to shareholders for action except with respect to any matter which
affects only one or more series or classes, in which case only the shares of the
affected series or class shall be entitled to vote.
All shares participate equally in dividends and other capital gains
distributions by the Fund and in the residual assets of the Fund in the event of
liquidation. Generally, the Corporation will not hold an annual meeting of
shareholders unless required by the 1940 Act.
The insurance company separate accounts, as the record shareholders in the
Fund, have the right to vote on matters submitted for a shareholder vote. Under
current interpretations of the 1940 Act, these insurance companies must solicit
voting instructions from contract owners and vote Fund shares in accordance with
the instructions received or, for Fund shares for which no voting instructions
were received, in the same proportion as those Fund shares for which
instructions were received. Contract owners should refer to the prospectus of
the insurance company's separate account for a complete description of their
voting rights.
TRANSFER AGENT, DIVIDEND-DISBURSING AGENT, AND DISTRIBUTOR. The Advisor, P.O.
Box 2936, Milwaukee, Wisconsin 53201, acts as transfer agent and
dividend-disbursing agent for the Fund. Strong Funds Distributors, Inc., P.O.
Box 2936, Milwaukee, Wisconsin 53201, an indirect subsidiary of the Advisor,
acts as distributor of the shares of the Fund.
PERFORMANCE INFORMATION. The Fund may advertise a variety of types of
performance information, including "yield," "average annual total return,"
"total return," and "cumulative total return." Each of these figures is based
upon historical results and does not represent the future performance of the
Fund.
Yield is an annualized figure, which means that it is assumed that the Fund
generates the same level of net investment income over a one-year period. The
Fund's yield is a measure of the net investment income per share earned by the
Fund over a specific 30-day period and is shown as a percentage of the net asset
value of the Fund's shares at the end of the period.
Average annual total return and total return figures measure both the net
investment income generated by, and the effect of any realized and unrealized
appreciation or depreciation of, the underlying investments in the Fund assuming
the reinvestment of all dividends and distributions. Total return figures are
---------------------
PROSPECTUS PAGE 19
<PAGE> 405
not annualized and simply represent the aggregate change of the Fund's
investments over a specified period of time.
The Fund's shares are sold at the net asset value per share of the Fund.
Returns and net asset value will fluctuate. Shares of the Fund are redeemable by
the separate accounts of insurance companies at the then current net asset value
per share for the Fund, which may be more or less than the original cost. TOTAL
RETURNS CONTAINED IN ADVERTISEMENTS INCLUDE THE EFFECT OF DEDUCTING THE FUND'S
EXPENSES, BUT MAY NOT INCLUDE CHARGES AND EXPENSES ATTRIBUTABLE TO ANY
PARTICULAR INSURANCE PRODUCT. SINCE SHARES MAY ONLY BE PURCHASED BY THE SEPARATE
ACCOUNTS OF CERTAIN INSURANCE COMPANIES, CONTRACT OWNERS SHOULD CAREFULLY REVIEW
THE PROSPECTUS OF THE SEPARATE ACCOUNT FOR INFORMATION ON FEES AND EXPENSES.
Excluding such fees and expenses from the Fund's total return quotations has the
effect of increasing the performance quoted. The Fund will not use information
concerning its investment performance in advertisements or sales materials
unless appropriate information concerning the relevant separate account is also
included. Additional information concerning the Fund's performance appears in
the SAI.
---------------------
PROSPECTUS PAGE 20
<PAGE> 406
APPENDIX
RATINGS OF DEBT OBLIGATIONS
<TABLE>
<CAPTION>
Standard & Poor's Moody's Investor Fitch Investors Duff & Phelps Thomsons
Definition Ratings Group Services, Inc. Service, Inc. Rating Co. IBCA, Inc. BankWatch, Inc.
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Highest quality AAA Aaa AAA AAA AAA AAA
High quality AA Aa AA AA AA AA
Upper medium grade A A A A A A
Medium grade BBB Baa BBB BBB BBB BBB
Low grade BB Ba BB BB BB BB
Speculative B B B B B B
Submarginal CCC, CC, C Caa, Ca CCC, CC, C CCC CCC, CC CCC, CC
Probably in
default D C DDD, DD, D DD C D
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
----------------------
PROSPECTUS PAGE A-1
<PAGE> 407
NOTES
<PAGE> 408
NOTES
<PAGE> 409
STATEMENT OF ADDITIONAL INFORMATION
STRONG GOVERNMENT SECURITIES FUND II
P.O. Box 2936
Milwaukee, Wisconsin 53201
Toll-Free: (800) 368-1683
Strong Government Securities Fund II (the "Fund") is a diversified series
of the Strong Variable Insurance Funds, Inc. (the "Corporation"), an open-end
management investment company designed to provide an investment vehicle for
variable annuity and variable life insurance contracts of certain insurance
companies. Shares in the Fund are only offered and sold to the separate
accounts of such insurance companies. The Fund is described herein and in the
Prospectus for the Fund dated May 1, 1997.
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the Prospectus for the Fund dated May 1, 1997 and the
prospectus for the separate account of the specific insurance product.
Requests for copies of the Fund's Prospectus may be made by calling one of the
numbers listed above.
This Statement of Additional Information is dated May 1, 1997.
<PAGE> 410
STRONG GOVERNMENT SECURITIES FUND II
<TABLE>
<S> <C>
TABLE OF CONTENTS PAGE
INVESTMENT RESTRICTIONS...................................... 3
INVESTMENT POLICIES AND TECHNIQUE............................ 4
Borrowing.................................................. 5
Convertible Securities..................................... 5
Depositary Receipts........................................ 5
Derivative Instruments..................................... 6
Illiquid Securities....................................... 12
Lending of Portfolio Securities........................... 13
Maturity.................................................. 14
Mortgage- and Asset-Backed Securities..................... 14
Mortgage Dollar Rolls and Reverse Repurchase Agreements... 15
Municipal Obligations..................................... 16
Repurchase Agreements..................................... 16
Short Sales Against the Box............................... 16
Temporary Defensive Position.............................. 17
Variable or Floating Rate Securities..................... 17
Warrants.................................................. 18
When-Issued Securities.................................... 18
Zero-Coupon, Step-Coupon and Pay-in-Kind Securities....... 18
DIRECTORS AND OFFICERS OF THE CORPORATION................... 19
PRINCIPAL SHAREHOLDERS...................................... 21
INVESTMENT ADVISOR AND DISTRIBUTOR.......................... 22
PORTFOLIO TRANSACTIONS AND BROKERAGE........................ 24
CUSTODIAN................................................... 26
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT................ 26
ADMINISTRATIVE SERVICES..................................... 27
TAXES....................................................... 27
DETERMINATION OF NET ASSET VALUE............................ 29
FUND ORGANIZATION........................................... 29
PERFORMANCE INFORMATION..................................... 29
GENERAL INFORMATION......................................... 35
PORTFOLIO MANAGEMENT........................................ 36
INDEPENDENT ACCOUNTANTS..................................... 36
LEGAL COUNSEL............................................... 37
FINANCIAL STATEMENTS........................................ 37
APPENDIX................................................... A-1
</TABLE>
______________________________
No person has been authorized to give any information or to make any
representations other than those contained in this Statement of Additional
Information and the Prospectus dated May 1, 1997 and, if given or made, such
information or representations may not be relied upon as having been authorized
by the Fund.
This Statement of Additional Information does not constitute an offer to sell
securities.
2
<PAGE> 411
INVESTMENT RESTRICTIONS
The investment objective of the Fund is to seek total return by investing
for a high level of current income with a moderate degree of share-price
fluctuation. The Fund's investment objective and policies are described in
detail in the Prospectus under the caption "Investment Objective and Policies."
The following are the Fund's fundamental investment limitations which cannot
be changed without shareholder approval.
The Fund:
1. May not with respect to 75% of its total assets, purchase the securities
of any issuer (except securities issued or guaranteed by the U.S.
government or its agencies or instrumentalities) if, as a result, (i) more
than 5% of the Fund's total assets would be invested in the securities of
that issuer, or (ii) the Fund would hold more than 10% of the outstanding
voting securities of that issuer.
2. May (i) borrow money from banks and (ii) make other investments or engage
in other transactions permissible under the Investment Company Act of 1940
(the "1940 Act") which may involve a borrowing, provided that the
combination of (i) and (ii) shall not exceed 33 1/3% of the value of the
Fund's total assets (including the amount borrowed), less the Fund's
liabilities (other than borrowings), except that the Fund may borrow up to
an additional 5% of its total assets (not including the amount borrowed)
from a bank for temporary or emergency purposes (but not for leverage or
the purchase of investments). The Fund may also borrow money from the
other Strong Funds or other persons to the extent permitted by applicable
law.
3. May not issue senior securities, except as permitted under the 1940 Act.
4. May not act as an underwriter of another issuer's securities, except to
the extent that the Fund may be deemed to be an underwriter within the
meaning of the Securities Act of 1933 in connection with the purchase and
sale of portfolio securities.
5. May not purchase or sell physical commodities unless acquired as a result
of ownership of securities or other instruments (but this shall not
prevent the Fund from purchasing or selling options, futures contracts, or
other derivative instruments, or from investing in securities or other
instruments backed by physical commodities).
6. May not make loans if, as a result, more than 33 1/3% of the Fund's total
assets would be lent to other persons, except through (i) purchases of
debt securities or other debt instruments, or (ii) engaging in repurchase
agreements.
7. May not purchase the securities of any issuer if, as a result, more than
25% of the Fund's total assets would be invested in the securities of
issuers, the principal business activities of which are in the same
industry.
8. May not purchase or sell real estate unless acquired as a result of
ownership of securities or other instruments (but this shall not prohibit
the Fund from purchasing or selling securities or other instruments backed
by real estate or of issuers engaged in real estate activities).
9. May, notwithstanding any other fundamental investment policy or
restriction, invest all of its assets in the securities of a single
open-end management investment company with substantially the same
fundamental investment objective, policies, and restrictions as the Fund.
3
<PAGE> 412
The following are the Fund's non-fundamental operating policies which may
be changed by the Board of Directors of the Corporation without shareholder
approval.
The Fund may not:
1. Sell securities short, unless the Fund owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short, or
unless it covers such short sale as required by the current rules and
positions of the Securities and Exchange Commission or its staff, and
provided that transactions in options, futures contracts, options on
futures contracts, or other derivative instruments are not deemed to
constitute selling securities short.
2. Purchase securities on margin, except that the Fund may obtain such
short-term credits as are necessary for the clearance of transactions; and
provided that margin deposits in connection with futures contracts,
options on futures contracts, or other derivative instruments shall not
constitute purchasing securities on margin.
3. Invest in illiquid securities if, as a result of such investment, more
than 15% of its net assets would be invested in illiquid securities, or
such other amounts as may be permitted under the 1940 Act.
4. Purchase securities of other investment companies except in compliance
with the 1940 Act and applicable state law.
5. Invest all of its assets in the securities of a single open-end
investment management company with substantially the same fundamental
investment objective, restrictions and policies as the Fund.
6. Engage in futures or options on futures transactions which are
impermissible pursuant to Rule 4.5 under the Commodity Exchange Act and,
in accordance with Rule 4.5, will use futures or options on futures
transactions solely for bona fide hedging transactions (within the meaning
of the Commodity Exchange Act), provided, however, that the Fund may, in
addition to bona fide hedging transactions, use futures and options on
futures transactions if the aggregate initial margin and premiums required
to establish such positions, less the amount by which any such options
positions are in the money (within the meaning of the Commodity Exchange
Act), do not exceed 5% of the Fund's net assets.
7. Borrow money except (i) from banks or (ii) through reverse repurchase
agreements or mortgage dollar rolls, and will not purchase securities when
bank borrowings exceed 5% of its total assets.
8. Make any loans other than loans of portfolio securities, except through
(i) purchases of debt securities or other debt instruments, or (ii)
engaging in repurchase agreements.
Except for the fundamental investment limitations listed above and the
Fund's investment objective, the other investment policies described in the
Prospectus and this Statement of Additional Information are not fundamental and
may be changed with approval of the Corporation's Board of Directors. Unless
noted otherwise, if a percentage restriction is adhered to at the time of
investment, a later increase or decrease in percentage resulting from a change
in the Fund's assets (i.e., due to cash inflows or redemptions) or in market
value of the investment or the Fund's assets will not constitute a violation of
that restriction.
INVESTMENT POLICIES AND TECHNIQUES
The following information supplements the discussion of the Fund's
investment objective, policies, and techniques that are described in detail in
the Prospectus under the captions "Investment Objective and Policies" and
"Implementation of Policies and Risks."
4
<PAGE> 413
BORROWING
The Fund may borrow money from banks and make other investments or engage
in other transactions permissible under the 1940 Act which may be considered a
borrowing (such as mortgage dollar rolls and reverse repurchase agreements) as
discussed under "Investment Restrictions." However, the Fund may not purchase
securities when bank borrowings exceed 5% of the Fund's total assets.
Presently, the Fund only intends to borrow from banks for temporary or
emergency purposes.
The Fund has established a line-of-credit (LOC) with certain banks by
which they may borrow funds for temporary or emergency purposes. A borrowing
is presumed to be for temporary or emergency purposes if it is repaid by the
Fund within sixty days and is not extended or renewed. The Fund intends to use
the LOC to meet large or unexpected redemptions that would otherwise force the
Fund to liquidate securities under circumstances which are unfavorable to the
Fund's remaining shareholders. The Fund pays a commitment fee to the banks for
the LOC.
CONVERTIBLE SECURITIES
The Fund may invest in convertible securities, which are bonds,
debentures, notes, preferred stocks, or other securities that may be converted
into or exchanged for a specified amount of common stock of the same or a
different issuer within a particular period of time at a specified price or
formula. A convertible security entitles the holder to receive interest
normally paid or accrued on debt or the dividend paid on preferred stock until
the convertible security matures or is redeemed, converted, or exchanged.
Convertible securities have unique investment characteristics in that they
generally (i) have higher yields than common stocks, but lower yields than
comparable non-convertible securities, (ii) are less subject to fluctuation in
value than the underlying stock since they have fixed income characteristics,
and (iii) provide the potential for capital appreciation if the market price of
the underlying common stock increases. Most convertible securities currently
are issued by U.S. companies, although a substantial Eurodollar convertible
securities market has developed, and the markets for convertible securities
denominated in local currencies are increasing.
The value of a convertible security is a function of its "investment
value" (determined by its yield in comparison with the yields of other
securities of comparable maturity and quality that do not have a conversion
privilege) and its "conversion value" (the security's worth, at market value,
if converted into the underlying common stock). The investment value of a
convertible security is influenced by changes in interest rates, with
investment value declining as interest rates increase and increasing as
interest rates decline. The credit standing of the issuer and other factors
also may have an effect on the convertible security's investment value. The
conversion value of a convertible security is determined by the market price of
the underlying common stock. If the conversion value is low relative to the
investment value, the price of the convertible security is governed principally
by its investment value. Generally, the conversion value decreases as the
convertible security approaches maturity. To the extent the market price of
the underlying common stock approaches or exceeds the conversion price, the
price of the convertible security will be increasingly influenced by its
conversion value. A convertible security generally will sell at a premium over
its conversion value by the extent to which investors place value on the right
to acquire the underlying common stock while holding a fixed income security.
A convertible security may be subject to redemption at the option of the
issuer at a price established in the convertible security's governing
instrument. If a convertible security held by the Fund is called for
redemption, the Fund will be required to permit the issuer to redeem the
security, convert it into the underlying common stock, or sell it to a third
party.
DEPOSITARY RECEIPTS
The Fund may invest in foreign securities by purchasing depositary
receipts, including American Depositary Receipts ("ADRs") and European
Depositary Receipts ("EDRs"), or other securities convertible into securities
of foreign issuers. These securities may not necessarily be denominated in the
same currency as the securities into which they may be converted. Generally,
ADRs, in registered form, are denominated in U.S. dollars and are designed for
use in the U.S. securities markets, while EDRs, in bearer form, may be
denominated in other currencies and are designed for use in the European
securities markets. ADRs are receipts typically issued by a U.S. bank or
trust company evidencing ownership of the underlying
5
<PAGE> 414
securities. EDRs are European receipts evidencing a similar arrangement. For
purposes of the Fund's investment policies, ADRs and EDRs are deemed to have
the same classification as the underlying securities they represent, except
that ADRs and EDRs shall be treated as indirect foreign investments. Thus, an
ADR or EDR representing ownership of common stock will be treated as common
stock. ADR and EDR depositary receipts do not eliminate all of the risks
associated with directly investing in the securities of foreign issuers.
ADR facilities may be established as either "unsponsored" or "sponsored."
While ADRs issued under these two types of facilities are in some respects
similar, there are distinctions between them relating to the rights and
obligations of ADR holders and the practices of market participants.
A depositary may establish an unsponsored facility without participation
by (or even necessarily the acquiescence of) the issuer of the deposited
securities, although typically the depositary requests a letter of
non-objection from such issuer prior to the establishment of the facility.
Holders of unsponsored ADRs generally bear all the costs of such facilities.
The depositary usually charges fees upon the deposit and withdrawal of the
deposited securities, the conversion of dividends into U.S. dollars, the
disposition of non-cash distributions, and the performance of other services.
The depositary of an unsponsored facility frequently is under no obligation to
pass through voting rights to ADR holders in respect of the deposited
securities. In addition, an unsponsored facility is generally not obligated to
distribute communications received from the issuer of the deposited securities
or to disclose material information about such issuer in the U.S. and thus
there may not be a correlation between such information and the market value of
the depositary receipts.
Sponsored ADR facilities are created in generally the same manner as
unsponsored facilities, except that the issuer of the deposited securities
enters into a deposit agreement with the depositary. The deposit agreement
sets out the rights and responsibilities of the issuer, the depositary, and the
ADR holders. With sponsored facilities, the issuer of the deposited securities
generally will bear some of the costs relating to the facility (such as
dividend payment fees of the depositary), although ADR holders continue to bear
certain other costs (such as deposit and withdrawal fees). Under the terms of
most sponsored arrangements, depositories agree to distribute notices of
shareholder meetings and voting instructions, and to provide shareholder
communications and other information to the ADR holders at the request of the
issuer of the deposited securities.
DERIVATIVE INSTRUMENTS
IN GENERAL. The Fund may use derivative instruments for any lawful
purpose consistent with the Fund's investment objective such as hedging or
managing risk. Derivative instruments are commonly defined to include
securities or contracts whose values depend on (or "derive" from) the value of
one or more other assets, such as securities, currencies, or commodities.
These "other assets" are commonly referred to as "underlying assets."
A derivative instrument generally consists of, is based upon, or exhibits
characteristics similar to options or forward contracts. Options and forward
contracts are considered to be the basic "building blocks" of derivatives. For
example, forward-based derivatives include forward contracts, swap contracts,
as well as exchange-traded futures. Option-based derivatives include privately
negotiated, over-the-counter (OTC) options (including caps, floors, collars,
and options on forward and swap contracts) and exchange-traded options on
futures. Diverse types of derivatives may be created by combining options or
forward contracts in different ways, and by applying these structures to a wide
range of underlying assets.
An option is a contract in which the "holder" (the buyer) pays a certain
amount (the "premium") to the "writer" (the seller) to obtain the right, but
not the obligation, to buy from the writer (in a "call") or sell to the writer
(in a "put") a specific asset at an agreed upon price at or before a certain
time. The holder pays the premium at inception and has no further financial
obligation. The holder of an option-based derivative generally will benefit
from favorable movements in the price of the underlying asset but is not
exposed to corresponding losses due to adverse movements in the value of the
underlying asset. The writer of an option-based derivative generally will
receive fees or premiums but generally is exposed to losses due to changes in
the value of the underlying asset.
A forward is a sales contract between a buyer (holding the "long"
position) and a seller (holding the "short" position) for an asset with
delivery deferred until a future date. The buyer agrees to pay a fixed price
at the agreed future date and the seller agrees to deliver the asset. The
seller hopes that the market price on the delivery date is less than the agreed
upon price,
6
<PAGE> 415
while the buyer hopes for the contrary. The change in value of a forward-based
derivative generally is roughly proportional to the change in value of the
underlying asset.
HEDGING. The Fund may use derivative instruments to protect against
possible adverse changes in the market value of securities held in, or are
anticipated to be held in, the Fund's portfolio. Derivatives may also be used
by the Fund to "lock-in" the Fund's realized but unrecognized gains in the
value of its portfolio securities. Hedging strategies, if successful, can
reduce the risk of loss by wholly or partially offsetting the negative effect
of unfavorable price movements in the investments being hedged. However,
hedging strategies can also reduce the opportunity for gain by offsetting the
positive effect of favorable price movements in the hedged investments.
MANAGING RISK. The Fund may also use derivative instruments to manage the
risks of the Fund's portfolio. Risk management strategies include, but are not
limited to, facilitating the sale of portfolio securities, managing the
effective maturity or duration of debt obligations in the Fund's portfolio,
establishing a position in the derivatives markets as a substitute for buying
or selling certain securities, or creating or altering exposure to certain
asset classes, such as equity, debt, and foreign securities. The use of
derivative instruments may provide a less expensive, more expedient or more
specifically focused way for the Fund to invest than "traditional" securities
(i.e., stocks or bonds) would.
EXCHANGE OR OTC DERIVATIVES. Derivative instruments may be
exchange-traded or traded in OTC transactions between private parties.
Exchange-traded derivatives are standardized options and futures contracts
traded in an auction on the floor of a regulated exchange. Exchange contracts
are generally very liquid. The exchange clearinghouse is the counterparty of
every contract. Thus, each holder of an exchange contract bears the credit
risk of the clearinghouse (and has the benefit of its financial strength)
rather than that of a particular counterparty. Over-the-counter transactions
are subject to additional risks, such as the credit risk of the counterparty to
the instrument and are less liquid than exchange-traded derivatives since they
often can only be closed out with the other party to the transaction.
RISKS AND SPECIAL CONSIDERATIONS. The use of derivative instruments
involves risks and special considerations as described below. Risks pertaining
to particular derivative instruments are described in the sections that follow.
(1) MARKET RISK. The primary risk of derivatives is the same as the risk
of the underlying assets, namely that the value of the underlying asset may go
up or down. Adverse movements in the value of an underlying asset can expose
the Fund to losses. Derivative instruments may include elements of leverage
and, accordingly, the fluctuation of the value of the derivative instrument in
relation to the underlying asset may be magnified. The successful use of
derivative instruments depends upon a variety of factors, particularly Strong
Capital Management, Inc.'s (the "Advisor") ability to predict movements of the
securities, currencies, and commodity markets, which requires different skills
than predicting changes in the prices of individual securities. There can be
no assurance that any particular strategy adopted will succeed. The Advisor's
decision to engage in a derivative instrument will reflect the Advisor's
judgment that the derivative transaction will provide value to the Fund and its
shareholders and is consistent with the Fund's objectives, investment
limitations, and operating policies. In making such a judgment, the Advisor
will analyze the benefits and risks of the derivative transaction and weigh
them in the context of the Fund's entire portfolio and investment objective.
(2) CREDIT RISK. The Fund will be subject to the risk that a loss may be
sustained by the Fund as a result of the failure of a counterparty to comply
with the terms of a derivative instrument. The counterparty risk for
exchange-traded derivative instruments is generally less than for
privately-negotiated or OTC derivative instruments, since generally a clearing
agency, which is the issuer or counterparty to each exchange-traded instrument,
provides a guarantee of performance. For privately-negotiated instruments,
there is no similar clearing agency guarantee. In all transactions, the Fund
will bear the risk that the counterparty will default, and this could result in
a loss of the expected benefit of the derivative transaction and possibly other
losses to the Fund. The Fund will enter into transactions in derivative
instruments only with counterparties that the Advisor reasonably believes are
capable of performing under the contract.
(3) CORRELATION RISK. When a derivative transaction is used to completely
hedge another position, changes in the market value of the combined position
(the derivative instrument plus the position being hedged) result from an
imperfect correlation between the price movements of the two instruments. With
a perfect hedge, the value of the combined position remains unchanged for any
change in the price of the underlying asset. With an imperfect hedge, the
values of the derivative instrument and its hedge are not perfectly correlated.
Correlation risk is the risk that there might be imperfect correlation, or
7
<PAGE> 416
even no correlation, between price movements of an instrument and price
movements of investments being hedged. For example, if the value of a
derivative instruments used in a short hedge (such as writing a call option,
buying a put option, or selling a futures contract) increased by less than the
decline in value of the hedged investments, the hedge would not be perfectly
correlated. Such a lack of correlation might occur due to factors unrelated to
the value of the investments being hedged, such as speculative or other
pressures on the markets in which these instruments are traded. The
effectiveness of hedges using instruments on indices will depend, in part, on
the degree of correlation between price movements in the index and price
movements in the investments being hedged.
(4) LIQUIDITY RISK. Derivatives are also subject to liquidity risk.
Liquidity risk is the risk that a derivative instrument cannot be sold, closed
out, or replaced quickly at or very close to its fundamental value. Generally,
exchange contracts are very liquid because the exchange clearinghouse is the
counterparty of every contract. OTC transactions are less liquid than
exchange-traded derivatives since they often can only be closed out with the
other party to the transaction. The Fund might be required by applicable
regulatory requirement to maintain assets as "cover," maintain segregated
accounts, and/or make margin payments when it takes positions in derivative
instruments involving obligations to third parties (i.e., instruments other
than purchased options). If the Fund was unable to close out its positions in
such instruments, it might be required to continue to maintain such assets or
accounts or make such payments until the position expired, matured, or was
closed out. The requirements might impair the Fund's ability to sell a
portfolio security or make an investment at a time when it would otherwise be
favorable to do so, or require that the Fund sell a portfolio security at a
disadvantageous time. The Fund's ability to sell or close out a position in an
instrument prior to expiration or maturity depends on the existence of a liquid
secondary market or, in the absence of such a market, the ability and
willingness of the counterparty to enter into a transaction closing out the
position. Therefore, there is no assurance that any derivatives position can
be sold or closed out at a time and price that is favorable to the Fund.
(5) LEGAL RISK. Legal risk is the risk of loss caused by the legal
unenforcibility of a party's obligations under the derivative. While a party
seeking price certainty agrees to surrender the potential upside in exchange
for downside protection, the party taking the risk is looking for a positive
payoff. Despite this voluntary assumption of risk, a counterparty that has
lost money in a derivative transaction may try to avoid payment by exploiting
various legal uncertainties about certain derivative products.
(6) SYSTEMIC OR "INTERCONNECTION" RISK. Interconnection risk is the risk
that a disruption in the financial markets will cause difficulties for all
market participants. In other words, a disruption in one market will spill
over into other markets, perhaps creating a chain reaction. Much of the OTC
derivatives market takes place among the OTC dealers themselves, thus creating
a large interconnected web of financial obligations. This interconnectedness
raises the possibility that a default by one large dealer could create losses
at other dealers and destabilize the entire market for OTC derivative
instruments.
GENERAL LIMITATIONS. The use of derivative instruments is subject to
applicable regulations of the Securities and Exchange Commission (the "SEC"),
the several options and futures exchanges upon which they may be traded, the
Commodity Futures Trading Commission ("CFTC"), and various state regulatory
authorities. In addition, the Fund's ability to use derivative instruments may
be limited by certain tax considerations. For a discussion of the federal
income tax treatment of the Fund's derivative instruments, see "Taxes
Derivative Instruments."
The Fund has filed a notice of eligibility for exclusion from the
definition of the term "commodity pool operator" with the CFTC and the National
Futures Association, which regulate trading in the futures markets. In
accordance with Rule 4.5 of the regulations under the Commodity Exchange Act
(the "CEA"), the notice of eligibility for the Fund includes representations
that the Fund will use futures contracts and related options solely for bona
fide hedging purposes within the meaning of CFTC regulations, provided that the
Fund may hold other positions in futures contracts and related options that do
not qualify as a bona fide hedging position if the aggregate initial margin
deposits and premiums required to establish these positions, less the amount by
which any such futures contracts and related options positions are "in the
money," do not exceed 5% of the Fund's net assets. Adherence to these
guidelines does not limit the Fund's risk to 5% of the Fund's assets.
8
<PAGE> 417
The SEC has identified certain trading practices involving derivative
instruments that involve the potential for leveraging the Fund's assets in a
manner that raises issues under the 1940 Act. In order to limit the potential
for the leveraging of the Fund's assets, as defined under the 1940 Act, the SEC
has stated that the Fund may use coverage or the segregation of the Fund's
assets. To the extent required by SEC guidelines, the Fund will not enter into
any such transactions unless it owns either: (i) an offsetting ("covered")
position in securities, options, futures, or derivative instruments; or
(ii) cash or liquid securities positions with a value sufficient at all times
to cover its potential obligations to the extent that the position is not
"covered". The Fund will also set aside cash and/or appropriate liquid assets
in a segregated custodial account if required to do so by the SEC and CFTC
regulations. Assets used as cover or held in a segregated account cannot be
sold while the derivative position is open, unless they are replaced with
similar assets. As a result, the commitment of a large portion of the Fund's
assets to segregated accounts could impede portfolio management or the Fund's
ability to meet redemption requests or other current obligations.
In some cases the Fund may be required to maintain or limit exposure to a
specified percentage of its assets to a particular asset class. In such cases,
when the Fund uses a derivative instrument to increase or decrease exposure to
an asset class and is required by applicable SEC guidelines to set aside liquid
assets in a segregated account to secure its obligations under the derivative
instruments, the Advisor may, where reasonable in light of the circumstances,
measure compliance with the applicable percentage by reference to the nature of
the economic exposure created through the use of the derivative instrument and
not by reference to the nature of the exposure arising from the liquid assets
set aside in the segregated account (unless another interpretation is specified
by applicable regulatory requirements).
OPTIONS. The Fund may use options for any lawful purpose consistent with
the Fund's investment objective such as hedging or managing risk. An option is
a contract in which the "holder" (the buyer) pays a certain amount (the
"premium") to the "writer" (the seller) to obtain the right, but not the
obligation, to buy from the writer (in a "call") or sell to the writer (in a
"put") a specific asset at an agreed upon price (the "strike price" or
"exercise price") at or before a certain time (the "expiration date"). The
holder pays the premium at inception and has no further financial obligation.
The holder of an option will benefit from favorable movements in the price of
the underlying asset but is not exposed to corresponding losses due to adverse
movements in the value of the underlying asset. The writer of an option will
receive fees or premiums but is exposed to losses due to changes in the value
of the underlying asset. The Fund may buy or write (sell) put and call options
on assets, such as securities, currencies, commodities, and indices of debt and
equity securities ("underlying assets") and enter into closing transactions
with respect to such options to terminate an existing position. Options used
by the Fund may include European, American, and Bermuda style options. If an
option is exercisable only at maturity, it is a "European" option; if it is
also exercisable prior to maturity, it is an "American" option. If it is
exercisable only at certain times, it is a "Bermuda" option.
The Fund may purchase (buy) and write (sell) put and call options
underlying assets and enter into closing transactions with respect to such
options to terminate an existing position. The purchase of call options serves
as a long hedge, and the purchase of put options serves as a short hedge.
Writing put or call options can enable the Fund to enhance income by reason of
the premiums paid by the purchaser of such options. Writing call options
serves as a limited short hedge because declines in the value of the hedged
investment would be offset to the extent of the premium received for writing
the option. However, if the security appreciates to a price higher than the
exercise price of the call option, it can be expected that the option will be
exercised and the Fund will be obligated to sell the security at less than its
market value or will be obligated to purchase the security at a price greater
than that at which the security must be sold under the option. All or a
portion of any assets used as cover for OTC options written by the Fund would
be considered illiquid to the extent described under "Investment Policies and
Techniques -- Illiquid Securities." Writing put options serves as a limited
long hedge because increases in the value of the hedged investment would be
offset to the extent of the premium received for writing the option. However,
if the security depreciates to a price lower than the exercise price of the put
option, it can be expected that the put option will be exercised and the Fund
will be obligated to purchase the security at more than its market value.
The value of an option position will reflect, among other things, the
historical price volatility of the underlying investment, the current market
value of the underlying investment, the time remaining until expiration, the
relationship of the exercise price to the market price of the underlying
investment, and general market conditions.
The Fund may effectively terminate its right or obligation under an option
by entering into a closing transaction. For example, the Fund may terminate
its obligation under a call or put option that it had written by purchasing an
identical call or put option; this is known as a closing purchase transaction.
Conversely, the Fund may terminate a position in a put or call
9
<PAGE> 418
option it had purchased by writing an identical put or call option; this is
known as a closing sale transaction. Closing transactions permit the Fund to
realize the profit or limit the loss on an option position prior to its
exercise or expiration.
The Fund may purchase or write both exchange-traded and OTC options.
Exchange-traded options are issued by a clearing organization affiliated with
the exchange on which the option is listed that, in effect, guarantees
completion of every exchange-traded option transaction. In contrast, OTC
options are contracts between the Fund and the other party to the transaction
("counter party") (usually a securities dealer or a bank) with no clearing
organization guarantee. Thus, when the Fund purchases or writes an OTC option,
it relies on the counter party to make or take delivery of the underlying
investment upon exercise of the option. Failure by the counter party to do so
would result in the loss of any premium paid by the Fund as well as the loss of
any expected benefit of the transaction.
The Fund's ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The Fund intends to
purchase or write only those exchange-traded options for which there appears to
be a liquid secondary market. However, there can be no assurance that such a
market will exist at any particular time. Closing transactions can be made for
OTC options only by negotiating directly with the counter party, or by a
transaction in the secondary market if any such market exists. Although the
Fund will enter into OTC options only with counter parties that are expected to
be capable of entering into closing transactions with the Fund, there is no
assurance that the Fund will in fact be able to close out an OTC option at a
favorable price prior to expiration. In the event of insolvency of the counter
party, the Fund might be unable to close out an OTC option position at any time
prior to its expiration. If the Fund were unable to effect a closing
transaction for an option it had purchased, it would have to exercise the
option to realize any profit.
The Fund may engage in options transactions on indices in much the same
manner as the options on securities discussed above, except the index options
may serve as a hedge against overall fluctuations in the securities market in
general.
The writing and purchasing of options is a highly specialized activity
that involves investment techniques and risks different from those associated
with ordinary portfolio securities transactions. Imperfect correlation between
the options and securities markets may detract from the effectiveness of
attempted hedging.
SPREAD TRANSACTIONS. The Fund may use spread transactions for any lawful
purpose consistent with the Fund's investment objective such as hedging or
managing risk. The Fund may purchase covered spread options from securities
dealers. Such covered spread options are not presently exchange-listed or
exchange-traded. The purchase of a spread option gives the Fund the right to
put, or sell, a security that it owns at a fixed dollar spread or fixed yield
spread in relationship to another security that the Fund does not own, but
which is used as a benchmark. The risk to the Fund in purchasing covered
spread options is the cost of the premium paid for the spread option and any
transaction costs. In addition, there is no assurance that closing
transactions will be available. The purchase of spread options will be used to
protect the Fund against adverse changes in prevailing credit quality spreads,
i.e., the yield spread between high quality and lower quality securities. Such
protection is only provided during the life of the spread option.
FUTURES CONTRACTS. The Fund may use futures contracts for any lawful
purpose consistent with the Fund's investment objective such as hedging or
managing risk. The Fund may enter into futures contracts, including interest
rate, index, and currency futures. The Fund may also purchase put and call
options, and write covered put and call options, on futures in which it is
allowed to invest. The purchase of futures or call options thereon can serve
as a long hedge, and the sale of futures or the purchase of put options thereon
can serve as a short hedge. Writing covered call options on futures contracts
can serve as a limited short hedge, and writing covered put options on futures
contracts can serve as a limited long hedge, using a strategy similar to that
used for writing covered options in securities. The Fund's hedging may include
purchases of futures as an offset against the effect of expected increases in
currency exchange rates and securities prices and sales of futures as an offset
against the effect of expected declines in currency exchange rates and
securities prices. The Fund may also write put options on futures contracts
while at the same time purchasing call options on the same futures contracts in
order to create synthetically a long futures contract position. Such options
would have the same strike prices and expiration dates. The Fund will engage
in this strategy only when the Advisor believes it is more advantageous to the
Fund than is purchasing the futures contract.
To the extent required by regulatory authorities, the Fund only enters
into futures contracts that are traded on national futures exchanges and are
standardized as to maturity date and underlying financial instrument. Futures
exchanges and trading are regulated under the CEA by the CFTC. Although
techniques other than sales and purchases of futures contracts could be
10
<PAGE> 419
used to reduce the Fund's exposure to market, currency, or interest rate
fluctuations, the Fund may be able to hedge its exposure more effectively and
perhaps at a lower cost through using futures contracts.
An interest rate futures contract provides for the future sale by one
party and purchase by another party of a specified amount of a specific
financial instrument (e.g., debt security) or currency for a specified price at
a designated date, time, and place. An index futures contract is an agreement
pursuant to which the parties agree to take or make delivery of an amount of
cash equal to the difference between the value of the index at the close of the
last trading day of the contract and the price at which the index futures
contract was originally written. Transaction costs are incurred when a futures
contract is bought or sold and margin deposits must be maintained. A futures
contract may be satisfied by delivery or purchase, as the case may be, of the
instrument, the currency or by payment of the change in the cash value of the
index. More commonly, futures contracts are closed out prior to delivery by
entering into an offsetting transaction in a matching futures contract.
Although the value of an index might be a function of the value of certain
specified securities, no physical delivery of those securities is made. If the
offsetting purchase price is less than the original sale price, the Fund
realizes a gain; if it is more, the Fund realizes a loss. Conversely, if the
offsetting sale price is more than the original purchase price, the Fund
realizes a gain; if it is less, the Fund realizes a loss. The transaction
costs must also be included in these calculations. There can be no assurance,
however, that the Fund will be able to enter into an offsetting transaction
with respect to a particular futures contract at a particular time. If the
Fund is not able to enter into an offsetting transaction, the Fund will
continue to be required to maintain the margin deposits on the futures
contract.
No price is paid by the Fund upon entering into a futures contract.
Instead, at the inception of a futures contract, the Fund is required to
deposit in a segregated account with its custodian, in the name of the futures
broker through whom the transaction was effected, "initial margin" consisting
of cash and/or other appropriate liquid assets in an amount generally equal to
10% or less of the contract value. Margin must also be deposited when writing
a call or put option on a futures contract, in accordance with applicable
exchange rules. Unlike margin in securities transactions, initial margin on
futures contracts does not represent a borrowing, but rather is in the nature
of a performance bond or good-faith deposit that is returned to the Fund at the
termination of the transaction if all contractual obligations have been
satisfied. Under certain circumstances, such as periods of high volatility,
the Fund may be required by an exchange to increase the level of its initial
margin payment, and initial margin requirements might be increased generally in
the future by regulatory action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of the Fund's obligations to or from a futures
broker. When the Fund purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast, when the Fund purchases
or sells a futures contract or writes a call or put option thereon, it is
subject to daily variation margin calls that could be substantial in the event
of adverse price movements. If the Fund has insufficient cash to meet daily
variation margin requirements, it might need to sell securities at a time when
such sales are disadvantageous. Purchasers and sellers of futures positions
and options on futures can enter into offsetting closing transactions by
selling or purchasing, respectively, an instrument identical to the instrument
held or written. Positions in futures and options on futures may be closed
only on an exchange or board of trade that provides a secondary market. The
Fund intends to enter into futures transactions only on exchanges or boards of
trade where there appears to be a liquid secondary market. However, there can
be no assurance that such a market will exist for a particular contract at a
particular time.
Under certain circumstances, futures exchanges may establish daily limits
on the amount that the price of a future or option on a futures contract can
vary from the previous day's settlement price; once that limit is reached, no
trades may be made that day at a price beyond the limit. Daily price limits do
not limit potential losses because prices could move to the daily limit for
several consecutive days with little or no trading, thereby preventing
liquidation of unfavorable positions.
If the Fund were unable to liquidate a futures or option on a futures
contract position due to the absence of a liquid secondary market or the
imposition of price limits, it could incur substantial losses. The Fund would
continue to be subject to market risk with respect to the position. In
addition, except in the case of purchased options, the Fund would continue to
be required to make daily variation margin payments and might be required to
maintain the position being hedged by the future or option or to maintain cash
or securities in a segregated account.
11
<PAGE> 420
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or options on futures contracts
might not correlate perfectly with movements in the prices of the investments
being hedged. For example, all participants in the futures and options on
futures contracts markets are subject to daily variation margin calls and might
be compelled to liquidate futures or options on futures contracts positions
whose prices are moving unfavorably to avoid being subject to further calls.
These liquidations could increase price volatility of the instruments and
distort the normal price relationship between the futures or options and the
investments being hedged. Also, because initial margin deposit requirements in
the futures markets are less onerous than margin requirements in the securities
markets, there might be increased participation by speculators in the future
markets. This participation also might cause temporary price distortions. In
addition, activities of large traders in both the futures and securities
markets involving arbitrage, "program trading" and other investment
strategies might result in temporary price distortions.
SWAP AGREEMENTS. The Fund may enter into interest rate, securities index,
commodity, or security and currency exchange rate swap agreements for any
lawful purpose consistent with the Fund's investment objective, such as for the
purpose of attempting to obtain or preserve a particular desired return or
spread at a lower cost to the Fund than if the Fund had invested directly in an
instrument that yielded that desired return or spread. The Fund also may enter
into swaps in order to protect against an increase in the price of, or the
currency exchange rate applicable to, securities that the Fund anticipates
purchasing at a later date. Swap agreements are two-party contracts entered
into primarily by institutional investors for periods ranging from a few weeks
to several years. In a standard "swap" transaction, two parties agree to
exchange the returns (or differentials in rates of return) earned or realized
on particular predetermined investments or instruments. The gross returns to
be exchanged or "swapped" between the parties are calculated with respect to a
"notional amount," i.e., the return on or increase in value of a particular
dollar amount invested at a particular interest rate, in a particular foreign
currency, or in a "basket" of securities representing a particular index. Swap
agreements may include interest rate caps, under which, in return for a
premium, one party agrees to make payments to the other to the extent that
interest rates exceed a specified rate, or "cap;" interest rate floors, under
which, in return for a premium, one party agrees to make payments to the other
to the extent that interest rates fall below a specified level, or "floor;" and
interest rate collars, under which a party sells a cap and purchases a floor,
or vice versa, in an attempt to protect itself against interest rate movements
exceeding given minimum or maximum levels.
The "notional amount" of the swap agreement is the agreed upon basis for
calculating the obligations that the parties to a swap agreement have agreed to
exchange. Under most swap agreements entered into by the Fund, the obligations
of the parties would be exchanged on a "net basis." Consequently, the Fund's
obligation (or rights) under a swap agreement will generally be equal only to
the net amount to be paid or received under the agreement based on the relative
values of the positions held by each party to the agreement (the "net amount").
The Fund's obligation under a swap agreement will be accrued daily (offset
against amounts owed to the Fund) and any accrued but unpaid net amounts owed
to a swap counterparty will be covered by the maintenance of a segregated
account consisting of cash, or liquid high grade debt obligations.
Whether the Fund's use of swap agreements will be successful in furthering
its investment objective will depend, in part, on the Advisor's ability to
predict correctly whether certain types of investments are likely to produce
greater returns than other investments. Swap agreements may be considered to
be illiquid. Moreover, the Fund bears the risk of loss of the amount expected
to be received under a swap agreement in the event of the default or bankruptcy
of a swap agreement counterparty. Certain restrictions imposed on the Fund by
the Internal Revenue Code may limit the Fund's ability to use swap agreements.
The swaps market is largely unregulated.
The Fund will enter swap agreements only with counterparties that the
Advisor reasonably believes are capable of performing under the swap
agreements. If there is a default by the other party to such a transaction,
the Fund will have to rely on its contractual remedies (which may be limited by
bankruptcy, insolvency or similar laws) pursuant to the agreements related to
the transaction.
Additional Derivative Instruments and Strategies. In addition to the
derivative instruments and strategies described above and in the Fund's
Prospectus, the Advisor expects to discover additional derivative instruments
and other hedging or risk management techniques. The Advisor may utilize these
new derivative instruments and techniques to the extent that they are
consistent with the Fund's investment objective and permitted by the Fund's
investment limitations, operating policies, and applicable regulatory
authorities.
12
<PAGE> 421
ILLIQUID SECURITIES
The Fund may invest in illiquid securities (i.e., securities that are not
readily marketable). However, the Fund will not acquire illiquid securities
if, as a result, they would comprise more than 15% of the value of the Fund's
net assets (or such other amounts as may be permitted under the 1940 Act).
However, as a matter of internal policy, the Advisor intends to limit the
Fund's investments in illiquid securities to 10% of its net assets.
The Board of Directors of the Fund, or its delegate, has the ultimate
authority to determine, to the extent permissible under the federal securities
laws, which securities are illiquid for purposes of this limitation. Certain
securities exempt from registration or issued in transactions exempt from
registration under the Securities Act of 1933, as amended (the "Securities
Act"), such as securities that may be resold to institutional investors under
Rule 144A under the Securities Act and Section 4(2) commercial paper, may be
considered liquid under guidelines adopted by the Fund's Board of Directors.
The Board of Directors of the Fund has delegated to the Advisor the
day-to-day determination of the liquidity of a security, although it has
retained oversight and ultimate responsibility for such determinations. The
Board of Directors has directed the Advisor to look to such factors as (i) the
frequency of trades or quotes for a security, (ii) the number of dealers
willing to purchase or sell the security and number of potential buyers, (iii)
the willingness of dealers to undertake to make a market in the security, (iv)
the nature of the security and nature of the marketplace trades, such as the
time needed to dispose of the security, the method of soliciting offers, and
the mechanics of transfer, (v) the likelihood that the security's marketability
will be maintained throughout the anticipated holding period, and (vi) any
other relevant factors. The Advisor may determine 4(2) commercial paper to be
liquid if (i) the 4(2) commercial paper is not traded flat or in default as to
principal and interest, (ii) the 4(2) commercial paper is rated in one of the
two highest rating categories by at least two nationally rated statistical
rating organizations ("NRSRO"), or if only one NRSRO rates the security, by
that NRSRO, or is determined by the Advisor to be of equivalent quality, and
(iii) the Advisor considers the trading market for the specific security taking
into account all relevant factors. With respect to the Fund's foreign
holdings, a foreign security may be considered liquid by the Advisor (despite
its restricted nature under the Securities Act) if the security can be freely
traded in a foreign securities market and all the facts and circumstances
support a finding of liquidity.
Restricted securities may be sold only in privately negotiated
transactions or in a public offering with respect to which a registration
statement is in effect under the Securities Act. Where registration is
required, the Fund may be obligated to pay all or part of the registration
expenses and a considerable period may elapse between the time of the decision
to sell and the time the Fund may be permitted to sell a security under an
effective registration statement. If, during such a period, adverse market
conditions were to develop, the Fund might obtain a less favorable price than
prevailed when it decided to sell. Restricted securities will be priced at
fair value as determined in good faith by the Board of Directors of the Fund.
If through the appreciation of restricted securities or the depreciation of
unrestricted securities, the Fund should be in a position where more than 15%
of the value of its net assets are invested in illiquid securities, including
restricted securities which are not readily marketable (except for 144A
Securities and 4(2) commercial paper deemed to be liquid by the Advisor), the
Fund will take such steps as is deemed advisable, if any, to protect liquidity.
The Fund may sell over-the-counter ("OTC") options and, in connection
therewith, segregate assets or cover its obligations with respect to OTC
options written by the Fund. The assets used as cover for OTC options written
by the Fund will be considered illiquid unless the OTC options are sold to
qualified dealers who agree that the Fund may repurchase any OTC option it
writes at a maximum price to be calculated by a formula set forth in the option
agreement. The cover for an OTC option written subject to this procedure would
be considered illiquid only to the extent that the maximum repurchase price
under the formula exceeds the intrinsic value of the option.
LENDING OF PORTFOLIO SECURITIES
The Fund is authorized to lend up to 33 1/3% of the total value of its
portfolio securities to broker-dealers or institutional investors that the
Advisor deems qualified, but only when the borrower maintains with the Fund's
custodian bank collateral either in cash or money market instruments in an
amount at least equal to the market value of the securities loaned, plus
accrued interest and dividends, determined on a daily basis and adjusted
accordingly. Although the Fund is authorized to lend, the Fund does not
presently intend to engage in lending. In determining whether to lend
securities to a particular broker-
13
<PAGE> 422
dealer or institutional investor, the Advisor will consider, and during the
period of the loan will monitor, all relevant facts and circumstances,
including the creditworthiness of the borrower. The Fund will retain authority
to terminate any loans at any time. The Fund may pay reasonable administrative
and custodial fees in connection with a loan and may pay a negotiated portion
of the interest earned on the cash or money market instruments held as
collateral to the borrower or placing broker. The Fund will receive reasonable
interest on the loan or a flat fee from the borrower and amounts equivalent to
any dividends, interest or other distributions on the securities loaned. The
Fund will retain record ownership of loaned securities to exercise beneficial
rights, such as voting and subscription rights and rights to dividends,
interest or other distributions, when retaining such rights is considered to be
in the Fund's interest.
MATURITY
The Fund's average portfolio maturity represents an average based on the
actual stated maturity dates of the debt securities in the Fund's portfolio,
except that (i) variable-rate securities are deemed to mature at the next
interest-rate adjustment date, (ii) debt securities with put features are
deemed to mature at the next put-exercise date, (iii) the maturity of
mortgage-backed securities is determined on an "expected life" basis as
determined by the Advisor, and (iv) securities being hedged with futures
contracts may be deemed to have a longer maturity, in the case of purchases of
futures contracts, and a shorter maturity, in the case of sales of futures
contracts, than they would otherwise be deemed to have. In addition, a
security that is subject to redemption at the option of the issuer on a
particular date (the "call date"), which is prior to the security's stated
maturity, may be deemed to mature on the call date rather than on its stated
maturity date. The call date of a security will be used to calculate average
portfolio maturity when the Advisor reasonably anticipates, based upon
information available to it, that the issuer will exercise its right to redeem
the security. The average portfolio maturity of the Fund is dollar-weighted
based upon the market value of the Fund's securities at the time of the
calculation.
MORTGAGE- AND ASSET-BACKED SECURITIES
Mortgage-backed securities represent direct or indirect participations in,
or are secured by and payable from, mortgage loans secured by real property,
and include single- and multi-class pass-through securities and collateralized
mortgage obligations. Such securities may be issued or guaranteed by U.S.
government agencies or instrumentalities, such as the Government National
Mortgage Association and the Federal National Mortgage Association, or by
private issuers, generally originators and investors in mortgage loans,
including savings associations, mortgage bankers, commercial banks, investment
bankers, and special purpose entities (collectively, "private lenders").
Mortgage-backed securities issued by private lenders may be supported by pools
of mortgage loans or other mortgage-backed securities that are guaranteed,
directly or indirectly, by the U.S. government or one of its agencies or
instrumentalities, or they may be issued without any governmental guarantee of
the underlying mortgage assets but with some form of non-governmental credit
enhancement.
Asset-backed securities have structural characteristics similar to
mortgage-backed securities. Asset-backed debt obligations represent direct or
indirect participation in, or secured by and payable from, assets such as motor
vehicle installment sales contracts, other installment loan contracts, home
equity loans, leases of various types of property, and receivables from credit
card or other revolving credit arrangements. The credit quality of most
asset-backed securities depends primarily on the credit quality of the assets
underlying such securities, how well the entity issuing the security is
insulated from the credit risk of the originator or any other affiliated
entities, and the amount and quality of any credit enhancement of the
securities. Payments or distributions of principal and interest on
asset-backed debt obligations may be supported by non-governmental credit
enhancements including letters of credit, reserve funds, overcollateralization,
and guarantees by third parties. The market for privately issued asset-backed
debt obligations is smaller and less liquid than the market for government
sponsored mortgage-backed securities.
The rate of principal payment on mortgage- and asset-backed securities
generally depends on the rate of principal payments received on the underlying
assets which in turn may be affected by a variety of economic and other
factors. As a result, the yield on any mortgage- and asset-backed security is
difficult to predict with precision and actual yield to maturity may be more or
less than the anticipated yield to maturity. The yield characteristics of
mortgage- and asset-backed securities differ from those of traditional debt
securities. Among the principal differences are that interest and principal
payments are made more frequently on mortgage-and asset-backed securities,
usually monthly, and that principal may be prepaid at any time because the
underlying mortgage loans or other assets generally may be prepaid at any time.
As a result, if the Fund purchases
14
<PAGE> 423
these securities at a premium, a prepayment rate that is faster than expected
will reduce yield to maturity, while a prepayment rate that is slower than
expected will have the opposite effect of increasing the yield to maturity.
Conversely, if the Fund purchases these securities at a discount, a prepayment
rate that is faster than expected will increase yield to maturity, while a
prepayment rate that is slower than expected will reduce yield to maturity.
Amounts available for reinvestment by a Fund are likely to be greater during a
period od declining interest rates and, as a result, are likely to be
reinvested at lower interest rates than during a period of rising interest
rates. Accelerated prepayments on securities purchased by the Fund at a
premium also impose a risk of loss of principal because the premium may not
have been fully amortized at the time the principal is prepaid in full. The
market for privately issued mortgage- and asset-backed securities is smaller
and less liquid than the market for government-sponsored mortgage-backed
securities.
While many mortgage- and asset-backed securities are issued with only one
class of security, many are issued in more than one class, each with different
payment terms. Multiple class mortgage- and asset-backed securities are issued
for two main reasons. First, multiple classes may be used as a method of
providing credit support. This is accomplished typically through creation of
one or more classes whose right to payments on the security is made subordinate
to the right to such payments of the remaining class or classes. Second,
multiple classes may permit the issuance of securities with payment terms,
interest rates, or other characteristics differing both from those of each
other and from those of the underlying assets. Examples include so-called
"strips" (mortgage - and asset-backed securities entitling the holder to
disproportionate interests with respect to the allocation of interest and
principal of the assets backing the security), and securities with class or
classes having characteristics which mimic the characteristics of non-mortgage-
or asset-backed securities, such as floating interest rates (i.e., interest
rates which adjust as a specified benchmark changes) or scheduled amortization
of principal.
The Fund may invest in stripped mortgage- or asset-backed securities,
which receive differing proportions of the interest and principal payments from
the underlying assets. The market value of such securities generally is more
sensitive to changes in prepayment and interest rates than is the case with
traditional mortgage- and asset-backed securities, and in some cases such
market value may be extremely volatile. With respect to certain stripped
securities, such as interest only and principal only classes, a rate of
prepayment that is faster or slower than anticipated may result in the Fund
failing to recover all or a portion of its investment, even though the
securities are rated investment grade.
Mortgage- and asset-backed securities backed by assets, other than as
described above, or in which the payment streams on the underlying assets are
allocated in a manner different than those described above may be issued in the
future. The Fund may invest in such securities if such investment is otherwise
consistent with its investment objectives and policies and with the investment
restrictions of the Fund.
MORTGAGE DOLLAR ROLLS AND REVERSE REPURCHASE AGREEMENTS
The Fund may engage in reverse repurchase agreements to facilitate
portfolio liquidity, a practice common in the mutual fund industry, or for
arbitrage transactions discussed below. In a reverse repurchase agreement, the
Fund would sell a security and enter into an agreement to repurchase the
security at a specified future date and price. The Fund generally retains the
right to interest and principal payments on the security. Since the Fund
receives cash upon entering into a reverse repurchase agreement, it may be
considered a borrowing. (See "Borrowing".) When required by guidelines of the
SEC, the Fund will set aside permissible liquid assets in a segregated account
to secure its obligations to repurchase the security.
The Fund may also enter into mortgage dollar rolls, in which the Fund
would sell mortgage-backed securities for delivery in the current month and
simultaneously contract to purchase substantially similar securities on a
specified future date. While the Fund would forego principal and interest paid
on the mortgage-backed securities during the roll period, the Fund would be
compensated by the difference between the current sales price and the lower
price for the future purchase as well as by any interest earned on the proceeds
of the initial sale. The Fund also could be compensated through the receipt of
fee income equivalent to a lower forward price. At the time the Fund would
enter into a mortgage dollar roll, it would set aside permissible liquid assets
in a segregated account to secure its obligation for the forward commitment to
buy mortgage-backed securities. Mortgage dollar roll transactions may be
considered a borrowing by the Fund. (See "Borrowing".)
The mortgage dollar rolls and reverse repurchase agreements entered into
by the Fund may be used as arbitrage transactions in which the Fund will
maintain an offsetting position in investment grade debt obligations or
repurchase
15
<PAGE> 424
agreements that mature on or before the settlement date on the related mortgage
dollar roll or reverse repurchase agreements. Since the Fund will receive
interest on the securities or repurchase agreements in which it invests the
transaction proceeds, such transactions may involve leverage. However, since
such securities or repurchase agreements will be high quality and will mature
on or before the settlement date of the mortgage dollar roll or reverse
repurchase agreement, the Advisor believes that such arbitrage transactions do
not present the risks to the Fund that are associated with other types of
leverage.
MUNICIPAL OBLIGATIONS
General obligation bonds are secured by the issuer's pledge of its full
faith, credit, and taxing power for the payment of interest and principal.
Revenue bonds are payable only from the revenues derived from a project or
facility or from the proceeds of a specified revenue source. Industrial
development bonds are generally revenue bonds secured by payments from and the
credit of private users. Municipal notes are issued to meet the short-term
funding requirements of state, regional, and local governments. Municipal
notes include tax anticipation notes, bond anticipation notes, revenue
anticipation notes, tax and revenue anticipation notes, construction loan
notes, short-term discount notes, tax-exempt commercial paper, demand notes,
and similar instruments. Municipal obligations include obligations, the
interest on which is exempt from federal income tax, that may become available
in the future as long as the Board of Directors of the Fund determines that an
investment in any such type of obligation is consistent with that Fund's
investment objective.
Municipal lease obligations may take the form of a lease, an installment
purchase, or a conditional sales contract. They are issued by state and local
governments and authorities to acquire land, equipment, and facilities, such as
state and municipal vehicles, telecommunications and computer equipment, and
other capital assets. The Fund may purchase these obligations directly, or it
may purchase participation interests in such obligations. Municipal leases are
generally subject to greater risks than general obligation or revenue bonds.
State constitutions and statutes set forth requirements that states or
municipalities must meet in order to issue municipal obligations. Municipal
leases may contain a covenant by the state or municipality to budget for,
appropriate, and make payments due under the obligation. Certain municipal
leases may, however, contain "non-appropriation" clauses which provide that the
issuer is not obligated to make payments on the obligation in future years
unless funds have been appropriated for this purpose each year. Accordingly,
such obligations are subject to "non-appropriation" risk. While municipal
leases are secured by the underlying capital asset, it may be difficult to
dispose of any such asset in the event of non-appropriation or other default.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with certain banks or
non-bank dealers. In a repurchase agreement, the Fund buys a security at one
price, and at the time of sale, the seller agrees to repurchase the obligation
at a mutually agreed upon time and price (usually within seven days). The
repurchase agreement, thereby, determines the yield during the purchaser's
holding period, while the seller's obligation to repurchase is secured by the
value of the underlying security. The Advisor will monitor, on an ongoing
basis, the value of the underlying securities to ensure that the value always
equals or exceeds the repurchase price plus accrued interest. Repurchase
agreements could involve certain risks in the event of a default or insolvency
of the other party to the agreement, including possible delays or restrictions
upon the Fund's ability to dispose of the underlying securities. Although no
definitive creditworthiness criteria are used, the Advisor reviews the
creditworthiness of the banks and non-bank dealers with which the Fund enters
into repurchase agreements to evaluate those risks. The Fund may, under
certain circumstances, deem repurchase agreements collateralized by U.S.
government securities to be investments in U.S. government securities.
SHORT SALES AGAINST THE BOX
The Fund may sell securities short against the box to hedge unrealized
gains on portfolio securities. Selling securities short against the box
involves selling a security that the Fund owns or has the right to acquire, for
delivery at a specified date in the future. If the Fund sells securities short
against the box, it may protect unrealized gains, but will lose the opportunity
to profit on such securities if the price rises.
16
<PAGE> 425
TEMPORARY DEFENSIVE POSITION
When the Advisor determines that market conditions warrant a temporary
defensive position, the Fund may invest without limitation in cash and
short-term fixed income securities, including U.S. government securities,
commercial paper, banker's acceptances, certificates of deposit, and time
deposits.
VARIABLE OR FLOATING RATE SECURITIES
The Fund may invest in securities which offer a variable- or floating-rate
of interest. Variable rate securities provide for automatic establishment of a
new interest rate at fixed intervals (e.g., daily, monthly, semi annually,
etc.). Floating rate securities generally provide for automatic adjustment of
the interest rate whenever some specified interest rate index changes. The
interest rate on variable or floating rate securities is ordinarily determined
by reference to or is a percentage of a bank's prime rate, the 90 day U.S.
Treasury bill rate, the rate of return on commercial paper or bank certificates
of deposit, an index of short term interest rates, or some other objective
measure.
Variable or floating rate securities frequently include a demand feature
entitling the holder to sell the securities to the issuer at par. In many
cases, the demand feature can be exercised at any time on 7 days notice; in
other cases, the demand feature is exercisable at any time on 30 days notice or
on similar notice at intervals of not more than one year. Some securities
which do not have variable or floating interest rates may be accompanied by
puts producing similar results and price characteristics. When considering the
maturity of any instrument which may be sold or put to the issuer or a third
party, the Fund may consider that instrument's maturity to be shorter than its
stated maturity.
Variable rate demand notes include master demand notes which are
obligations that permit the Fund to invest fluctuating amounts, which may
change daily without penalty, pursuant to direct arrangements between the Fund,
as lender, and the borrower. The interest rates on these notes fluctuate from
time to time. The issuer of such obligations normally has a corresponding
right, after a given period, to prepay in its discretion the outstanding
principal amount of the obligations plus accrued interest upon a specified
number of days' notice to the holders of such obligations. The interest rate
on a floating-rate demand obligation is based on a known lending rate, such as
a bank's prime rate, and is adjusted automatically each time such rate is
adjusted. The interest rate on a variable-rate demand obligation is adjusted
automatically at specified intervals. Frequently, such obligations are secured
by letters of credit or other credit support arrangements provided by banks.
Because these obligations are direct lending arrangements between the lender
and borrower, it is not contemplated that such instruments will generally be
traded. There generally is not an established secondary market for these
obligations, although they are redeemable at face value. Accordingly, where
these obligations are not secured by letters of credit or other credit support
arrangements, the Fund's right to redeem is dependent on the ability of the
borrower to pay principal and interest on demand. Such obligations frequently
are not rated by credit rating agencies and, if not so rated, the Fund may
invest in them only if the Advisor determines that at the time of investment
the obligations are of comparable quality to the other obligations in which the
Fund may invest. The Advisor, on behalf of the Fund, will consider on an
ongoing basis the creditworthiness of the issuers of the floating and variable
rate demand obligations in the Fund's portfolio.
The Fund will not invest more than 10% of its net assets in variable- and
floating-rate demand obligations that are not readily marketable (a variable-
or floating-rate demand obligation that may be disposed of on not more than
seven days notice will be deemed readily marketable and will not be subject to
this limitation). (See "Illiquid Securities" and "Investment Restrictions.")
In addition, each variable- or floating-rate obligation must meet the credit
quality requirements applicable to all the Fund's investments at the time of
purchase. When determining whether such an obligation meets the Fund's credit
quality requirements, the Fund may look to the credit quality of the financial
guarantor providing a letter of credit or other credit support arrangement.
In determining the Fund's weighted average portfolio maturity, the Fund
will consider a floating or variable rate security to have a maturity equal to
its stated maturity (or redemption date if it has been called for redemption),
except that it may consider (i) variable rate securities to have a maturity
equal to the period remaining until the next readjustment in the
17
<PAGE> 426
interest rate, unless subject to a demand feature, (ii) variable rate
securities subject to a demand feature to have a remaining maturity equal to
the longer of (a) the next readjustment in the interest rate or (b) the period
remaining until the principal can be recovered through demand, and (iii)
floating rate securities subject to a demand feature to have a maturity equal
to the period remaining until the principal can be recovered through demand.
Variable and floating rate securities generally are subject to less principal
fluctuation than securities without these attributes since the securities
usually trade at amortized cost following the readjustment in the interest rate.
WARRANTS
The Fund may acquire warrants. Warrants are securities giving the holder
the right, but not the obligation, to buy the stock of an issuer at a given
price (generally higher than the value of the stock at the time of issuance)
during a specified period or perpetually. Warrants may be acquired separately
or in connection with the acquisition of securities. Warrants do not carry
with them the right to dividends or voting rights with respect to the
securities that they entitle their holder to purchase, and they do not
represent any rights in the assets of the issuer. As a result, warrants may be
considered to have more speculative characteristics than certain other types of
investments. In addition, the value of a warrant does not necessarily change
with the value of the underlying securities, and a warrant ceases to have value
if it is not exercised prior to its expiration date.
WHEN-ISSUED SECURITIES
The Fund may purchase securities on a "when-issued" basis. The price of
debt obligations purchased on a when-issued basis, which may be expressed in
yield terms, generally is fixed at the time the commitment to purchase is made,
but delivery and payment for the securities take place at a later date.
Normally, the settlement date occurs within 45 days of the purchase although in
some cases settlement may take longer. During the period between the purchase
and settlement, no payment is made by the Fund to the issuer and no interest on
the debt obligations accrues to the Fund. Forward commitments 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 value of
the Fund's other assets. While when-issued securities may be sold prior to the
settlement date, the Fund intends to purchase such securities with the purpose
of actually acquiring them unless a sale appears desirable for investment
reasons. At the time the Fund makes the commitment to purchase a security on a
when-issued basis, it will record the transaction and reflect the value of the
security in determining its net asset value. The Fund does not believe that
its net asset value will be adversely affected by purchases of securities on a
when-issued basis.
To the extent required by the SEC, the Fund will maintain cash and
marketable securities equal in value to commitments for when-issued securities.
Such segregated securities either will mature or, if necessary, be sold on or
before the settlement date. When the time comes to pay for when-issued
securities, the Fund will meet its obligations from then-available cash flow,
sale of the securities held in the separate account, described above, sale of
other securities or, although it would not normally expect to do so, from the
sale of the when-issued securities themselves (which may have a market value
greater or less than the Fund's payment obligation).
ZERO-COUPON, STEP-COUPON AND PAY-IN-KIND SECURITIES
The Fund may invest in zero-coupon, step-coupon, and pay-in-kind
securities. These securities are debt securities that do not make regular cash
interest payments. Zero-coupon and step-coupon securities are sold at a deep
discount to their face value. Pay-in-kind securities pay interest through the
issuance of additional securities. Because such securities do not pay current
cash income, the price of these securities can be volatile when interest rates
fluctuate. While these securities do not pay current cash income, federal
income tax law requires the holders of zero-coupon, step-coupon, and
pay-in-kind securities to include in income each year the portion of the
original issue discount (or deemed discount) and other non-cash income on such
securities accruing that year. In order to continue to qualify as a "regulated
investment company" under the Internal Revenue Code and avoid a certain excise
tax, the Fund may be required to distribute a portion of such discount and
income and may be required to dispose of other portfolio securities, which may
occur in periods of adverse market prices, in order to generate cash to meet
these distribution requirements.
18
<PAGE> 427
DIRECTORS AND OFFICERS OF THE CORPORATION
Directors and officers of the Corporation, together with information as to
their principal business occupations during the last five years, and other
information are shown below. Each director who is deemed an "interested
person," as defined in the 1940 Act, is indicated by an asterisk (*). Each
officer and director holds the same position with the 25 registered open-end
management investment companies consisting of 38 mutual funds, which are
managed by the Advisor (the "Strong Funds"). The Strong Funds, in the
aggregate, pays each Director who is not a director, officer, or employee of
the Advisor, or any affiliated company (a "disinterested director") an annual
fee of $50,000, plus $100 per Board meeting for each Strong Fund. In addition,
each disinterested director is reimbursed by the Strong Funds for travel and
other expenses incurred in connection with attendance at such meetings. Other
officers and directors of the Strong Funds receive no compensation or expense
reimbursement from the Strong Funds.
*RICHARD S. STRONG (DOB 5/12/42), Chairman of the Board and Director of the
Corporation.
Prior to August 1985, Mr. Strong was Chief Executive Officer of the
Advisor, which he founded in 1974. Since August 1985, Mr. Strong has been a
Security Analyst and Portfolio Manager of the Advisor. In October 1991, Mr.
Strong also became the Chairman of the Advisor. Mr. Strong is a director of
the Advisor. Mr. Strong has been in the investment management business since
1967. Mr. Strong has served the Corporation as a director since December 1990
and as Chairman of the Board since January 1992.
MARVIN E. NEVINS (DOB 7/9/18), Director of the Corporation.
Private Investor. From 1945 to 1980, Mr. Nevins was Chairman of Wisconsin
Centrifugal Inc.; a foundry. From July 1983 to December 1986, he was Chairman
of General Casting Corp., Waukesha, Wisconsin, a foundry. Mr. Nevins is a
former Chairman of the Wisconsin Association of Manufacturers & Commerce. He
was also a regent of the Milwaukee School of Engineering and a member of the
Board of Trustees of the Medical College of Wisconsin. Mr. Nevins has served
the Corporation as a director since December 1990.
WILLIE D. DAVIS (DOB 7/24/34), Director of the Corporation.
Mr. Davis has been director of Alliance Bank Since 1980, Sara Lee
Corporation (a food/consumer products company) since 1983, KMart Corporation (a
discount consumer products company) since 1985, YMCA Metropolitan - Los Angeles
since 1985, Dow Chemical Company since 1988, MGM Grand, Inc. (an
entertainment/hotel company) since 1990, WICOR, Inc. (a utility company) since
1990, Johnson Controls, Inc. (an industrial company) since 1992, L.A. Gear (a
footwear/sportswear company) since 1992, and Rally's Hamburger, Inc. since
1994. Mr. Davis has been a trustee of the University of Chicago since 1980,
Marquette University since 1988, and Occidental College since 1990. Since
1977, Mr. Davis has been President and Chief Executive Officer of All Pro
Broadcasting, Inc. Mr. Davis was a director of the Fireman's Fund (an
insurance company) from 1975 until 1990. Mr. Davis has served the Corporation
as a director since July 1994.
*JOHN DRAGISIC (DOB 11/26/40), President and Director of the Corporation.
Mr. Dragisic has been President of the Advisor since October 1995, and a
director of the Advisor since July 1994. Mr. Dragisic served as Vice Chairman
of the Advisor from July 1994 until October 1995. Mr. Dragisic was the
President and Chief Executive Officer of Grunau Company, Inc. (a mechanical
contracting and engineering firm), Milwaukee, Wisconsin from 1987 until July
1994. From 1981 to 1987, he was an Executive Vice President with Grunau
Company, Inc. From 1969 until 1973, Mr. Dragisic worked for the InterAmerican
Development Bank. Mr. Dragisic received his Ph.D. in Economics in 1971 from
the University of Wisconsin - Madison and his B.A. degree in Economics in 1962
from Lake Forest College. Mr. Dragisic has served the Corporation as Vice
Chairman from July 1994 until October 1995; as President since October 1995;
and as a director from July 1991 until July 1994, and since April 1995.
19
<PAGE> 428
STANLEY KRITZIK (DOB 1/9/30), Director of the Corporation.
Mr. Kritzik has been a Partner of Metropolitan Associates since 1962, a
Director of Aurora Health Care since 1987, and Health Network Ventures, Inc.
since 1992. Mr. Kritzik has served the Corporation as a director since April
1995.
WILLIAM F. VOGT (DOB 7/19/47), Director of the Corporation.
Mr. Vogt has been the President of Vogt Management Consulting, Inc. since
1990. From 1982 until 1990, he served as Executive Director of University
Physicians of the University of Colorado. Mr. Vogt is the Past President of
the Medical Group Management Association and a Fellow of the American College
of Medical Practice Executives. Mr. Vogt has served the Corporation as a
director since April 1995.
LAWRENCE A. TOTSKY (DOB 5/6/59), C.P.A., Vice President of the Corporation.
Mr. Totsky has been Senior Vice President of the Advisor since December
1994. Mr. Totsky acted as the Advisor's Manager of Shareholder Accounting and
Compliance from June 1987 to June 1991 when he was named Director of Mutual
Fund Administration. Mr. Totsky has served the Corporation as a Vice President
since May 1993.
THOMAS P. LEMKE (DOB 7/30/54), Vice President of the Corporation.
Mr. Lemke has been Senior Vice President, Secretary, and General Counsel
of the Advisor since September 1994. For two years prior to joining the
Advisor, Mr. Lemke acted as Resident Counsel for Funds Management at J.P.
Morgan & Co., Inc. From February 1989 until April 1992, Mr. Lemke acted as
Associate General Counsel to Sanford C. Bernstein Co., Inc. For two years
prior to that, Mr. Lemke was Of Counsel at the Washington, D.C. law firm of Tew
Jorden & Schulte, a successor of Finley, Kumble & Wagner. From August 1979
until December 1986, Mr. Lemke worked at the Securities and Exchange
Commission, most notably as the Chief Counsel to the Division of Investment
Management (November 1984 - December 1986), and as Special Counsel to the
Office of Insurance Products, Division of Investment Management (April 1982 -
October 1984). Mr. Lemke has served the Corporation as a Vice President since
October 1994.
STEPHEN J. SHENKENBERG (DOB 6/14/58), Vice President and Secretary of the
Corporation.
Mr. Shenkenberg has been Deputy General Counsel to the Advisor since
November 1996. From December 1992 until November 1996 Mr. Shenkenberg acted as
Associate Counsel to the Advisor. From June 1987 until December 1992, Mr.
Shenkenberg was an attorney for Godfrey & Kahn, S.C., a Milwaukee law firm.
Mr. Shenkenberg has served the Corporation as a Vice President since April 1996
and as Secretary since October 1996.
JOHN S. WEITZER (DOB 10/31/67), Vice President of the Corporation.
Mr. Weitzer has been an Associate Counsel of the Advisor since July 1993.
Mr. Weitzer has served the Corporation as a Vice President since January 1996.
Except for Messrs. Nevins, Davis, Kritzik and Vogt, the address of all of
the above persons is P.O. Box 2936, Milwaukee, Wisconsin 53201. Mr. Nevins'
address is 6075 Pelican Bay Boulevard, Naples, Florida 34108. Mr. Davis'
address is 161 North La Brea, Inglewood, California 90301. Mr. Kritzik's
address is 1123 North Astor Street, P.O. Box 92547, Milwaukee, Wisconsin
53202-0547. Mr. Vogt's address is 2830 East Third Avenue, Denver, Colorado
80206.
In addition to the positions listed above, the following individuals also
hold the following positions with Strong Holdings, Inc. ("Holdings"), a
Wisconsin corporation and subsidiary of the Advisor; Strong Funds Distributors,
Inc., the Fund's underwriter ("Distributors"), Heritage Reserve Development
Corporation ("Heritage"), and Strong Service Corporation ("SSC"), each of which
is a Wisconsin corporation and subsidiary of Holdings; Fussville Real Estate
Holdings L.L.C. ("Real Estate Holdings") and Sherwood Development L.L.C.
("Sherwood"), each of which is a Wisconsin Limited
20
<PAGE> 429
Liability Company and subsidiary of the Advisor and Heritage; and Fussville
Development L.L.C. ("Fussville Development"), a Wisconsin Limited Liability
Company and subsidiary of the Advisor and Real Estate Holdings:
RICHARD S. STRONG:
CHAIRMAN AND A DIRECTOR - Holdings and Distributors (since October 1993);
Heritage (since January 1994); and SSC (since November 1995).
CHAIRMAN AND A MEMBER OF THE MANAGING BOARD - Real Estate Holdings and
Fussville Development (since December 1995 and February 1994,
respectively); and Sherwood (since October 1994).
JOHN DRAGISIC:
PRESIDENT AND A DIRECTOR - Holdings (since December 1995 and July 1994,
respectively); Distributors (since September 1996 and July 1994,
respectively); Heritage (since May 1994 and August 1994, respectively);
and SSC (since November 1995).
VICE CHAIRMAN AND A MEMBER OF THE MANAGING BOARD - Real Estate and
Fussville Development (since December 1995 and August 1994,
respectively); and Sherwood (since October 1994).
THOMAS P. LEMKE:
VICE PRESIDENT - Holdings, Heritage, Real Estate Holdings, and Fussville
Development (since December 1995); Distributors (since October 1996);
Sherwood (since October 1994); and SSC (since November 1995).
STEPHEN J. SHENKENBERG:
VICE PRESIDENT AND SECRETARY - Distributors (since December 1995).
SECRETARY - Holdings, Heritage, Fussville Development, Real Estate
Holdings, and Sherwood (since December 1995); and SSC (since November
1995).
As of March 31, 1997, the officers and directors of the Corporation in the
aggregate beneficially owned 8,811 shares of common stock of the Fund which was
48.31% of the Fund's outstanding shares.
PRINCIPAL SHAREHOLDERS
Except for the organizational shares of the Fund, the Fund's shares are
held of record by an insurance company separate account. As of March 31, 1997,
the following persons owned of record or is known by the Fund to own of record
or beneficially more than 5% of the Fund's outstanding shares:
<TABLE>
<CAPTION>
Name and Address Shares Percent of Class
----------------------------- ------ ----------------
<S> <C> <C>
Fortis Benefits Insurance Co. 9,427 51.69%
P.O. Box 64284
St. Paul, MN 55164-0284
</TABLE>
A shareholder owning more than 25% of the Fund's shares may be considered
a "controlling person" of the Fund. Accordingly, its vote could have a more
significant effect on matters presented to shareholders for approval than the
vote of other Fund shareholders.
21
<PAGE> 430
INVESTMENT ADVISOR AND DISTRIBUTOR
The Advisor to the Fund is Strong Capital Management, Inc. Mr. Richard S.
Strong controls the Advisor. Mr. Strong is the Chairman and a director of the
Advisor, Mr. Dragisic is the President and a director of the Advisor, Mr.
Totsky is a Senior Vice President of the Advisor, Mr. Lemke is a Senior Vice
President, Secretary, and General Counsel of the Advisor, Mr. Shenkenberg is
Vice President, Assistant Secretary, and Deputy General Counsel of the Advisor,
and Mr. Weitzer is an Associate Counsel of the Advisor. A brief description of
the Fund's investment advisory agreement ("Advisory Agreement") is set forth in
the Prospectus under "Management."
The Fund's Advisory Agreement is dated July 10, 1995, and will remain in
effect as to the Fund for a period of two years. The Advisory Agreement was
approved by the Fund's initial shareholder on its first day of operations. The
Advisory Agreement is required to be approved annually by the Board of
Directors of the Corporation or by vote of a majority of the Fund's outstanding
voting securities (as defined in the 1940 Act). In either case, each annual
renewal must also be approved by the vote of a majority of the Corporation's
directors who are not parties to the Advisory Agreement or interested persons
of any such party, cast in person at a meeting called for the purpose of voting
on such approval. The Advisory Agreement is terminable, without penalty, on 60
days' written notice by the Board of Directors of the Corporation, by vote of a
majority of the Fund's outstanding voting securities, or by the Advisor. In
addition, the Advisory Agreement will terminate automatically in the event of
its assignment.
Under the terms of the Advisory Agreement, the Advisor manages the Fund's
investments subject to the supervision of the Corporation's Board of Directors.
The Advisor is responsible for investment decisions and supplies investment
research and portfolio management. At its expense, the Advisor provides office
space and all necessary office facilities, equipment, and personnel for
servicing the investments of the Fund. The Advisor places all orders for the
purchase and sale of the Fund's securities at its expense.
Except for expenses assumed by the Advisor, as set forth above, or by the
Distributor, as described below with respect to the distribution of the Fund's
shares, the Fund is responsible for all its other expenses, including, without
limitation, interest charges, taxes, brokerage commissions and similar
expenses; organizational expenses; expenses of issue, sale, repurchase or
redemption of shares; expenses of registering or qualifying shares for sale
with the states and the SEC; expenses for printing and distributing
Prospectuses and quarterly financial statements to existing shareholders;
charges of custodians, transfer agent fees (including the printing and mailing
of reports and notices to shareholders), registrars, auditing and legal
services, clerical services related to recordkeeping and shareholder relations,
and printing of stock certificates; and fees for directors who are not
"interested persons" of the Advisor; and its allocable share of the
Corporation's expenses.
As compensation for its services, the Fund pays to the Advisor a monthly
management fee at the annual rate of .60% of the Fund's average daily net asset
value. (See "Additional Information - Calculation of Net Asset Value" in the
Prospectus.) From time to time, the Advisor may voluntarily waive all or a
portion of its management fee for the Fund. In 1996, the Fund paid the Advisor
$743 in management fees. Without the Advisor's waiver of a portion of its
management fee, the Fund would have paid the Advisor $1,416 in management fees.
The Advisory Agreement requires the Advisor to reimburse the Fund in the
event that the expenses and charges payable by the Fund in any fiscal year,
including the management fee but excluding taxes, interest, brokerage
commissions, and similar fees and to the extent permitted extraordinary
expenses, exceed two percent (2%) of the average net asset value of the Fund
for such year, as determined by valuations made as of the close of each
business day of the year. Reimbursement of expenses in excess of the
applicable limitation will be made on a monthly basis and will be paid to the
Fund by reduction of the Advisor's fee, subject to later adjustment month by
month for the remainder of the Fund's fiscal year. The Advisor may from time
to time absorb expenses for the Fund in addition to the reimbursement of
expenses in excess of applicable limitations.
On July 12, 1994, the Securities and Exchange Commission (the "SEC") filed
an administrative action (the "Order") against the Advisor, Mr. Strong, and
another employee of the Advisor in connection with conduct that occurred
between 1987 and early 1990. In re Strong/Corneliuson Capital Management, Inc.;
et al. Admin. Proc. File No. 3-8411. The proceeding was settled by consent
without admitting or denying the allegations in the Order. The Order found that
the Advisor and Mr. Strong
22
<PAGE> 431
aided and abetted violations of Section 17(a) of the 1940 Act by effecting
trades between mutual funds, and between mutual funds and Harbour Investments
Ltd. ("Harbour"), without complying with the exemptive provisions of SEC Rule
17a-7 or otherwise obtaining an exemption. It further found that the Advisor
violated, and Mr. Strong aided and abetted violations of, the disclosure
provisions of the 1940 Act and the Investment Advisers Act of 1940 by
misrepresenting the Advisor's policy on personal trading and by failing to
disclose trading by Harbour, an entity in which principals of the Advisor owned
between 18 and 25 percent of the voting stock. As part of the settlement, the
respondents agreed to a censure and a cease and desist order and the Advisor
agreed to various undertakings, including adoption of certain procedures and a
limitation for six months on accepting certain types of new advisory clients.
On June 6, 1996, the Department of Labor (the "DOL") filed an action
against the Advisor for equitable relief alleging violations of the Employee
Retirement Income Security Act of 1974 ("ERISA") in connection with cross
trades that occurred between 1987 and late 1989 involving certain pension
accounts managed by the Advisor. Contemporaneous with this filing, the
Advisor, without admitting or denying the DOL's allegations, agreed to the
entry of a consent judgment resolving all matters relating to the allegations.
Reich v. Strong Capital Management, Inc., (U.S.D.C. E.D. WI) (the "Consent
Judgment"). Under the terms of the Consent Judgment, the Advisor agreed to
reimburse the affected accounts a total of $5.9 million. The settlement did
not have any material impact on the Advisor's financial position or operations.
The Fund and the Advisor have adopted a Code of Ethics (the "Code") which
governs the personal trading activities of all "Access Persons" of the Advisor.
Access Persons include every director and officer of the Advisor and the
investment companies managed by the Advisor, including the Fund, as well as
certain employees of the Advisor who have access to information relating to the
purchase or sale of securities by the Advisor on behalf of accounts managed by
it. The Code is based upon the principal that such Access Persons have a
fiduciary duty to place the interests of the Fund and the Advisor's other
clients ahead of their own.
The Code requires Access Persons (other than Access Persons who are
independent directors of the investment companies managed by the Advisor,
including the Fund) to, among other things, preclear their securities
transactions (with limited exceptions, such as transactions in shares of mutual
funds, direct obligations of the U.S. government, and certain options on
broad-based securities market indexes) and to execute such transactions through
the Advisor's trading department. The Code, which applies to all Access Persons
(other than Access Persons who are independent directors of the investment
companies managed by the Advisor, including the Fund), includes a ban on
acquiring any securities in an initial public offering, other than a new
offering of a registered open-end investment company, and a prohibition from
profiting on short-term trading in securities. In addition, no Access Person
may purchase or sell any security which, is contemporaneously being purchased
or sold, or to the knowledge of the Access Person, is being considered for
purchase or sale, by the Advisor on behalf of any mutual fund or other account
managed by it. Finally, the Code provides for trading "black out" periods of
seven calendar days during which time Access Persons who are portfolio managers
may not trade in securities which have been purchased or sold by any mutual
fund or other account managed by the portfolio manager.
From time to time the Advisor votes the shares owned by the Fund according
to its Statement of General Proxy Voting Policy ("Proxy Voting Policy"). The
general principal of the Proxy Voting Policy is to vote any beneficial interest
in an equity security prudently and solely in the best long-term economic
interest of the Fund and its beneficiaries considering all relevant factors and
without undue influence from individuals or groups who may have an economic
interest in the outcome of a proxy vote. Shareholders may obtain a copy of the
Proxy Voting Policy upon request from the Advisor.
The Advisor provides investment advisory services for multiple clients and
may give advice and take action, with respect to any client, that may differ
from the advice given, or the timing or nature of action taken, with respect to
any one account. However, the Advisor will allocate over a period of time, to
the extent practical, investment opportunities to each account on a fair and
equitable basis relative to other similarly-situated client accounts. The
Advisor, its principals and associates (to the extent not prohibited by the
Code), and other clients of the Advisor may have, acquire, increase, decrease,
or dispose of securities or interests therein at or about the same time that
the Advisor is purchasing or selling securities or interests therein for an
account that are or may be deemed to be inconsistent with the actions taken by
such persons.
Under a Distribution Agreement dated July 10, 1995 with the Corporation
(the "Distribution Agreement"), Strong Funds Distributors, Inc.
("Distributor"), a subsidiary of the Advisor, acts as underwriter of the Fund's
shares. The Distribution Agreement provides that the Distributor will use its
best efforts to distribute the Fund's shares. Shares are only offered and sold
23
<PAGE> 432
to the separate accounts of certain insurance companies. Since the Fund is a
"no-load" fund, no sales commissions are charged on the purchase of Fund
shares. Certain sales charges may apply to the variable annuity or life
insurance contract, which should be described in the prospectus of the
insurance company's separate account. The Distribution Agreement further
provides that the Distributor will bear the additional costs of printing
prospectuses and shareholder reports which are used for selling purposes, as
well as advertising and other costs attributable to the distribution of the
Fund's shares. The Distributor is an indirect subsidiary of the Advisor and
controlled by the Advisor and Richard S. Strong. The Distribution Agreement is
subject to the same termination and renewal provisions as are described above
with respect to the Advisory Agreement.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Advisor is responsible for decisions to buy and sell securities for
the Fund and for the placement of the Fund's investment business and the
negotiation of the commissions to be paid on such transactions. It is the
policy of the Advisor to seek the best execution at the best security price
available with respect to each transaction, in light of the overall quality of
brokerage and research services provided to the Advisor or the Fund. In
over-the-counter transactions, orders are placed directly with a principal
market maker unless it is believed that a better price and execution can be
obtained using a broker. The best price to the Fund means the best net price
without regard to the mix between purchase or sale price and commission, if
any. In selecting broker-dealers and in negotiating commissions, the Advisor
considers a variety of factors, including best price and execution, the full
range of brokerage services provided by the broker, as well as its capital
strength and stability, and the quality of the research and research services
provided by the broker. Brokerage will not be allocated based on the sale of
any shares of the Strong Funds.
The Advisor has adopted procedures that provide generally for the Advisor
to seek to bunch orders for the purchase or sale of the same security for the
Fund, other mutual funds managed by the Advisor, and other advisory clients
(collectively, the "client accounts"). The Advisor will bunch orders when it
deems it to be appropriate and in the best interest of the client accounts.
When a bunched order is filled in its entirety, each participating client
account will participate at the average share price for the bunched order on
the same business day, and transaction costs shall be shared pro rata based on
each client's participation in the bunched order. When a bunched order is only
partially filled, the securities purchased will be allocated on a pro rata
basis to each client account participating in the bunched order based upon the
initial amount requested for the account, subject to certain exceptions, and
each participating account will participate at the average share price for the
bunched order on the same business day.
Section 28(e) of the Securities Exchange Act of 1934 ("Section 28(e)")
permits an investment advisor, under certain circumstances, to cause an account
to pay a broker or dealer a commission for effecting a transaction in excess of
the amount of commission another broker or dealer would have charged for
effecting the transaction in recognition of the value of the brokerage and
research services provided by the broker or dealer. Brokerage and research
services include (a) furnishing advice as to the value of securities, the
advisability of investing in, purchasing or selling securities, and the
availability of securities or purchasers or sellers of securities; (b)
furnishing analyses and reports concerning issuers, industries, securities,
economic factors and trends, portfolio strategy, and the performance of
accounts; and (c) effecting securities transactions and performing functions
incidental thereto (such as clearance, settlement, and custody).
In carrying out the provisions of the Advisory Agreement, the Advisor may
cause the Fund to pay a broker, which provides brokerage and research services
to the Advisor, a commission for effecting a securities transaction in excess
of the amount another broker would have charged for effecting the transaction.
The Advisor believes it is important to its investment decision-making process
to have access to independent research. The Advisory Agreement provides that
such higher commissions will not be paid by the Fund unless (a) the Advisor
determines in good faith that the amount is reasonable in relation to the
services in terms of the particular transaction or in terms of the Advisor's
overall responsibilities with respect to the accounts as to which it exercises
investment discretion; (b) such payment is made in compliance with the
provisions of Section 28(e), other applicable state and federal laws, and the
Advisory Agreement; and (c) in the opinion of the Advisor, the total
commissions paid by the Fund will be reasonable in relation to the benefits to
the Fund over the long term. The investment management fee paid by the Fund
under the Advisory Agreement is not reduced as a result of the Advisor's
receipt of research services.
24
<PAGE> 433
Generally, research services provided by brokers may include information
on the economy, industries, groups of securities, individual companies,
statistical information, accounting and tax law interpretations, political
developments, legal developments affecting portfolio securities, technical
market action, pricing and appraisal services, credit analysis, risk
measurement analysis, performance analysis, and analysis of corporate
responsibility issues. Such research services are received primarily in the
form of written reports, telephone contacts, and personal meetings with
security analysts. In addition, such research services may be provided in the
form of access to various computer-generated data, computer hardware and
software, and meetings arranged with corporate and industry spokespersons,
economists, academicians, and government representatives. In some cases,
research services are generated by third parties but are provided to the
Advisor by or through brokers. Such brokers may pay for all or a portion of
computer hardware and software costs relating to the pricing of securities.
Where the Advisor itself receives both administrative benefits and
research and brokerage services from the services provided by brokers, it makes
a good faith allocation between the administrative benefits and the research
and brokerage services, and will pay for any administrative benefits with cash.
In making good faith allocations of costs between administrative benefits and
research and brokerage services, a conflict of interest may exist by reason of
the Advisor's allocation of the costs of such benefits and services between
those that primarily benefit the Advisor and those that primarily benefit the
Fund and other advisory clients.
From time to time, the Advisor may purchase new issues of securities for
the Fund in a fixed price offering. In these situations, the seller may be a
member of the selling group that will, in addition to selling the securities to
the Fund and other advisory clients, provide the Advisor with research. The
National Association of Securities Dealers has adopted rules expressly
permitting these types of arrangements under certain circumstances. Generally,
the seller will provide research "credits" in these situations at a rate that
is higher than that which is available for typical secondary market
transactions. These arrangements may not fall within the safe harbor of Section
28(e).
Each year, the Advisor considers the amount and nature of research and
research services provided by brokers, as well as the extent to which such
services are relied upon, and attempts to allocate a portion of the brokerage
business of the Fund and other advisory clients on the basis of that
consideration. In addition, brokers may suggest a level of business they would
like to receive in order to continue to provide such services. The actual
brokerage business received by a broker may be more or less than the suggested
allocations, depending upon the Advisor's evaluation of all applicable
considerations.
The Advisor has informal arrangements with various brokers whereby, in
consideration for providing research services and subject to Section 28(e), the
Advisor allocates brokerage to those firms, provided that their brokerage and
research services were satisfactory to the Advisor and their execution
capabilities were compatible with the Advisor's policy of seeking best
execution at the best security price available, as discussed above. In no case
will the Advisor make binding commitments as to the level of brokerage
commissions it will allocate to a broker, nor will it commit to pay cash if any
informal targets are not met. The Advisor anticipates it will continue to
enter into such brokerage arrangements.
The Advisor may direct the purchase of securities on behalf of the Fund
and other advisory clients in secondary market transactions, in public
offerings directly from an underwriter, or in privately negotiated transactions
with an issuer. When the Advisor believes the circumstances so warrant,
securities purchased in public offerings may be resold shortly after
acquisition in the immediate aftermarket for the security in order to take
advantage of price appreciation from the public offering price or for other
reasons. Short-term trading of securities acquired in public offerings, or
otherwise, may result in higher portfolio turnover and associated brokerage
expenses.
The Advisor places portfolio transactions for other advisory accounts,
including other mutual funds managed by the Advisor. Research services
furnished by firms through which the Fund effects its securities transactions
may be used by the Advisor in servicing all of its accounts; not all of such
services may be used by the Advisor in connection with the Fund. In the
opinion of the Advisor, it is not possible to measure separately the benefits
from research services to each of the accounts (including the Fund) managed by
the Advisor. Because the volume and nature of the trading activities of the
accounts are not uniform, the amount of commissions in excess of those charged
by another broker paid by each account for brokerage and research services will
vary. However, in the opinion of the Advisor, such costs to the Fund will not
be disproportionate to the benefits received by the Fund on a continuing basis.
25
<PAGE> 434
The Advisor seeks to allocate portfolio transactions equitably whenever
concurrent decisions are made to purchase or sell securities by the Fund and
another advisory account. In some cases, this procedure could have an adverse
effect on the price or the amount of securities available to the Fund. In
making such allocations between the Fund and other advisory accounts, the main
factors considered by the Advisor are the respective investment objectives, the
relative size of portfolio holdings of the same or comparable securities, the
availability of cash for investment, the size of investment commitments
generally held, and the opinions of the persons responsible for recommending
the investment.
Where consistent with a client's investment objectives, investment
restrictions, and risk tolerance, the Advisor may purchase securities sold in
underwritten public offerings for client accounts, commonly referred to as
"deal" securities. The Advisor has adopted deal allocation procedures (the
"procedures"), summarized below, that reflect the Advisor's overriding policy
that deal securities must be allocated among participating client accounts in a
fair and equitable manner and that deal securities may not be allocated in a
manner that unfairly discriminates in favor of certain clients or types of
clients.
The procedures provide that, in determining which client accounts a
portfolio manager team will seek to have purchase deal securities, the team
will consider all relevant factors including, but not limited to, the nature,
size, and expected allocation to the Advisor of deal securities; the size of
the account(s); the accounts' investment objectives and restrictions; the risk
tolerance of the client; the client's tolerance for possibly higher portfolio
turnover; the amount of commissions generated by the account during the past
year; and the number of other deals the client has participated in during the
past year.
Where more than one of the Advisor's portfolio manager team seeks to have
client accounts participate in a deal and the amount of deal securities
allocated to the Advisor by the underwriting syndicate is less than the
aggregate amount ordered by the Advisor (a "reduced allocation"), the deal
securities will be allocated among the portfolio manager teams based on all
relevant factors. The primary factor shall be assets under management,
although other factors that may be considered in the allocation decision
include, but are not limited to, the nature, size, and expected allocation of
the deal; the amount of brokerage commissions or other amounts generated by the
respective participating portfolio manager teams; and which portfolio manager
team is primarily responsible for the Advisor receiving securities in the deal.
Based on the relevant factors, the Advisor has established general allocation
percentages for its portfolio manager teams, and these percentages are reviewed
on a regular basis to determine whether asset growth or other factors make it
appropriate to use different general allocation percentages for reduced
allocations.
When a portfolio manager team receives a reduced allocation of deal
securities, the portfolio manager team will allocate the reduced allocation
among client accounts in accordance with the allocation percentages set forth
in the team's initial allocation instructions for the deal securities, except
where this would result in a de minimis allocation to any client account. On a
regular basis, the Advisor reviews the allocation of deal securities to ensure
that they have been allocated in a fair and equitable manner that does not
unfairly discriminate in favor of certain clients or types of clients.
During 1996, the Fund did not pay any brokerage commissions.
CUSTODIAN
As custodian of the Fund's assets, Firstar Trust Company, P.O. Box 761,
Milwaukee, Wisconsin 53201, has custody of all securities and cash of the Fund,
delivers and receives payment for securities sold, receives and pays for
securities purchased, collects income from investments, and performs other
duties, all as directed by officers of the Corporation. The custodian is in no
way responsible for any of the investment policies or decisions of the Fund.
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT
The Advisor acts as transfer agent and dividend-disbursing agent for the
Fund at no cost.
26
<PAGE> 435
ADMINISTRATIVE SERVICES
From time to time the Fund and/or the Advisor may enter into arrangements
under which certain administrative services may be performed by the insurance
companies that purchase shares in the Fund. These administrative services may
include, among other things, responding to ministerial inquiries concerning the
Fund's investment objective, investment program, policies and performance,
transmitting, on behalf of the Fund, proxy statements, annual reports, updated
prospectuses, and other communications regarding the Fund, and providing only
related services as the Fund or its shareholders may reasonably request.
Depending on the arrangements, the Fund and/or Advisor may compensate such
insurance companies or their agents directly or indirectly for the
administrative services. To the extent the Fund compensates the insurance
company for these services, the Fund will pay the insurance company an annual
fee that will vary depending upon the number of contract holders that utilize
the Fund as the funding medium for their contracts. The insurance company may
impose other account or service charges. See the prospectus for the separate
account of the insurance company for additional information regarding such
charges.
TAXES
GENERAL
As indicated under "Additional Information - Distributions and Taxes" in
the Prospectus, the Fund intends to continue to qualify annually for treatment
as a regulated investment company ("RIC") under the Internal Revenue Code of
1986, as amended (the "Code"). This qualification does not involve government
supervision of the Fund's management practices or policies.
In order to qualify for treatment as a RIC under the Code, the Fund must
distribute to its shareholders for each taxable year at least 90% of its
investment company taxable income (consisting generally of net investment
income, net short-term capital gain, and net gains from certain foreign
currency transactions) ("Distribution Requirement") and must meet several
additional requirements. Among these requirements are the following: (1) the
Fund must derive at least 90% of its gross income each taxable year from
dividends, interest, payments with respect to securities loans, or other income
(including gains from options, futures, or forward contracts) derived with
respect to its business of investing in securities ("Income Requirement"); (2)
the Fund must derive less than 30% of its gross income each taxable year from
the sale or other disposition of securities, or any of the following, that were
held for less than three months - options or futures (or options and futures
with respect to securities) ("30% Limitation"); (3) at the close of each
quarter of the Fund's taxable year, at least 50% of the value of its total
assets must be represented by cash and cash items, U.S. government securities,
securities of other RICs, and other securities, with these other securities
limited, in respect of any one issuer, to an amount that does not exceed 5% of
the value of the Fund's total assets and that does not represent more than 10%
of the issuer's outstanding voting securities; and (4) at the close of each
quarter of the Fund's taxable year, not more than 25% of the value of its total
assets may be invested in securities (other than U.S. government securities or
the securities of other RICs) of any one issuer. From time to time the Advisor
may find it necessary to make certain types of investments for the purpose of
ensuring that the Fund continues to qualify for treatment as a RIC under the
Code.
If Fund shares are sold at a loss after being held for six months or less,
the loss will be treated as long-term, instead of short-term, capital loss to
the extent of any capital gain distributions received on those shares.
In addition, the Fund must satisfy the diversification requirements of
Section 817(h) of the Code. In general, for a Fund to meet these investment
diversification requirements, Treasury regulations require that no more than
55% of the total value of the assets of the Fund may be represented by any one
investment, no more than 70% by two investments, no more than 80% by three
investments and no more than 90% by four investments. Generally, for purposes
of the regulations, all securities of the same issuer are treated as a single
investment. With respect to the United States Government securities (including
any security that is issued, guaranteed or insured by the United States or an
instrumentality of the United States), each governmental agency or
instrumentality is treated as a separate issuer. Compliance with the
regulations is tested on the
27
<PAGE> 436
last day of each calendar year quarter. There is a 30-day period after the end
of each calendar year quarter in which to cure any non-compliance with these
requirements.
DERIVATIVE INSTRUMENTS
The use of derivatives strategies, such as purchasing and selling
(writing) options and futures, involves complex rules that will determine for
income tax purposes the character and timing of recognition of the gains and
losses the Fund realizes in connection therewith. Income from transactions in
options and futures derived by the Fund with respect to its business of
investing in securities will qualify as permissible income under the Income
Requirement. However, income from the disposition of options and futures will
be subject to the 30% Limitation if they are held for less than three months.
Income from the disposition of options and futures that are not directly
related to the Fund's principal business of investing in securities (or options
and futures with respect to securities) also will be subject to the 30%
Limitation if they are held for less than three months.
If the Fund satisfies certain requirements, any increase in value of a
position that is part of a "designated hedge" will be offset by any decrease in
value (whether realized or not) of the offsetting hedging position during the
period of the hedge for purposes of determining whether the Fund satisfies the
30% Limitation. Thus, only the net gain (if any) from the designated hedge
will be included in gross income for purposes of that limitation. The Fund
intends that, when it engages in hedging strategies, the hedging transactions
will qualify for this treatment, but at the present time it is not clear
whether this treatment will be available for all of the Fund's hedging
transactions. To the extent this treatment is not available or is not elected
by the Fund, it may be forced to defer the closing out of certain options,
futures, or forward currency contracts beyond the time when it otherwise would
be advantageous to do so, in order for the Fund to continue to qualify as a
RIC.
For federal income tax purposes, the Fund is required to recognize as
income for each taxable year its net unrealized gains and losses on options and
futures that are subject to section 1256 of the Code ("Section 1256 Contracts")
and are held by the Fund as of the end of the year, as well as gains and losses
on Section 1256 Contracts actually realized during the year. Except for
Section 1256 Contracts that are part of a "mixed straddle" and with respect to
which the Fund makes a certain election, any gain or loss recognized with
respect to Section 1256 Contracts is considered to be 60% long-term capital
gain or loss and 40% short-term capital gain or loss, without regard to the
holding period of the Section 1256 Contract. Unrealized gains on Section 1256
Contracts that have been held by the Fund for less than three months as of the
end of its taxable year, and that are recognized for federal income tax
purposes as described above, will not be considered gains on investments held
for less than three months for purposes of the 30% Limitation.
ZERO-COUPON, STEP-COUPON, AND PAY-IN-KIND SECURITIES
The Fund may acquire zero-coupon, step-coupon, or other securities issued
with original issue discount. As a holder of those securities, the Fund must
include in its income the original issue discount that accrues on the
securities during the taxable year, even if the Fund receives no corresponding
payment on the securities during the year. Similarly, the Fund must include in
its income securities it receives as "interest" on pay-in-kind securities.
Because the Fund annually must distribute substantially all of its investment
company taxable income, including any original issue discount and other
non-cash income, to satisfy the Distribution Requirement, it may be required in
a particular year to distribute as a dividend an amount that is greater than
the total amount of cash it actually receives. Those distributions may be made
from the proceeds on sales of portfolio securities, if necessary. The Fund may
realize capital gains or losses from those sales, which would increase or
decrease its investment company taxable income or net capital gain, or both.
In addition, any such gains may be realized on the disposition of securities
held for less than three months. Because of the 30% Limitation, any such gains
would reduce the Fund's ability to sell other securities, or certain options,
futures, or forward currency contracts, held for less that three months that
it might wish to sell in the ordinary course of its portfolio management.
The foregoing federal tax discussion as well as the tax discussion
contained within the Prospectus under "Additional Information - Distributions
and Taxes" is intended to provide you with an overview of the impact of federal
income tax provisions on the Fund or its shareholders. These tax provisions
are subject to change by legislative or administrative action at the federal,
state, or local level, and any changes may be applied retroactively. Any such
action that limits or restricts the Fund's current ability to pass-through
earnings without taxation at the Fund level, or otherwise materially changes
the Fund's tax treatment, could adversely affect the value of a shareholder's
investment in the Fund. Because the Fund's taxes are a
28
<PAGE> 437
complex matter, you should consult your tax adviser for more detailed
information concerning the taxation of the Fund and the federal, state, and
local tax consequences to shareholders of an investment in the Fund.
DETERMINATION OF NET ASSET VALUE
A more complete discussion of the Fund's determination of net asset value
is contained in the Prospectus. Generally, the net asset value of the Fund
will be determined as of the close of trading on each day the New York Stock
Exchange (the "NYSE") is open for trading except for bank holidays. The NYSE is
open for trading Monday through Friday except New Year's Day, Presidents' Day,
Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and
Christmas Day. Additionally, if any of the aforementioned holidays falls on a
Saturday, the NYSE will not be open for trading on the preceding Friday, and
when any such holiday falls on a Sunday, the NYSE will not be open for trading
on the succeeding Monday, unless unusual business conditions exist, such as the
ending of a monthly or the yearly accounting period.
FUND ORGANIZATION
The Fund is a series of Strong Variable Insurance Funds, Inc., a Wisconsin
corporation (the "Corporation"). The Corporation (formerly known as Strong
Discovery Fund II, Inc., formerly known as Strong D Fund, Inc.) was organized
on December 28, 1990 and is authorized to issue an indefinite number of shares
of common stock and series and classes of series of shares of common stock,
with a par value of $.00001 per share. The Corporation is authorized to issue
an indefinite number of shares of common stock of the Fund. Each share of the
Corporation has one vote, and all shares of a series participate equally in
dividends and other capital gains distributions and in the residual assets of
that Fund in the event of liquidation. Fractional shares have the same rights
proportionately as do full shares. Shares of the Corporation have no
preemptive, conversion, or subscription rights. The Corporation currently has
seven series of common stock outstanding. The assets belonging to each series
of shares is held separately by a custodian, and in effect each series is a
separate fund. All holders of shares of the Corporation would vote on each
matter presented to shareholders for action except with respect to any matter
which affects only one or more series or classes, in which case only the shares
of the affected series or class shall be entitled to vote. Because of current
federal securities law requirements the Corporation expects that its
shareholders will offer to owners of variable annuity and variable life
insurance contracts the opportunity to instruct them as to how shares allocable
to their contracts will be voted with respect to certain matters, such as
approval of changes to the investment advisory agreement.
PERFORMANCE INFORMATION
As described under "Additional Information - Performance Information" in
the Prospectus, the Fund's historical performance or return may be shown in the
form of "yield," "average annual total return," "total return," and
"cumulative total return." From time to time, the Advisor may voluntarily
waive all or a portion of its management fee and/or absorb certain expenses for
the Fund. Total returns contained in advertisements include the effect of
deducting the Fund's expenses, but may not include charges and expenses
attributable to any particular insurance product. Since shares may only be
purchased by the separate accounts of certain insurance companies, contracts
owners should carefully review the prospectus of the separate account for
information on fees and expenses. Excluding such fees and expenses from the
Fund's total return quotations has the effect of increasing the performance
quoted.
YIELD
The Fund's yield is computed in accordance with a standardized method
prescribed by rules of the SEC. Under that method, the current yield quotation
for the Fund is based on a one month or 30-day period. The yield is computed
by dividing the net investment income per share earned during the 30-day or one
month period by the maximum offering price per share on the last day of the
period, according to the following formula:
29
<PAGE> 438
6
YIELD = 2[( a-b + 1) - 1]
---
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursements).
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends.
d = the maximum offering price per share on the last day of the
period.
For the 30-day period ended December 31, 1996, the Fund's yield was 2.72%.
During this period, the Advisor waived management fees of .60% and absorbed
expenses 2.12%. Without this waiver and absorption, the Fund's yield would
have been 0%.
In computing yield, the Fund follows certain standardized accounting
practices specified by SEC rules. These practices are not necessarily
consistent with those that the Fund uses to prepare annual and interim
financial statements in conformity with generally accepted accounting
principles.
DISTRIBUTION RATE
The distribution rate is computed, according to a non-standardized
formula, by dividing the total amount of actual distributions per share paid by
the Fund over a twelve month period by the Fund's net asset value on the last
day of the period. The distribution rate differs from the Fund's yield because
the distribution rate includes distributions to shareholders from sources other
than dividends and interest, such as premium income from option writing and
short-term capital gains. Therefore, the Fund's distribution rate may be
substantially different than its yield. Both the Fund's yield and distribution
rate will fluctuate.
AVERAGE ANNUAL TOTAL RETURN
The Fund's average annual total return quotation is computed in accordance
with a standardized method prescribed by rules of the SEC. The average annual
total return for the Fund for a specific period is found by first taking a
hypothetical $10,000 investment ("initial investment") in the Fund's shares on
the first day of the period and computing the "redeemable value" of that
investment at the end of the period. The redeemable value is then divided by
the initial investment, and this quotient is taken to the Nth root (N
representing the number of years in the period) and one is subtracted from the
result, which is then expressed as a percentage. The calculation assumes that
all income and capital gains dividends paid by the Fund have been reinvested at
net asset value on the reinvestment dates during the period.
TOTAL RETURN
Calculation of the Fund's total return is not subject to a standardized
formula. Total return performance for a specific period is calculated by first
taking an investment (assumed below to be $10,000) ("initial investment") in
the Fund's shares on the first day of the period and computing the "ending
value" of that investment at the end of the period. The total return
percentage is then determined by subtracting the initial investment from the
ending value and dividing the remainder by the initial investment and
expressing the result as a percentage. The calculation assumes that all income
and capital gains dividends paid by the Fund have been reinvested at net asset
value on the reinvestment dates during the period. Total return may also be
shown as the increased dollar value of the hypothetical investment over the
period.
CUMULATIVE TOTAL RETURN
Calculation of the Fund's cumulative total return is not subject to a
standardized formula and represents the simple change in value of an investment
over a stated period and may be quoted as a percentage or as a dollar amount.
Total returns and cumulative total returns may be broken down into their
components of income and capital (including capital gains and changes in share
price) in order to illustrate the relationship between these factors and their
contributions to total return.
30
<PAGE> 439
The Fund's performance figures are based upon historical results and do
not represent future performance. The Fund's shares are sold at net asset
value per share. The Fund's returns and net asset value will fluctuate and
shares are redeemable at the then current net asset value of the Fund, which
may be more or less than original cost. Factors affecting the Fund's
performance include general market conditions, operating expenses, and
investment management. Any additional fees charged by an insurance company or
other financial services firm would reduce the returns described in this
section.
The table below shows performance information for the period from January
31, 1996 (inception) through December 31, 1996. Securities prices fluctuated
during these periods.
GOVERNMENT SECURITIES FUND II
<TABLE>
<CAPTION>
Average
Total Return Annual Total Return
Initial $10,000 Ending Value Percentage Percentage
Investment December 31, 1996 Increase Increase
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Life of Fund $10,000 $9,959 -0.41% -
The Fund's total return for the three months ending March 31, 1997, was -1.34%.
</TABLE>
COMPARISONS
(1) U.S. TREASURY BILLS, NOTES, OR BONDS
Investors may also wish to compare the performance of the Fund to that of
United States Treasury bills, notes, or bonds, which are issued by the U.S.
government, because such instruments represent alternative income producing
products. Treasury obligations are issued in selected denominations. Rates of
Treasury obligations are fixed at the time of issuance and payment of principal
and interest is backed by the full faith and credit of the United States
Treasury. The market value of such instruments will generally fluctuate
inversely with interest rates prior to maturity and will equal par value at
maturity.
(2) CERTIFICATES OF DEPOSIT
Investors may wish to compare the Fund's performance to that of
certificates of deposit offered by banks and other depositary institutions.
Certificates of deposit represent an alternative income producing product.
Certificates of deposit may offer fixed or variable interest rates and
principal is guaranteed and may be insured. Withdrawal of the deposits prior to
maturity normally will be subject to a penalty. Rates offered by banks and
other depositary institutions are subject to change at any time specified by
the issuing institution.
(3) MONEY MARKET FUNDS
Investors may also want to compare performance of the Fund to that of
money market funds. Money market fund yields will fluctuate and an investment
in money market fund shares is neither insured nor guaranteed by the U.S.
government, but share values usually remain stable.
(4) LIPPER ANALYTICAL SERVICES, INC. ("LIPPER") AND OTHER INDEPENDENT
RANKING ORGANIZATIONS
From time to time, in marketing and other fund literature, the Fund's
performance may be compared to the performance of other mutual funds in general
or to the performance of particular types of mutual funds, with similar
investment goals, as tracked by independent organizations. Among these
organizations, Lipper, a widely used independent research firm which ranks
mutual funds by overall performance, investment objectives, and assets, may be
cited. Lipper performance figures are based on changes in net asset value,
with all income and capital gain dividends reinvested. Such calculations do
not include the effect of any sales charges imposed by other funds. The Fund
will be compared to Lipper's appropriate fund category, that is, by fund
objective and portfolio holdings.
31
<PAGE> 440
(5) MORNINGSTAR, INC.
The Fund's performance may also be compared to the performance of other
mutual funds by Morningstar, Inc. which rates funds on the basis of historical
risk and total return. Morningstar's ratings range from five stars (highest)
to one star (lowest) and represent Morningstar's assessment of the historical
risk level and total return of the Fund as a weighted average for 3, 5, and 10
year periods. Ratings are not absolute and do not represent future results.
(6) VARDS REPORT
The Fund's performance may also be compared to the performance of other
variable annuity products in general or to the performance of particular types
of variable annuity products, with similar investment goals, as tracked by the
VARDS Report (Variable Annuity Research and Data Service Report) produced by
Financial Planning Resources, Inc. The VARDS Report is a monthly performance
analysis of the variable annuity industry.
(7) INDEPENDENT SOURCES
Evaluations of Fund performance made by independent sources may also be
used in advertisements concerning the Fund, including reprints of, or
selections from, editorials or articles about the Fund, especially those with
similar objectives. Sources for Fund performance information and articles
about the Fund may include publications such as Money, Forbes, Kiplinger's,
Smart Money, Morningstar, Inc., Financial World, Business Week, U.S. News and
World Report, The Wall Street Journal, Barron's, and a variety of investment
newsletters.
(8) VARIOUS BANK PRODUCTS
The Fund's performance also may be compared on a before or after-tax basis
to various bank products, including the average rate of bank and thrift
institution money market deposit accounts, Super N.O.W. accounts and
certificates of deposit of various maturities as reported in the Bank Rate
Monitor, National Index of 100 leading banks, and thrift institutions as
published by the Bank Rate Monitor, Miami Beach, Florida. The rates published
by the Bank Rate Monitor National Index are averages of the personal account
rates offered on the Wednesday prior to the date of publication by 100 large
banks and thrifts in the top ten Consolidated Standard Metropolitan Statistical
Areas. The rates provided for the bank accounts assume no compounding and are
for the lowest minimum deposit required to open an account. Higher rates may
be available for larger deposits.
With respect to money market deposit accounts and Super N.O.W. accounts,
account minimums range upward from $2,000 in each institution and compounding
methods vary. Super N.O.W. accounts generally offer unlimited check writing
while money market deposit accounts generally restrict the number of checks
that may be written. If more than one rate is offered, the lowest rate is
used. Rates are determined by the financial institution and are subject to
change at any time specified by the institution. Generally, the rates offered
for these products take market conditions and competitive product yields into
consideration when set. Bank products represent a taxable alternative income
producing product. Bank and thrift institution deposit accounts may be
insured. Shareholder accounts in the Fund are not insured. Bank passbook
savings accounts compete with money market mutual fund products with respect to
certain liquidity features but may not offer all of the features available from
a money market mutual fund, such as check writing. Bank passbook savings
accounts normally offer a fixed rate of interest while the yield of the Fund
fluctuates. Bank checking accounts normally do not pay interest but compete
with money market mutual fund products with respect to certain liquidity
features (e.g., the ability to write checks against the account). Bank
certificates of deposit may offer fixed or variable rates for a set term.
(Normally, a variety of terms are available.) Withdrawal of these deposits
prior to maturity will normally be subject to a penalty.
(9) INDICES
The Fund may compare its performance to a wide variety of indices
including the following:
(a) The Consumer Price Index
(b) Merrill Lynch 91 Day Treasury Bill Index
(c) Merrill Lynch Government/Corporate 1-3 Year Index
(d) IBC/Donoghue's Taxable Money Fund AverageTM
(e) IBC/Donoghue's Government Money Fund AverageTM
(f) Salomon Brothers 1-Month Treasury Bill Index
(g) Salomon Brothers 3-Month Treasury Bill Index
32
<PAGE> 441
(h) Salomon Brothers 1-Year Treasury Benchmark-on-the-Run Index
(i) Salomon Brothers 1-3 Year
Treasury/Government-Sponsored/Corporate Bond Index
(j) Salomon Brothers Corporate Bond Index
(k) Salomon Brothers AAA, AA, A, BBB, and BB Corporate Bond
Indexes
(l) Salomon Brothers Broad Investment-Grade Bond Index
(m) Salomon Brothers High-Yield BBB Index
(n) Lehman Brothers Aggregate Bond Index
(o) Lehman Brothers 1-3 Year Government/Corporate Bond Index
(p) Lehman Brothers Intermediate Government/Corporate Bond Index
(q) Lehman Brothers Intermediate AAA, AA, and A Corporate Bond
Indexes
(r) Lehman Brothers Government/Corporate Bond Index
(s) Lehman Brothers Corporate Baa Index
(t) Lehman Brothers Intermediate Corporate Baa Index
(10) HISTORICAL ASSET CLASS RETURNS
From time to time, marketing materials may portray the historical returns
of various asset classes. Such presentations will typically compare the
average annual rates of return of inflation, U.S. Treasury bills, bonds, common
stocks, and small stocks. There are important differences between each of these
investments that should be considered in viewing any such comparison. The
market value of stocks will fluctuate with market conditions, and small-stock
prices generally will fluctuate more than large-stock prices. Stocks are
generally more volatile than bonds. In return for this volatility, stocks have
generally performed better than bonds or cash over time. Bond prices generally
will fluctuate inversely with interest rates and other market conditions, and
the prices of bonds with longer maturities generally will fluctuate more than
those of shorter-maturity bonds. Interest rates for bonds may be fixed at the
time of issuance, and payment of principal and interest may be guaranteed by
the issuer and, in the case of U.S. Treasury obligations, backed by the full
faith and credit of the U.S. Treasury.
(11) STRONG VARIABLE INSURANCE FUNDS
The Strong Variable Insurance Funds offer a range of investment options.
All of the members of the Strong Variable Insurance Funds and their investment
objectives are listed below. The Funds are listed in ascending order of risk
and return, as determined by the Funds' Advisor.
FUND NAME INVESTMENT OBJECTIVE
<TABLE>
<S> <C>
Strong Advantage Fund II Current income with a very low degree of
share-price fluctuation.
Strong Government Securities Fund II Total return by investing for a high
level of current income with a moderate
degree of share-price fluctuation.
Strong Asset Allocation Fund II High total return consistent with
reasonable risk over the long term.
Strong Special Fund II Capital growth.
Strong Growth Fund II Capital growth.
Strong Discovery Fund II Capital growth.
Strong International Stock Fund II Capital growth.
</TABLE>
Each Fund may from time to time be compared to the other Funds in the
Strong Variable Insurance Funds based on a risk/reward spectrum. In general,
the amount of risk associated with any investment product is commensurate with
that product's potential level of reward. The Strong Variable Insurance Funds'
risk/reward continuum or any Fund's position on the continuum may be described
or diagrammed in marketing materials. The Strong Variable Insurance Funds'
risk/reward continuum positions the risk and reward potential of each Fund
relative to the other Strong Variable Insurance Funds, but is not intended to
position any Fund relative to other mutual funds or investment products.
Marketing materials may also discuss the relationship between risk and reward
as it relates to an individual investor's portfolio. Financial goals vary from
person to person. You may choose one or more of the Strong Variable Insurance
Funds to help you reach your financial goals.
The Advisor also serves as advisor to the Strong Family of Funds, which is
a retail fund complex composed of 26 open-end management investment companies.
33
<PAGE> 442
ADDITIONAL FUND INFORMATION
(1) DURATION
Duration is a calculation that seeks to measure the price sensitivity of a
bond or a bond fund to changes in interest rates. It measures bond price
sensitivity to interest rate changes by taking into account the time value of
cash flows generated over the bond's life. Future interest and principal
payments are discounted to reflect their present value and then are multiplied
by the number of years they will be received to produce a value that is
expressed in years. Since duration can also be computed for the Funds, you can
estimate the effect of interest rates on a Fund's share price. Simply multiply
the Fund's duration by an expected change in interest rates. For example, the
price of a Fund with a duration of two years would be expected to fall
approximately two percent if market interest rates rose by one percentage
point.
(2) PORTFOLIO CHARACTERISTICS
In order to present a more complete picture of a Fund's portfolio,
marketing materials may include various actual or estimated portfolio
characteristics, including but not limited to median market capitalizations,
earnings per share, alphas, betas, price/earnings ratios, returns on equity,
dividend yields, capitalization ranges, growth rates, price/book ratios, top
holdings, sector breakdowns, asset allocations, quality breakdowns, and
breakdowns by geographic region.
(3) MEASURES OF VOLATILITY AND RELATIVE PERFORMANCE
Occasionally statistics may be used to specify Fund volatility or risk.
The general premise is that greater volatility connotes greater risk undertaken
in achieving performance. Measures of volatility or risk are generally used to
compare the Fund's net asset value or performance relative to a market index.
One measure of volatility is beta. Beta is the volatility of a fund relative
to the total market as represented by the Standard & Poor's 500 Stock Index. A
beta of more than 1.00 indicates volatility greater than the market, and a beta
of less than 1.00 indicates volatility less than the market. Another measure
of volatility or risk is standard deviation. Standard deviation is a
statistical tool that measures the degree to which a fund's performance has
varied from its average performance during a particular time period.
Standard deviation is calculated using the following formula:
2
Standard deviation = the square root of E(xi - xm)
-------
n-1
where E = "the sum of",
xi = each individual return during the time period,
xm = the average return over the time period, and
n = the number of individual returns during the time period.
Statistics may also be used to discuss a Fund's relative performance. One
such measure is alpha. Alpha measures the actual return of a fund compared to
the expected return of a fund given its risk (as measured by beta). The
expected return is based on how the market as a whole performed, and how the
particular fund has historically performed against the market. Specifically,
alpha is the actual return less the expected return. The expected return is
computed by multiplying the advance or decline in a market representation by
the fund's beta. A positive alpha quantifies the value that the fund manager
has added, and a negative alpha quantifies the value that the fund manager has
lost.
Other measures of volatility and relative performance may be used as
appropriate. However, all such measures will fluctuate and do not represent
future results.
34
<PAGE> 443
GENERAL INFORMATION
BUSINESS PHILOSOPHY
The Advisor is an independent, Midwestern-based investment advisor, owned
by professionals active in its management. Recognizing that investors are the
focus of its business, the Advisor strives for excellence both in investment
management and in the service provided to investors. This commitment affects
many aspects of the business, including professional staffing, product
development, investment management, and service delivery.
The increasing complexity of the capital markets requires specialized
skills and processes for each asset class and style. Therefore, the Advisor
believes that active management should produce greater returns than a passively
managed index. The Advisor has brought together a group of top-flight
investment professionals with diverse product expertise, and each concentrates
on their investment specialty. The Advisor believes that people are the firm's
most important asset. For this reason, continuity of professionals is critical
to the firm's long-term success.
INVESTMENT ENVIRONMENT
Discussions of economic, social, and political conditions and their impact
on the Fund may be used in advertisements and sales materials. Such factors
that may impact the Fund include, but are not limited to, changes in interest
rates, political developments, the competitive environment, consumer behavior,
industry trends, technological advances, macroeconomic trends, and the supply
and demand of various financial instruments. In addition, marketing materials
may cite the portfolio management's views or interpretations of such factors.
EIGHT BASIC PRINCIPLES FOR SUCCESSFUL MUTUAL FUND INVESTING
These common sense rules are followed by many successful investors. They
make sense for beginners, too. If you have a question on these principles, or
would like to discuss them with us, please contact us at 1-800-368-3863.
1. Have a plan - even a simple plan can help you take control of your
financial future. Review your plan once a year, or if your circumstances
change.
2. Start investing as soon as possible. Make time a valuable ally. Let it
put the power of compounding to work for you, while helping to reduce your
potential investment risk.
3. Diversify your portfolio. By investing in different asset classes -
stocks, bonds, and cash - you help protect against poor performance in one
type of investment while including investments most likely to help you
achieve your important goals.
4. Invest regularly. Investing is a process, not a one-time event. By
investing regularly over the long term, you reduce the impact of
short-term market gyrations, and you attend to your long-term plan before
you're tempted to spend those assets on short-term needs.
5. Maintain a long-term perspective. For most individuals, the best
discipline is staying invested as market conditions change. Reactive,
emotional investment decisions are all too often a source of regret - and
principal loss.
6. Consider stocks to help achieve major long-term goals. Over time, stocks
have provided the more powerful returns needed to help the value of your
investments stay well ahead of inflation.
7. Keep a comfortable amount of cash in your portfolio. To meet current
needs, including emergencies, use a money market fund or a bank account -
not your long-term investment assets.
35
<PAGE> 444
8. Know what you're buying. Make sure you understand the potential risks and
rewards associated with each of your investments. Ask questions... request
information...make up your own mind. And choose a fund company that helps
you make informed investment decisions.
PORTFOLIO MANAGEMENT
The portfolio manager works with a team of analysts, traders, and
administrative personnel. From time to time, marketing materials may discuss
various members of the team, including their education, investment experience,
and other credentials.
The Advisor believes that actively managing the Fund's portfolio and
adjusting the average portfolio maturity according to the Advisor's interest
rate outlook is the best way to achieve the Fund's objectives. This policy is
based on a fundamental belief that economic and financial conditions create
favorable and unfavorable investment periods (or seasons) and that these
different seasons require different investment approaches. Through its active
management approach, the Advisor seeks to avoid or reduce any negative change
in the Fund's net asset value per share during the periods of falling bond
prices and provide consistently positive annual returns throughout the seasons
of investment.
The Advisor's investment philosophy includes the following basic beliefs:
1. Active management pursued by a team with a uniform discipline across the
fixed income spectrum can produce results that are superior to those
produced through passive management.
2. Controlling risk by making only moderate deviations from the defined
benchmark is the cornerstone of successful fixed income investing.
3. Successful fixed income management is best pursued on a top-down basis
utilizing fundamental techniques.
The investment process includes decisions made at four levels that are
consistent with the Advisor's viewpoint of the path of economic activity,
interest rates, and the supply of and demand for credit. The goal is to derive
equivalent amounts of excess performance and risk control over the long run
from each of the four levels of decision-making:
1. Duration. The Fund's portfolio duration is managed within a range
relative to its benchmark.
2. Yield Curve. Modest overweights and underweights along the yield curve
are made to benefit from changes in the yield curve's shape.
3. Sector/Quality. Sector weightings are generally maintained between zero
and two times those of the benchmark.
4. Security Selection. Quantitative analysis drives issue selection in the
Treasury and mortgage marketplace. Proactive credit research drives
corporate issue selection.
Risk control is pursued at three levels:
1. Portfolio structure. In structuring the portfolio, the Advisor carefully
considers such factors as position sizes, duration, benchmark
characteristics, and the use of illiquid securities.
2. Credit research. Proactive credit research is used to identify issues
which the Advisor believes will be candidates for credit upgrade. This
research includes visiting company management, establishing appropriate
values for credit ratings, and monitoring yield spread relationships.
3. Portfolio monitoring. Portfolio fundamentals are re-evaluated
continuously, and buy/sell targets are established and generally adhered
to.
INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P., 411 East Wisconsin Avenue, Milwaukee, Wisconsin
53202, have been selected as the independent accountants for the Fund,
providing audit services and assistance and consultation with respect to the
preparation of filings with the SEC.
36
<PAGE> 445
LEGAL COUNSEL
Godfrey & Kahn, S.C., 780 North Water Street, Milwaukee, Wisconsin 53202,
acts as outside legal counsel for the Fund.
FINANCIAL STATEMENTS
The Annual Report for the Governments Securities Fund II for the period
from January 31, 1996 (inception) through December 31, 1996 that is attached
hereto contains the following financial information for the Fund:
(a) Schedule of Investments in Securities
(b) Statement of Operations
(c) Statement of Assets and Liabilities
(d) Statement of Changes in Net Assets
(e) Notes to Financial Statements
(f) Financial Highlights
(g) Report of Independent Accountants
37
<PAGE> 446
APPENDIX
BOND RATINGS
STANDARD & POOR'S DEBT RATINGS
A Standard & Poor's corporate or municipal debt rating is a current
assessment of the creditworthiness of an obligor with respect to a specific
obligation. This assessment may take into consideration obligors such as
guarantors, insurers, or lessees.
The debt rating is not a recommendation to purchase, sell, or hold a
security, inasmuch as it does not comment as to market price or suitability for
a particular investor.
The ratings are based on current information furnished by the issuer or
obtained by S&P from other sources it considers reliable. S&P does not perform
an audit in connection with any rating and may, on occasion, rely on unaudited
financial information. The ratings may be changed, suspended, or withdrawn as
a result of changes in, or unavailability of, such information, or based on
other circumstances.
The ratings are based, in varying degrees, on the following
considerations:
1. Likelihood of default capacity and willingness of
the obligor as to the timely payment of interest and repayment
of principal in accordance with the terms of the obligation.
2. Nature of and provisions of the obligation.
3. Protection afforded by, and relative position of,
the obligation in the event of bankruptcy, reorganization, or
other arrangement under the laws of bankruptcy and other laws
affecting creditors' rights.
INVESTMENT GRADE
AAA Debt rated 'AAA' has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA Debt rated 'AA' has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree.
A Debt rated 'A' has a strong capacity to pay interest and repay
principal, although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher-rated
categories.
BBB Debt rated 'BBB' is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
SPECULATIVE GRADE
Debt rated 'BB', 'B', 'CCC', 'CC' and 'C' is regarded as having
predominantly speculative characteristics with respect to capacity to pay
interest and repay principal. 'BB' indicates the least degree of speculation
and 'C' the highest. While such debt will likely have some quality and
protective characteristics, these are outweighed by large uncertainties or
major exposures to adverse conditions.
BB Debt rated 'BB' has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The 'BB'
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied 'BBB-' rating.
B Debt rated 'B' has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial, or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The 'B' rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied 'BB' or 'BB-' rating.
A-1
<PAGE> 447
CCC Debt rated 'CCC' has a currently identifiable vulnerability to
default, and is dependent upon favorable business, financial, and economic
conditions to meet timely payment of interest and repayment of principal. In
the event of adverse business, financial, or economic conditions, it is not
likely to have the capacity to pay interest and repay principal. The 'CCC'
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied 'B' or 'B-' rating.
CC Debt rated 'CC' typically is applied to debt subordinated to senior
debt that is assigned an actual or implied 'CCC' rating.
C Debt rated 'C' typically is applied to debt subordinated to senior debt
which is assigned an actual or implied 'CCC-' rating. The 'C' rating may be
used to cover a situation where a bankruptcy petition has been filed, but debt
service payments are continued.
CI The rating 'CI' is reserved for income bonds on which no interest is
being paid.
D Debt rated 'D' is in payment default. The 'D' rating category is used
when interest payments or principal payments are not made on the date due, even
if the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grade period. The 'D' rating also will be
used upon the filing of a bankruptcy petition if debt service payments are
jeopardized.
MOODY'S LONG-TERM DEBT RATINGS
Aaa - Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edged". Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa - Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risk appear somewhat larger than in Aaa
securities.
A - Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper-medium grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may be
present which suggest a susceptibility to impairment some time in the future.
Baa - Bonds which are rated Baa are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest
payments and principal security appear adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable over
any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba - Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate, and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
maintenance of other terms of the contract over any long period of time may be
small.
Caa - Bonds which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to principal
or interest.
Ca - Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other marked
shortcomings.
C - Bonds which are rated C are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
A-2
<PAGE> 448
FITCH INVESTORS SERVICE, INC. BOND RATINGS
Fitch investment grade bond and preferred stock ratings provide a guide to
investors in determining the credit risk associated with a particular security.
The ratings represent Fitch's assessment of the issuer's ability to meet the
obligations of a specific debt or preferred issue in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the
issuer's future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided
by insurance policies or financial guaranties unless otherwise indicated.
Bonds and preferred stock carrying the same rating are of similar but not
necessarily identical credit quality since the rating categories do not fully
reflect small differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for other reasons.
AAA Bonds and preferred stock considered to be investment grade
and of the highest credit quality. The obligor has an exceptionally
strong ability to pay interest and/or dividends and repay principal,
which is unlikely to be affected by reasonably foreseeable events.
AA Bonds and preferred stock considered to be investment grade
and of very high credit quality. The obligor's ability to pay
interest and/or dividends and repay principal is very strong,
although not quite as strong as bonds rated 'AAA'. Because bonds
and preferred stock rated in the 'AAA' and 'AA' categories are not
significantly vulnerable to foreseeable future developments,
short-term debt of the issuers is generally rated 'F-1+'.
A Bonds and preferred stock considered to be investment grade
and of high credit quality. The obligor's ability to pay interest
and/or dividends and repay principal is considered to be strong,
but may be more vulnerable to adverse changes in economic
conditions and circumstances than debt or preferred securities with
higher ratings.
BBB Bonds and preferred stock considered to be investment grade
and of satisfactory credit quality. The obligor's ability to pay
interest or dividends and repay principal is considered to be
adequate. Adverse changes in economic conditions and circumstances,
however, are more likely to have adverse impact on these securities
and, therefore, impair timely payment. The likelihood that the
ratings of these bonds or preferred will fall below investment grade
is higher than for securities with higher ratings.
Fitch speculative grade bond or preferred stock ratings provide a guide to
investors in determining the credit risk associated with a particular security.
The ratings ('BB' to 'C') represent Fitch's assessment of the likelihood of
timely payment of principal and interest or dividends in accordance with the
terms of obligation for issues not in default. For defaulted bonds or
preferred stock, the rating ('DDD' to 'D') is an assessment of the ultimate
recovery value through reorganization or liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer or possible recovery value in
bankruptcy, the current and prospective financial condition and operating
performance of the issuer and any guarantor, as well as the economic and
political environment that might affect the issuer's future financial strength.
Bonds or preferred stock that have the same rating are of similar but not
necessarily identical credit quality since the rating categories cannot fully
reflect the differences in the degrees of credit risk.
A-3
<PAGE> 449
BB Bonds or preferred stock are considered speculative. The
obligor's ability to pay interest or dividends and repay principal
may be affected over time by adverse economic changes. However,
business and financial alternatives can be identified, which could
assist the obligor in satisfying its debt service requirements.
B Bonds or preferred stock are considered highly speculative.
While bonds in this class are currently meeting debt service
requirements or paying dividends, the probability of continued
timely payment of principal and interest reflects the obligor's
limited margin of safety and the need for reasonable business and
economic activity throughout the life of the issue.
CCC Bonds or preferred stock have certain identifiable
characteristics that, if not remedied, may lead to default. The
ability to meet obligations requires an advantageous business and
economic environment.
CC Bonds or preferred stock are minimally protected. Default
in payment of interest and/or principal seems probable over time.
C Bonds are in imminent default in payment of interest or
principal or suspension of preferred stock dividends is imminent.
DDD, DD,
and D Bonds are in default on interest and/or principal payments
or preferred stock dividends are suspended. Such securities are
extremely speculative and should be valued on the basis of their
ultimate recovery value in liquidation or reorganization of the
obligor. 'DDD' represents the highest potential for recovery of
these securities, and 'D' represents the lowest potential for
recovery.
DUFF & PHELPS, INC. LONG-TERM DEBT RATINGS
These ratings represent a summary opinion of the issuer's long-term
fundamental quality. Rating determination is based on qualitative and
quantitative factors which may vary according to the basic economic and
financial characteristics of each industry and each issuer. Important
considerations are vulnerability to economic cycles as well as risks related to
such factors as competition, government action, regulation, technological
obsolescence, demand shifts, cost structure, and management depth and
expertise. The projected viability of the obligor at the trough of the cycle
is a critical determination.
Each rating also takes into account the legal form of the security, (e.g.,
first mortgage bonds, subordinated debt, preferred stock, etc.). The extent of
rating dispersion among the various classes of securities is determined by
several factors including relative weightings of the different security classes
in the capital structure, the overall credit strength of the issuer, and the
nature of covenant protection. Review of indenture restrictions is important
to the analysis of a company's operating and financial constraints. From time
to time, Duff & Phelps Credit Rating Co. places issuers or security classes on
Rating Watch. The Rating Watch Status results from a need to notify investors
and the issuer that there are conditions present leading us to re-evaluate the
current rating(s). A listing on Rating Watch, however, does not mean a rating
change is inevitable. The Rating Watch Status can either be resolved quickly
or over a longer period of time, depending on the reasons surrounding the
placement on Rating Watch. The "up" designation means a rating may be
upgraded; the "down" designation means a rating may be downgraded, and the
uncertain designation means a rating may be raised or lowered.
The Credit Rating Committee formally reviews all ratings once per quarter
(more frequently, if necessary). Ratings of 'BBB-' and higher fall within the
definition of investment grade securities, as defined by bank and insurance
supervisory authorities. Structured finance issues, including real estate,
asset-backed and mortgage-backed financings, use this same rating scale with
minor modification in the definitions. Thus, an investor can compare the
credit quality of investment alternatives across industries and structural
types. A "Cash Flow Rating" (as noted for specific ratings) addresses the
likelihood that aggregate principal and interest will equal or exceed the rated
amount under appropriate stress conditions.
<TABLE>
<CAPTION>
RATING SCALE DEFINITION
- --------------------------------------------------------------------------------
<S> <C>
AAA Highest credit quality. The risk factors are negligible, being
only slightly more than for risk-free U.S. Treasury debt.
</TABLE>
A-4
<PAGE> 450
- --------------------------------------------------------------------------------
AA+ High credit quality. Protection factors are strong. Risk is modest,
AA but may vary slightly from time to time because of economic conditions.
AA-
- --------------------------------------------------------------------------------
A+ Protection factors are average but adequate. However, risk factors are
A more variable and greater in periods of economic stress.
A-
- --------------------------------------------------------------------------------
BBB+ Below-average protection factors but still considered sufficient for
BBB prudent investment. Considerable variability in risk during economic
BBB- cycles.
- --------------------------------------------------------------------------------
BB+ Below investment grade but deemed likely to meet obligations when due.
BB Present or prospective financial protection factors fluctuate according
BB- to industry conditions or company fortunes. Overall quality may move up
or down frequently within this category.
- --------------------------------------------------------------------------------
B+ Below investment grade and possessing risk that obligations will not be
B met when due. Financial protection factors will fluctuate widely
B- according to economic cycles, industry conditions and/or company
fortunes. Potential exists for frequent changes in the rating within
this category or into a higher or lower rating grade.
- --------------------------------------------------------------------------------
CCC Well below investment grade securities. Considerable uncertainty exists
as to timely payment of principal, interest or preferred dividends.
Protection factors are narrow and risk can be substantial with
unfavorable economic/industry conditions, and/or with unfavorable
company developments.
- --------------------------------------------------------------------------------
DD Defaulted debt obligations. Issuer failed to meet scheduled principal
and/or interest payments.
DP Preferred stock with dividend arrearages.
_____________________________________________________________________________
IBCA LONG-TERM DEBT RATINGS
AAA - Obligations for which there is the lowest expectation of investment
risk. Capacity for timely repayment of principal and interest is substantial,
such that adverse changes in business, economic or financial conditions are
unlikely to increase investment risk substantially.
AA - Obligations for which there is a very low expectation of investment
risk. Capacity for timely repayment of principal and interest is substantial.
Adverse changes in business, economic or financial conditions may increase
investment risk, albeit not very significantly.
A - Obligations for which there is a low expectation of investment risk.
Capacity for timely repayment of principal and interest is strong, although
adverse changes in business, economic or financial conditions may lead to
increased investment risk.
BBB - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial
conditions are more likely to lead to increased investment risk than for
obligations in other categories.
A-5
<PAGE> 451
BB - Obligations for which there is a possibility of investment risk
developing. Capacity for timely repayment of principal and interest exists,
but is susceptible over time to adverse changes in business, economic or
financial conditions.
B - Obligations for which investment risk exists. Timely repayment of
principal and interest is not sufficiently protected against adverse changes in
business, economic or financial conditions.
CCC - Obligations for which there is a current perceived possibility of
default. Timely repayment of principal and interest is dependent on favorable
business, economic or financial conditions.
CC - Obligations which are highly speculative or which have a high risk of
default.
C - Obligations which are currently in default.
NOTES: "+" or "-" may be appended to a rating below AAA to denote relative
status within major rating categories. Ratings of BB and below are assigned
where it is considered that speculative characteristics are present.
THOMSON BANKWATCH LONG-TERM DEBT RATINGS
Long-Term Debt Ratings assigned by Thomson BankWatch also weigh heavily
government ownership and support. The quality of both the company's management
and franchise are of even greater importance in the Long-Term Debt Rating
decisions. Long-Term Debt Ratings look out over a cycle and are not adjusted
frequently for what we believe are short-term performance aberrations.
Long-Term Debt Ratings can be restricted to local currency debt - ratings
will be identified by the designation LC. In addition, Long-Term Debt Ratings
may include a plus (+) or minus (-) to indicate where within the category the
issue is placed. BankWatch Long-Term Debt Ratings are based on the following
scale:
Investment Grade
AAA (LC-AAA) - Indicates that the ability to repay principal and interest
on a timely basis is extremely high.
AA (LC-AA) - Indicates a very strong ability to repay principal and
interest on a timely basis, with limited incremental risk compared to issues
rated in the highest category.
A (LC-A) - Indicates the ability to repay principal and interest is
strong. Issues rated A could be more vulnerable to adverse developments (both
internal and external) than obligations with higher ratings.
BBB (LC-BBB) - The lowest investment-grade category; indicates an
acceptable capacity to repay principal and interest. BBB issues are more
vulnerable to adverse developments (both internal and external) than
obligations with higher ratings.
Non-Investment Grade - may be speculative in the likelihood of timely repayment
of principal and interest
BB (LC-BB) - While not investment grade, the BB rating suggests that the
likelihood of default is considerably less than for lower-rated issues.
However, there are significant uncertainties that could affect the ability to
adequately service debt obligations.
B (LC-B) - Issues rated B show higher degree of uncertainty and therefore
greater likelihood of default than higher-rated issues. Adverse developments
could negatively affect the payment of interest and principal on a timely
basis.
CCC (LC-CCC) - Issues rated CCC clearly have a high likelihood of default,
with little capacity to address further adverse changes in financial
circumstances.
CC (LC-CC) - CC is applied to issues that are subordinate to other
obligations rated CCC and are afforded less protection in the event of
bankruptcy or reorganization.
D (LC-D) - Default.
A-6
<PAGE> 452
SHORT-TERM RATINGS
STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt considered short-term in the relevant
market.
Ratings are graded into several categories, ranging from 'A-1' for the
highest quality obligations to 'D' for the lowest. These categories are as
follows:
A-1 This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus sign (+) designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated 'A-1'.
A-3 Issues carrying this designation have adequate capacity for timely
payment. They are, however, more vulnerable to the adverse effects of changes
in circumstances than obligations carrying the higher designations.
B Issues rated 'B' are regarded as having only speculative capacity for
timely payment.
C This rating is assigned to short-term debt obligations with doubtful
capacity for payment.
D Debt rated 'D' is in payment default. The 'D' rating category is used
when interest payments or principal payments are not made on the date due, even
if the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grace period.
STANDARD & POOR'S NOTE RATINGS
An S&P note rating reflects the liquidity factors and market-access risks
unique to notes. Notes maturing in three years or less will likely receive a
note rating. Notes maturing beyond three years will most likely receive a
long-term debt rating.
The following criteria will be used in making the assessment:
- Amortization schedule - the larger the final maturity
relative to other maturities, the more likely the issue is to be
treated as a note.
- Source of payment - the more the issue depends on the market
for its refinancing, the more likely it is to be treated as a note.
Note rating symbols and definitions are as follows:
SP-1 Strong capacity to pay principal and interest. Issues determined to
possess very strong characteristics are given a plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term of the
notes.
SP-3 Speculative capacity to pay principal and interest.
MOODY'S SHORT-TERM RATINGS
Moody's short-term debt ratings are opinions of the ability of issuers to
repay punctually senior debt obligations. These obligations have an original
maturity not exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment ability of rated issuers:
A-7
<PAGE> 453
Issuers rated Prime-1 (or supporting institutions) have a superior ability
for repayment of senior short-term debt obligations. Prime-1 repayment ability
will often be evidenced by many of the following characteristics: (i) leading
market positions in well-established industries, (ii) high rates of return on
funds employed, (iii) conservative capitalization structure with moderate
reliance on debt and ample asset protection, (iv) broad margins in earnings
coverage of fixed financial charges and high internal cash generation, and (v)
well established access to a range of financial markets and assured sources of
alternate liquidity.
Issuers rated Prime-2 (or supporting institutions) have a strong ability
for repayment of senior short-term debt obligations. This will normally be
evidenced by many of the characteristics cited above, but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be
more affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The effect of industry
characteristics and market compositions may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt
protection measurements and may require relatively high financial leverage.
Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
FITCH INVESTORS SERVICE, INC. SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes.
The short-term rating places greater emphasis than a long-term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
F-1+ Exceptionally Strong Credit Quality. Issues assigned this
rating are regarded as having the strongest degree of assurance for
timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating
reflect an assurance of timely payment only slightly less in degree
than issues rated 'F-1+'.
F-2 Good Credit Quality. Issues assigned this rating have a
satisfactory degree of assurance for timely payment but the margin
of safety is not as great as for issues assigned 'F-1+' and 'F-1'
ratings.
F-3 Fair Credit Quality. Issues assigned this rating have
characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause
these securities to be rated below investment grade.
F-S Weak Credit Quality. Issues assigned this rating have
characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial
and economic conditions.
D Default. Issues assigned this rating are in actual or
imminent payment default.
LOC The symbol LOC indicates that the rating is based on a letter
of credit issued by a commercial bank.
DUFF & PHELPS, INC. SHORT-TERM DEBT RATINGS
Duff & Phelps' short-term ratings are consistent with the rating criteria
used by money market participants. The ratings apply to all obligations with
maturities of under one year, including commercial paper, the uninsured portion
of certificates of deposit, unsecured bank loans, master notes, bankers
acceptances, irrevocable letters of credit, and current maturities of long-term
debt. Asset-backed commercial paper is also rated according to this scale.
A-8
<PAGE> 454
Emphasis is placed on liquidity which is defined as not only cash from
operations, but also access to alternative sources of funds including trade
credit, bank lines, and the capital markets. An important consideration is the
level of an obligor's reliance on short-term funds on an ongoing basis.
The distinguishing feature of Duff & Phelps' short-term ratings is the
refinement of the traditional '1' category. The majority of short-term debt
issuers carry the highest rating, yet quality differences exist within that
tier. As a consequence, Duff & Phelps has incorporated gradations of '1+' (one
plus) and '1-' (one minus) to assist investors in recognizing those
differences.
From time to time, Duff & Phelps places issuers or security classes on
Rating Watch. The Rating Watch status results from a need to notify investors
and the issuer that there are conditions present leading us to re-evaluate the
current rating(s). A listing on Rating Watch, however, does not mean a rating
change is inevitable.
The Rating Watch status can either be resolved quickly or over a longer
period of time, depending on the reasons surrounding the placement on Rating
Watch. The "up" designation means a rating may be upgraded; the "down"
designation means a rating may be downgraded, and the "uncertain" designation
means a rating may be raised or lowered.
<TABLE>
<CAPTION>
Rating Scale: Definition
------------- ----------
High Grade
----------
<S> <C>
D-1+ Highest certainty of timely payment. Short-Term liquidity,
including internal operating factors and/or access to alternative
sources of funds, is outstanding, and safety is just below risk-free
U.S. Treasury short-term obligations.
D-1 Very high certainty of timely payment. Liquidity factors are
excellent and supported by good fundamental protection factors.
Risk factors are minor.
D-1- High certainty of timely payment. Liquidity factors are
strong and supported by good fundamental protection factors. Risk
factors are very small.
Good Grade
----------
D-2 Good certainty of timely payment. Liquidity factors and
company fundamentals are sound. Although ongoing funding needs may
enlarge total financing requirements, access to capital markets is
good. Risk factors are small.
Satisfactory Grade
------------------
D-3 Satisfactory liquidity and other protection factors qualify
issues as to investment grade. Risk factors are larger and subject
to more variation. Nevertheless, timely payment is expected.
Non-Investment Grade
--------------------
D-4 Speculative investment characteristics. Liquidity is not
sufficient to insure against disruption in debt service. Operating
factors and market access may be subject to a high degree of
variation.
Default
-------
D-5 Issuer failed to meet scheduled principal and/or interest payments.
</TABLE>
THOMSON BANKWATCH (TBW) SHORT-TERM RATINGS
The TBW Short-Term Ratings apply, unless otherwise noted, to specific debt
instruments of the rated entities with a maturity of one year or less. TBW
Short-Term Ratings are intended to assess the likelihood of an untimely or
incomplete payments of principal or interest.
TBW-1 The highest category; indicates a very high likelihood that
principal and interest will be paid on a timely basis.
A-9
<PAGE> 455
TBW-2 The second highest category; while the degree of safety regarding
timely repayment of principal and interest is strong, the relative degree of
safety is not as high as for issues rated "TBW-1".
TBW-3 The lowest investment-grade category; indicates that while the
obligation is more susceptible to adverse developments (both internal and
external) than those with higher ratings, the capacity to service principal and
interest in a timely fashion is considered adequate.
TBW-4 The lowest rating category; this rating is regarded as
non-investment grade and therefore speculative.
IBCA SHORT-TERM RATINGS
IBCA Short-Term Ratings assess the borrowing characteristics of banks and
corporations, and the capacity for timely repayment of debt obligations. The
Short-Term Ratings relate to debt which has a maturity of less than one year.
A1 Obligations supported by the highest capacity for timely repayment.
Where issues possess a particularly strong credit feature, a rating of
A1+ is assigned.
A2 Obligations supported by a good capacity for timely repayment.
A3 Obligations supported by a satisfactory capacity for timely repayment.
B Obligations for which there is an uncertainty as to the capacity to
ensure timely repayment.
C Obligations for which there is a high risk of default or which are
currently in default.
A-10
<PAGE> 456
STRONG VARIABLE INSURANCE FUNDS, INC.
PART C
OTHER INFORMATION
Item 24. Financial Statements and Exhibits
---------------------------------
(a) Financial Statements:
(1) Strong Discovery Fund II, Strong Advantage Fund II,
Strong Asset Allocation Fund II, Strong International
Stock Fund II, and Strong Government Securities Fund II
(Audited)
Schedule of Investments in Securities
Statement of Operations
Statement of Assets and Liabilities
Statement of Changes in Net Assets
Notes to Financial Statements
Financial Highlights
Report of Independent Accountants
Incorporated by reference to the Annual Reports to
Shareholders of the Strong Variable Insurance Funds dated
December 31, 1996, pursuant to Rule 411 under the
Securities Act of 1933. (File Nos. 33-45321 and 811-6553)
(2) Strong Growth Fund II (Unaudited)
Schedule of Investments in Securities
Statement of Operations
Statement of Assets and Liabilities
Statement of Changes in Net Assets
Notes to Financial Statements
Financial Highlights
Included in Parts A & B.
(b) Exhibits
(1) Articles of Incorporation dated July 31, 1996
(2) Bylaws dated October 20, 1995 (3)
(3) Inapplicable
(4) Inapplicable
(5) Investment Advisory Agreement (1)
(5.1) Schedule of Additional Funds (Strong Advantage
Fund II, Strong Asset Allocation Fund II, Strong Government
Securities Fund II, Strong Growth Fund II, and Strong
International Stock Fund II) (3)
(6) Distribution Agreement (3)
(7) Inapplicable
(8) Custody Agreement with Firstar (Strong Advantage Fund II,
Strong Asset Allocation Fund II, Strong Discovery Fund II,
Strong Government Securities Fund II, and Strong Growth
Fund II) (5)
(8.1) Custody Agreement with Brown Brothers Harriman Co. (Strong
International Stock Fund II) (5)
(8.1.1)Amendment to Custody Agreement with Brown Brothers Harriman
& Co. (Strong International Stock Fund II) (4)
C-1
<PAGE> 457
(8.1.1.1) Amendment to Custody Agreement with Brown Brothers
Harriman & Co. dated August 20, 1996 (Strong
International Stock Fund II)
(8.2) Global Custody Agreement with Brown Brothers Harriman &
Co. (Strong Advantage Fund II, Strong Asset Allocation
Fund II, Strong Discovery Fund II, and Strong Growth Fund
II) (5)
(9) Shareholder Servicing Agent Agreement (3)
(10) Inapplicable
(11) Consent of Auditor
(12) Inapplicable
(13) Inapplicable
(14) Inapplicable
(15) Inapplicable
(16) Computation of Performance Figures
(17) Financial Data Schedule
(18) Inapplicable
(19) Power of Attorney dated April 24, 1997
(20) Letter of Representation
(21.1) Code of Ethics for Access Persons dated October 18, 1996
(21.2) Code of Ethics for Non-Access Persons dated October 18,
1996
______________________________________
(1) Incorporated herein by reference to Post-Effective Amendment No. 7 to the
Registration Statement on Form N-1A of Registrant filed on or about April
20, 1995.
(2) Incorporated herein by reference to Post-Effective Amendment No. 8 to the
Registration Statement on Form N-1A of Registrant filed on or about May 9,
1995.
(3) Incorporated herein by reference to Post-Effective Amendment No. 9 to the
Registration Statement on Form N-1A of Registrant filed on or about July
7, 1995.
(4) Incorporated herein by reference to Post-Effective Amendment No. 11 to
the Registration Statement on Form N-1A of Registrant filed on or about
April 23, 1996.
(5) Incorporated herein by reference to Post-Effective Amendment No. 13 to
the Registration Statement on Form N-1A of Registrant filed on or about
July 30, 1996.
Item 25. Persons Controlled by or under Common Control with Registrant
Registrant neither controls any person nor is under common control
with any other person.
Item 26. Number of Holders of Securities
<TABLE>
<CAPTION>
Number of Record Holders
Title of Class as of March 31, 1997
-------------- --------------------
<S> <C>
Common Stock, $.00001 par value:
Strong Advantage Fund II 5
Strong Asset Allocation Fund II 4
Strong Discovery Fund II 14
Strong Government Securities Fund II 2
Strong Growth Fund II 3
Strong International Stock Fund II 8
</TABLE>
C-2
<PAGE> 458
Item 27. Indemnification
Officers and directors are insured under a joint errors and omissions
insurance policy underwritten by American International Group and Great
American Insurance Company in the aggregate amount of $80,000,000, subject to
certain deductions. Pursuant to the authority of the Wisconsin Business
Corporation Law, Article VII of Registrant's Bylaws provides as follows:
ARTICLE VII. INDEMNIFICATION OF OFFICERS AND DIRECTORS
SECTION 7.01. MANDATORY INDEMNIFICATION. The Corporation shall
indemnify, to the full extent permitted by the WBCL, as in effect from
time to time, the persons described in Sections 180.0850 through
180.0859 (or any successor provisions) of the WBCL or other
provisions of the law of the State of Wisconsin relating to
indemnification of directors and officers, as in effect from time
to time. The indemnification afforded such persons by this section
shall not be exclusive of other rights to which they may be entitled
as a matter of law.
SECTION 7.02. PERMISSIVE SUPPLEMENTARY BENEFITS. The
Corporation may, but shall not be required to, supplement the right of
indemnification under Section 7.01 by (a) the purchase of insurance on
behalf of any one or more of such persons, whether or not the
Corporation would be obligated to indemnify such person under
Section 7.01; (b) individual or group indemnification agreements
with any one or more of such persons; and (c) advances for related
expenses of such a person.
SECTION 7.03. AMENDMENT. This Article VII may be amended or
repealed only by a vote of the shareholders and not by a vote of the
Board of Directors.
SECTION 7.04. INVESTMENT COMPANY ACT. In no event shall the
Corporation indemnify any person hereunder in contravention of any
provision of the Investment Company Act.
Item 28. Business and Other Connections of Investment Advisor
The information contained under "Management" in the Prospectus and
under "Directors and Officers of the Corporation" and "Investment Advisor and
Distributor" in the Statement of Additional Information is hereby incorporated
by reference pursuant to Rule 411 under the Securities Act of 1933.
Item 29. Principal Underwriters
(a) Strong Funds Distributors, Inc., principal underwriter for
Registrant, also serves as principal underwriter for Strong Advantage Fund,
Inc.; Strong Asia Pacific Fund, Inc.; Strong Asset Allocation Fund, Inc.; Strong
Common Stock Fund, Inc.; Strong Conservative Equity Funds, Inc.; Strong
Corporate Bond Fund, Inc.; Strong Discovery Fund, Inc.; Strong Equity Funds,
Inc.; Strong Government Securities Fund, Inc.; Strong Heritage Reserve Series,
Inc.; Strong High-Yield Municipal Bond Fund, Inc.; Strong Income Funds, Inc.;
Strong Institutional Funds, Inc.; Strong International Bond Fund, Inc.; Strong
International Stock Fund, Inc.; Strong Money Market Fund, Inc.; Strong Municipal
Bond Fund, Inc.; Strong Municipal Funds, Inc.; Strong Opportunity Fund, Inc.;
Strong Schafer Value Fund, Inc.; Strong Short-Term Bond Fund, Inc.; Strong
Short-Term Global Bond Fund, Inc.; Strong Short-Term Municipal Bond Fund, Inc.;
Strong Special Fund II, Inc.; and Strong Total Return Fund, Inc.
(b) The information contained under "Management" in the Prospectus and
under "Directors and Officers of the Corporation" and "Investment Advisor and
Distributor" in the Statement of Additional Information is hereby incorporated
by reference pursuant to Rule 411 under the Securities Act of 1933.
(c) None
C-3
<PAGE> 459
Item 30. Location of Accounts and Records
All accounts, books, or other documents required to be maintained by
Section 31(a) of the Investment Company Act of 1940 and the rules promulgated
thereunder are in the physical possession of Registrant's Vice President,
Thomas P. Lemke, at Registrant's corporate offices, 100 Heritage Reserve,
Menomonee Falls, Wisconsin 53051.
Item 31. Management Services
All management-related service contracts entered into by Registrant
are discussed in Parts A and B of this Registration Statement.
Item 32. Undertakings
(a) Inapplicable.
(b) The Registrant undertakes to file a post-effective amendment,
using financial statements which need not be certified, within four to six
months from commencement of operations with respect to Strong Growth Fund II.
(c) The Registrant undertakes to furnish to each person to whom a
prospectus is delivered, upon request and without charge, a copy of Strong
Discovery Fund II's, Strong Advantage Fund II's, Strong Asset Allocation Fund
II's, Strong Government Securities Fund II's, and Strong International Stock
Fund II's latest annual report to shareholders.
C-4
<PAGE> 460
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant certifies that it meets all of
the requirements for effectiveness of this Post-Effective Amendment No. 14 to
the Registration Statement pursuant to Rule 485(b) under the Securities Act of
1933 and has duly caused this Post-Effective Amendment No. 14 to the
Registration Statement to be signed on its behalf by the undersigned, thereto
duly authorized, in the Village of Menomonee Falls, and State of Wisconsin on
the 24th day of April, 1997.
STRONG VARIABLE INSURANCE FUNDS, INC.
(Registrant)
By: /s/ John Dragisic
----------------------------------
John Dragisic, President
Pursuant to the requirements of the Securities Act of 1933, this
Post-Effective Amendment No. 14 to the Registration Statement on Form N-1A has
been signed below by the following persons in the capacities and on the date
indicated.
<TABLE>
<CAPTION>
NAME TITLE DATE
---- ----- ----
<S> <C> <C>
President (Principal Executive
Officer and acting Principal
Financial and Accounting Officer)
/s/ John Dragisic and a Director April 24, 1997
- -----------------------
John Dragisic
/s/ Richard S. Strong Chairman of the Board and a Director April 24, 1997
- -----------------------
Richard S. Strong
Director April 24, 1997
- -----------------------
Marvin E. Nevins*
Director April 24, 1997
- ----------------------
Willie D. Davis*
Director April 24, 1997
- ----------------------
William F. Vogt*
Director April 24, 1997
- -----------------------
Stanley Kritzik*
</TABLE>
* John S. Weitzer signs this document pursuant to powers of attorney filed
with this Post-Effective Amendment No. 14 to the Registration Statement on
Form N-1A.
By:/s/ John S. Weitzer
---------------------------
John S. Weitzer
<PAGE> 461
EXHIBIT INDEX
<TABLE>
<CAPTION>
EDGAR
Exhibit No. Exhibit Exhibit No.
- ----------- ------- -----------
<S> <C> <C>
(1) Articles of Incorporation EX-99.B1
(8.1.1.1) Amendment to Custody Agreement with Brown Brothers EX-99.B8.1.1.1
Harriman & Co. (Strong International Stock Fund II)
[B
(11) Consent of Auditor EX-99.B11
(16) Computation of Performance Figures (Strong Discovery EX-99.B16
Fund II, Strong Advantage Fund II, Strong Asset
Allocation Fund II, Strong International Stock Fund II,
and Strong Government Securities Fund II)
(17) Financial Data Schedule EX-27.1 Discovery II
EX-27.2 International
Stock II
EX-27.3 Advantage II
EX-27.4 Asset Allocation II
EX-27.5 Government
Securities II
(19) Power of Attorney EX-99.B19
(20) Letter of Representation EX-99.B20
(21.1) Code of Ethics for Access Persons EX-99.B21.1
(21.2) Code of Ethics for Non-Access Persons EX-99.B21.2
</TABLE>
<PAGE> 1
EXHIBIT 99.B1
AMENDED AND RESTATED ARTICLES OF INCORPORATION
OF STRONG VARIABLE INSURANCE FUNDS, INC.
These Amended and Restated Articles of Incorporation shall supersede and
replace the heretofore existing Articles of Incorporation of Strong Variable
Insurance Funds, Inc., as amended to date, a corporation organized under
Chapter 180 of the Wisconsin Statutes:
ARTICLE I
The name of the corporation (hereinafter, the "Corporation") is:
Strong Variable Insurance Funds, Inc.
ARTICLE II
The period of existence of the Corporation shall be perpetual.
ARTICLE III
The purpose for which the Corporation is organized is, without limitation,
to act as a registered management investment company under 15 USC 80a-1 to
80a-64, as amended from time to time (the "Investment Company Act"), and for
any other purposes for which corporations may be organized under Chapter 180 of
the Wisconsin Statutes, as amended from time to time (the "WBCL").
ARTICLE IV
A. The Corporation shall have the authority to issue an indefinite number
of shares of Common Stock with a par value of $.00001 per share. Subject to the
following paragraph the authorized shares are classified as follows:
<TABLE>
Class Authorized Number of Shares
------------------------------------ ---------------------------
<S> <C>
Strong Discovery Fund II Indefinite
Strong Asset Allocation Fund II Indefinite
Strong International Stock Fund II Indefinite
Strong Advantage Fund II Indefinite
Strong Growth Fund II Indefinite
Strong Government Securities Fund II Indefinite
Strong Short-Term Bond Fund II Indefinite
</TABLE>
B. The Board of Directors is authorized to classify or to reclassify (i.e.
into classes and series of classes), from time to time, any unissued shares of
the Corporation by setting, changing, or eliminating the distinguishing
designation and the preferences, limitations, and relative rights, in whole or
in part, to the fullest extent permissible under the WBCL.
Unless otherwise provided by the Board of Directors prior to the issuance
of shares, the shares of any and all classes and series shall be subject to the
following:
1. The Board of Directors may redesignate a class or series whether or not
shares of such class or series are issued and outstanding, provided that such
redesignation does not affect the preferences, limitations, and relative
rights, in whole or in part, of such class or series.
<PAGE> 2
2. The assets and liabilities and the income and expenses for each class
shall be attributable to that class. The assets and liabilities and the income
and expenses of each series within a class shall be determined separately and,
accordingly, the net asset value of shares may vary from series to series within
a class. The income or gain and the expense or liabilities of the Corporation
shall be allocated to each class or series as determined by or under the
direction of the Board of Directors.
3. Shares of each class or series shall be entitled to such dividends or
distributions, in shares or in cash or both, as may be declared from time to
time by the Board of Directors with respect to such class or series. Dividends
or distributions shall be paid on shares of a class or series only out of the
assets belonging to that class or series.
4. Any shares redeemed by the Corporation shall be deemed to be canceled
and restored to the status of authorized but unissued shares of the particular
class or series.
5. In the event of the liquidation or dissolution of the Corporation,
the holders of a class or series shall be entitled to receive, as a class or
series, out of the assets of the Corporation available for distribution to
shareholders, the assets belonging to that class or series less the liabilities
allocated to that class or series. The assets so distributable to the holders of
a class or series shall be distributed among such holders in proportion to the
number of shares of that class or series held by them and recorded on the books
of the Corporation. In the event that there are any assets available for
distribution that are not attributable to any particular class or series, such
assets shall be allocated to all classes or series in proportion to the net
asset value of the respective class or series.
6. All holders of shares shall vote as a single class and series except
with respect to any matter which affects only one or more series or class of
shares, in which case only the holders of shares of the class or series affected
shall be entitled to vote.
7. For purposes of the Corporation's Registration Statement filed with
the Securities and Exchange Commission under the Securities Act of 1933 and the
Investment Company Act of 1940, including all prospectuses and Statements of
Additional Information, and other reports filed under the Investment Company Act
of 1940, references therein to "classes" of the Corporation's common stock shall
mean "series", as used in these Articles of Incorporation and the WBCL, and
references therein to "series" shall mean "classes", as used in these Articles
of Incorporation and the WBCL.
C. The Corporation may issue fractional shares. Any fractional shares
shall carry proportionately all the rights of whole shares, including, without
limitation, the right to vote and the right to receive dividends and
distributions.
D. The Board of Directors of the Corporation may authorize the issuance
and sale of any class or series of shares from time to time in such amount and
on such terms and conditions, for such purposes and for such amounts or kind of
consideration as the Board of Directors shall determine, subject to any limits
required by then applicable law. Nothing in this paragraph shall be construed
in any way as limiting the Board of Directors authority to issue the
Corporation's shares in connection with a share dividend under the WBCL.
E. Subject to the suspension of the right of redemption or postponement of
the date of payment or satisfaction upon redemption in accordance with the
Investment Company Act, each holder of any class or series of the Common Stock
of the Corporation, upon request and after complying with the redemption
procedures established by or under the supervision of the Board of Directors,
shall be entitled to require the Corporation to redeem out of legally available
funds all or any part of the Common Stock standing in the name of such holder
on the books of the Corporation at the net asset value (as determined in
accordance with the Investment Company Act) of such shares (less any applicable
redemption fee). Any such redeemed shares shall be canceled and restored to the
status of authorized but unissued shares.
2
<PAGE> 3
F. The Board of Directors may authorize the Corporation, at its option and
to the extent permitted by and in accordance with the Investment Company Act,
to redeem any shares of Common Stock of any class or series of the Corporation
owned by any shareholder under circumstances deemed appropriate by the Board of
Directors in its sole discretion from time to time, including without
limitation the failure to maintain ownership of a specified minimum number or
value of shares of Common Stock of any class or series of the Corporation, at
the net asset value (as determined in accordance with the Investment Company
Act) of such shares (less any applicable redemption fee).
G. The Board of Directors of the Corporation may, upon reasonable notice
to the holders of Common Stock of any class or series of the Corporation,
impose a fee for the redemption of shares, such fee to be not in excess of the
amount set forth in the Corporation's then existing Bylaws and to apply in the
case of such redemptions and under such terms and conditions as the Board of
Directors shall determine. The Board of Directors shall have the authority to
rescind imposition of any such fee in its discretion and to reimpose the
redemption fee from time to time upon reasonable notice.
H. No holder of the Common Stock of any class or series of the Corporation
shall, as such holder, have any right to purchase or subscribe for any shares
of the Common Stock of any class or series of the Corporation which it may
issue or sell other than such right, if any, as the Board of Directors, in its
sole discretion, may determine.
I. With respect to any class or series, the Board of Directors may adopt
provisions to seek to maintain a stable net asset value per share. Without
limiting the foregoing, the Board of Directors may determine that the net asset
value per share of any class or series should be maintained at a designated
constant value and may establish procedures, not inconsistent with applicable
law, to accomplish that result. Such procedures may include a requirement, in
the event of a net loss with respect to the particular class or series from
time to time, for automatic pro rata capital contributions from each
shareholder of that class or series in amounts sufficient to maintain the
designated constant share value.
ARTICLE V
The number of directors shall be fixed by the Bylaws of the Corporation.
ARTICLE VI
The Corporation reserves the right to enter into, from time to time,
investment advisory agreements providing for the management and supervision of
the investments of the Corporation, the furnishing of advice to the Corporation
with respect to the desirability of investing in, purchasing or selling
securities or other assets and the furnishing of clerical and administrative
services to the Corporation. Such agreements shall contain such other terms,
provisions and conditions as the Board of Directors of the Corporation may deem
advisable and as are permitted by the Investment Company Act.
The Corporation may, without limitation, designate distributors,
custodians, transfer agents, registrars and/or disbursing agents for the stock
and assets of the Corporation and employ and fix the powers, rights, duties,
responsibilities and compensation of each such distributor, custodian, transfer
agent, registrar and/or disbursing agent.
ARTICLE VII
If the Board of Directors redesignate the outstanding Common Stock in
accordance with paragraph A of Article IV, the Board of Directors shall
designate the corporation with a generic name that is consistent with the name
of the first series and any subsequent series.
3
<PAGE> 4
ARTICLE VIII
The registered office of the Corporation is located at 100 Heritage
Reserve, in the Village of Menomonee Falls, Waukesha County, Wisconsin 53051
and the name of the registered agent at such address is Thomas P. Lemke.
This instrument was drafted by:
John S. Weitzer
Strong Capital Management, Inc.
100 Heritage Reserve
Menomonee Falls, Wisconsin 53051
4
<PAGE> 1
EXHIBIT 8.1.1.1
AMENDMENT TO THE CUSTODIAN AGREEMENT
AMENDMENT entered into as of this 26th day of August, 1996 to the Custodian
Agreement among STRONG VARIABLE INSURANCE FUNDS, INC.-STRONG INTERNATIONAL
STOCK FUND II, (the "Fund") and BROWN BROTHERS HARRIMAN & CO. (the "Custodian")
dated as of July 10, 1995 (the "Agreement") as amended October 20, 1995.
In consideration of the Custodian's offering subcustodial services to the
Funds in Russia, the Funds and the Custodian agree that the Agreement is hereby
amended as follows:
1. Section 2A. Safekeeping, is amended by the addition of the following
phrase at the end of said Section:
"provided, however, that the Custodian's responsibility for safekeeping
equity securities of Russian issuers ("Russian Equities") hereunder shall
be limited to the safekeeping of relevant share extracts from the share
registration books maintained by the entities providing share registration
services to issuers of Russian Equities (each a "Registrar") indicating an
investor's ownership of such securities (each a "Share Extract").
2. Section 2C. Registered Name: Nominees is amended by the addition of
the following at the end of said Section:
"However, with respect to Russian Equities, the Custodian shall
instruct a Subcustodian to ensure that registration thereof shall be
reflected on the books of the issuer's Registrar, subject to the following
conditions, but shall in no event be liable for losses or costs incurred as
a result of delays or failures in the registration process, including
without limitation the inability to obtain or enforce relevant Share
Extracts, unless such delays or failures are due to the Custodian's or
Subcustodian's negligence, fraud, or willful default. Such registration
may be in the name of a nominee of a Subcustodian. In the event
registration is in the name of a Fund, such Fund hereby
1
<PAGE> 2
acknowledges that only the Custodian or Subcustodian may give instructions
to the Registrar to transfer or engage in other transactions involving the
Russian Equities so registered.
A Subcustodian may from time to time enter into contracts with Registrars
with respect to the registration of Russian Equities ("Registrar Contracts").
The Custodian shall provide the Funds with a list of the Russian Equities with
respect to which the Subcustodian has entered into a Registrar Contract, and
will promptly provide the Funds with updates to that list whenever the
Subcustodian enters into any new Registrar Contracts. Such Registrar Contracts
will include (i) regular share confirmations by the Subcustodian, (ii)
reregistrations within set time frames, (iii) use of a Subcustodian's nominee
name, (iv) direct access by auditors of the Subcustodian or its clients to share
registers, and (v) specification of the Registrar's responsibilities and
liabilities. It is hereby acknowledged and agreed that the Custodian does not
represent or warrant that such Registrar Contracts are enforceable.
If a Fund instructs the Custodian to settle a purchase of a Russian Equity,
the Custodian will instruct a Subcustodian to use reasonable efforts to
reregister the Russian Equity and obtain a Share Extract in a timely manner.
After completion of reregistration of a Russian Equity in respect of which
a Subcustodian has entered into a Registrar Contract, the Custodian shall
instruct the Subcustodian to monitor such registrar using reasonable efforts
and to promptly notify the Custodian upon the Subcustodian's obtaining
knowledge of the occurrence of any of the following events ("Registrar
Events"): (i) a Registrar has eliminated a shareholder from the register or has
altered registration records; (ii) a Registrar has refused to register
securities in the name of a particular purchaser and the purchaser or seller
has alleged that the registrar's refusal to so register was unlawful; (iii) a
Registrar holds for its own account shares of an issuer for which it serves as
registrar; (iv) if a Registrar Contract is in effect with a Registrar, and the
Registrar notifies the Subcustodian that it will no longer be able materially
to comply with the terms of the Registrar Contract; or the Subcustodian has
actual knowledge that a registrar has engaged in conduct that indicates it
will not materially comply with the provisions or (v) if the Registrar has
materially breached such Contract. The Custodian shall promptly inform the
Fund of the occurrence of a Registrar Event provided the Subcustodian has
actual notice of the Registrar Event.
It shall be the sole responsibility of each Fund to promptly contact the
Custodian prior to executing any transaction in a Russian Equity to determine
whether a Registrar Contract exists in respect of an issuer not included on the
list provided to the Fund.
If a Fund instructs the Custodian by Proper Instruction to settle a
purchase of a Russian Equity in respect of which the Subcustodian has not
entered into a Registrar Contract, then the Custodian shall instruct the
Subcustodian to endeavor to settle such transaction in accordance with the
Proper Instruction and with the provisions of Section 2.D of this Agreement,
notwithstanding the absence of any such Registrar Contract and subject to the
requirement that the Custodian provide and promptly update the Registrar
Contract list with the respect to Russian Equities and without the Custodian
being required to notify the Fund that no such Registrar Contract is then in
effect, and it being understood that neither the Custodian nor the Subcustodian
shall be required to follow the procedure set forth in the second preceding
paragraph."
3. Section 2 D. Purchases, is amended by the addition of the following at
the end of said Section:
2
<PAGE> 3
"Without limiting the generality of the foregoing, the following
provisions shall apply with respect to settlement of purchases of
securities in Russia. Unless otherwise instructed by Proper Instructions
acceptable to the Custodian, the Custodian shall only authorize a
Subcustodian to make payment for purchases of Russian Equities upon receipt
of the relevant Share Extract in respect of the Fund's purchases. With
respect to securities other than Russian Equities, settlement of purchases
shall be made in accordance with securities processing or settlement
practices which the Custodian in its discretion determines to be a market
practice. Subject to the exercise of reasonable care, the Custodian shall
only be responsible for securities purchased upon actual receipt of such
securities at the premises of its Subcustodian, provided that the
Custodian's responsibility for securities represented by Share Extracts
shall be limited to the safekeeping of the relevant Share Extract upon
actual receipt of such Share Extract at the premises of the Subcustodian."
4. Section 2 E. Exchanges, is amended by inserting after the word
"exchange" in the second line thereof, the following phrase:
", in accordance with the registration procedures described in Section
2 C., of this Agreement,"
5. Section 2 F. Sales of Securities, is amended by the addition of the
following at the end of said Section:
"Without limiting the generality of the foregoing, the following
provisions shall apply with respect to settlement of sales of securities in
Russia. Unless otherwise expressly instructed by Proper Instructions
acceptable to the Custodian, settlement of sales of securities shall be
made in accordance with securities processing or settlement practices which
the Custodian in its discretion determines to be a market practice. Each
Fund hereby expressly acknowledges that such market practice might
require delivery of securities prior to receipt of payment and that the
Fund bears the risk of payment in instances where delivery of securities is
made prior to receipt of payment therefor in accordance with Proper
Instructions received by the Custodian or pursuant to the Custodian's
determination in its discretion that such delivery is in accordance with
market practice. Subject to the exercise of reasonable care, the Custodian
shall not be responsible for any securities delivered from the premises of
the Subcustodian from the time they leave such premises."
3
<PAGE> 4
6. Section 2 H., Exercise of Rights: Tender Offers, is replaced in
its entirety with the following:
Section 2 H., Exercise of Rights Tender Offers -- Upon timely
receipt of Proper Instructions, to use reasonable efforts to take any
action required by the terms of a rights offer, tender offer, put,
call, merger, consolidation, reorganization or other corporate action
affecting securities held on behalf of a Fund. The Custodian shall use
reasonable efforts to act on such Proper Instructions but will not be
held liable for any losses or costs incurred as a result of such
actions or as a result of the Custodian's inability for reasons beyond
its control to take the actions requested by such Proper Instructions,
provided however, that the Custodian or Subcustodian was not
negligent in performing its duties under this section. The Custodian
shall promptly inform the Fund whenever it is unable to take any
actions requested by Proper Instructions."
7. Section 2 I. Stock Dividends, Rights, Etc., is modified by the
addition of the following paragraph at the end of said Section:
"With respect to Russian Equities, to request a Subcustodian to
obtain a Share Extract with respect to all Russian Equities issued by
reason of a stock dividend, bonus issue or other distribution
resulting from a corporate action not requiring instructions from the
shareholder of the security, provided that the Custodian shall not be
responsible for its inability to obtain any such Share Extract or for
the failure of a Registrar or any agent thereof to record the Fund's
ownership on the issuer's records, unless such inability is due to the
negligence, fraud, or willful default of the Custodian or Subcustodian
or Agent selected by the Custodian or Subcustodian"
8. Section 3. Powers and Duties of the Custodian with Respect to the
Appointment of Subcustodians, is modified by the insertion of the following at
the end of the first paragraph of Section 3:
"With respect to Russia, each Fund hereby expressly acknowledges
that a Subcustodian for Russian securities may utilize the services of
Rosvneshtorgbank (also called Vneshtorgbank RF) ("VTB") which, as of
the date of this amendment, meets the requirements of Rule 17f-5 under
the Investment Company Act of 1940. Each Fund acknowledges that the
rights of the Subcustodian against the VTB may consist only of a
contractual claim. Neither the Custodian nor the Subcustodian shall be
responsible or liable to a Fund or its shareholders for the acts or
omissions of the VTB unless any loss
4
<PAGE> 5
results from the negligence, fraud or willful default of the Custodian
or Subcustodian. In the event of a loss of securities or cash held on
behalf of a Fund through the VTB, the Custodian shall not be
responsible to a Fund or its shareholders unless and to the extent it
in fact recovers from the Subcustodian."
9. Section 6 B. Liability of the Custodian with Respect to Use of
Securities Systems and Foreign Depositories, is amended by the insertion of the
following at the end of said Section.
"Notwithstanding anything in this Agreement to the contrary,
neither the Custodian nor the Subcustodian shall be responsible or
liable to a Fund or its shareholders for the acts or omissions of a
Foreign Depository in Russia, and in addition, neither the Custodian
nor a Subcustodian shall be responsible or liable to a Fund or its
shareholders for the failure of the Custodian or Subcustodian to
assert rights effectively against any such Foreign Depository unless
due to the negligence, fraud, or willful default of the Custodian or
Subcustodian."
10. The first paragraph of Section 6 D., Standard of Care: Liability:
Indemnification is replaced in its entirety with the following:
"The Custodian shall be held only to the exercise of reasonable
care in carrying out the provisions of this Agreement, provided that
the Custodian shall not thereby be required to take any action which
is in contravention of any applicable law, rule or regulation or any
order or judgment of any court of competent jurisdiction. With respect
to securities issued by Russian issuers or settlement in Russia of
securities transactions, reasonable care shall mean reasonable
practices under the circumstances as measured by prevailing custodial
practices among international financial institutions in Russia, and
negligence as used herein shall mean the failure to exercise
reasonable care as defined in this sentence. The Custodian shall in no
event be liable for consequential or indirect losses or from loss of
goodwill.
"Notwithstanding the foregoing, the Custodian shall have no
liability in respect of any loss, damage or expense suffered by a Fund
or any shareholder of a Fund insofar as such loss, damage or expense
arises from investment risk inherent in investing in capital markets
or in holding assets in a particular country or jurisdiction,
including without limitation, (i) political, legal, economic,
settlement and custody infrastructure, and currency and exchange rate
risks; (ii) investment and repatriation restrictions; (iii) a Fund's
inability to protect and enforce any local legal rights including
rights of title and beneficial ownership; (iv) corruption and crime in
the local market; (v) unreliable information which emanates from the
local market; (vi) volatility of banking and financial systems and
infrastructure; (vii) bankruptcy and insolvency risks of any and all
5
<PAGE> 6
local banking agents, counterparties to cash and securities
transactions or registrars or transfer agents; and (vii) risk of
issuer insolvency or default.
"It is understood that no Registrar, whether or not any such
Registrar has entered into a contract or other arrangement with a
Subcustodian or Foreign Depository, is or shall be considered or
deemed to be a Foreign Depository or an agent of the Custodian or any
Subcustodian, and accordingly neither the Custodian nor the
Subcustodian shall be responsible for or liable to a Fund or to the
shareholders of a Fund for the acts or omissions of any such Registrar
unless such acts or omissions result from the negligence, fraud or
willful default of the Custodian or Subcustodian. It is also agreed
that each Fund shall be responsible for preparation and filing of tax
returns, reports and other documents on any activities it undertakes
in Russia which are to be filed with any relevant governmental or
other authority and for the payment of any taxes, levies, duties or
similar liability the Fund incurs in respect of property held or sold
in Russia or of payments or distributions received in respect thereof
in Russia. Accordingly, each Fund hereby agrees to indemnify and hold
harmless the Custodian from any loss, cost or expense resulting from
the imposition or assessment of any such tax, duty, levy or liability
or any expenses related thereto."
11. A new Section 14., Risk Disclosure Acknowledgment, is added at
the end of the present Section 13:
"Each Fund hereby acknowledges that it has received, has read and
has understood the Custodian's Risk Disclosure Statement, a copy of
which is attached hereto and is incorporated herein by reference. Each
Fund further acknowledges that the Risk Disclosure Statement is not
comprehensive, and warrants and represents to the Custodian that it
has undertaken its own review of the risks associated with
investment in Russia and has concluded that such investment is
appropriate for the Fund and in no way conflicts with the Fund's
constitutive documents, investment objective, duties to its
shareholders or with any regulatory requirements applicable to the
Fund."
12. A new Section 15., Registrar System Reports, is added at the end
of the new section 14:
"Credit Suisse (Moscow) Ltd. will prepare for distribution to the
Board of Directors a quarterly report identifying any concerns Credit
Suisse (Moscow) Ltd. has regarding the Russian share registration
system that should be brought to the Board of Directors' attention.
This report will include detailed information regarding the steps
Credit Suisse (Moscow) Ltd. has taken during the reporting period to
ensure that the Fund's interests continue to be appropriately
recorded. This duty to report will
6
<PAGE> 7
commence upon Board of Director approval of investment in Russia. The
first quarterly report will be submitted to the Board of Directors
after the first full quarter of the fund's investment in Russia. Each
report will contain only new information from the date of the last
quarterly report."
Except as amended above, all the provisions of the Agreement as
heretofore in effect shall remain in full force and effect.
IN WITNESS WHEREOF, the parties have executed this Amendment as of the
date first set forth above.
STRONG VARIABLE INSURANCE BROWN BROTHERS HARRIMAN & CO.
FUNDS, INC. on behalf of
STRONG INTERNATIONAL
STOCK FUND II
/s/ John S. Weitzer /s/ Stokley P. Towler
- ------------------------ ---------------------------
Name: John S. Weitzer Name: Stokley P. Towler
Title: Vice President Title: Partner
7
<PAGE> 1
EXHIBIT 99.B11
CONSENT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Strong Variable Insurance Funds, Inc.
We consent to the incorporation by reference in Post-Effective Amendment No. 14
to the Registration Statement of Strong Variable Insurance Funds, Inc. on Form
N-1A of our reports dated February 3, 1997 on our audits of the financial
statements and financial highlights of Strong Advantage Fund II, Strong Asset
Allocation Fund II, Strong Discovery Fund II, Strong Government Securities Fund
II and Strong International Stock Fund II (each a series of Strong Variable
Insurance Funds, Inc.), which reports are included in each Fund's Annual Report
to Shareholders for the year ended December 31, 1996, which are also
incorporated by reference in the Registration Statement. We also consent to
the reference to our Firm under the caption "Independent Accountants" in the
Statement of Additional Information.
/s/ Coopers & Lybrand L.L.P.
Coopers & Lybrand L.L.P.
Milwaukee, Wisconsin
April 24, 1997
<PAGE> 1
Strong Discovery Fund II
EXHIBIT 16
----------
SCHEDULE OF COMPUTATION OF
PERFORMANCE QUOTATIONS
I. AVERAGE ANNUAL TOTAL RETURN
A. Formula
-------
n n ____
P (1+T) =ERV or T = \ /ERV/P - 1
Where: P = a hypothetical initial payment of $10,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $10,000 payment
made at the beginning of the stated periods at the stated
periods.
B. Calculation
-----------
n ____
T = \ /ERV/P - 1
1. One-year period 12-31-95 through 12-31-96
1 _____________
0.81% = \ /10,081/10,000 - 1
2. Since inception 05-08-92 through 12-31-96
4.648 _____________
12.29% = \ /17,138/10,000 - 1
III. TOTAL RETURN
A. Formula
-------
EV-IV
-----
IV = TR
Where: EV = Value at the end of the period, including reinvestment of
all dividends and capital gains distributions
IV = Initial value of a hypothetical investment at the net asset
value
TR = Total Return
Calculation
-----------
EV-IV
-----
IV = TR
One-year period ended December 31, 1996
10,081-10,000
-------------
10,000 = 0.81%
<PAGE> 2
Strong Advantage Fund II
EXHIBIT 16
----------
SCHEDULE OF COMPUTATION OF
PERFORMANCE QUOTATIONS
I. CURRENT ANNUALIZED YIELD: 30 days ended December 31, 1996
A. Formula
-------
a-b 6
YIELD = 2[(------ +1) -1]
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of
reimbursements).
c = the average daily number of shares outstanding
during the period.
d = the maximum offering price per share on the last
day of the period.
B. Calculation
-----------
7,151.02 - 2,613.49 6
YIELD = 2[(--------------------- +1) -1]
67,875.416 x 10.03
YIELD = 1.70%
<PAGE> 3
II. AVERAGE ANNUAL TOTAL RETURN
A. Formula
-------
n n ____
P(1 + T) = ERV or T = \ /ERV/P - 1
Where: P = a hypothetical initial payment of $10,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $10,000
payment made at the beginning of the stated periods at
the end of the stated periods.
B. Calculation
-----------
n ____
T = \ /ERV/P - 1
1. One-year period 12-31-95 through 12-31-96
1 _____________
4.92% = \ /10,492/10,000 - 1
2. Since inception 11-30-95 through 12-31-96
1.083 _____________
5.24% = \ /10,572/10,000 - 1
III. TOTAL RETURN
A. Formula
-------
EV-IV
-----
IV = TR
Where: EV = Value at the end of the period, including reinvestment
of all dividends and capital gains distributions
IV = Initial value of a hypothetical investment at the net
asset value
TR = Total Return
B. Calculation
-----------
EV-IV
-----
IV = TR
One-year period ended December 31, 1996
10,492 - 10,000
---------------
10,000 = 4.92%
<PAGE> 4
Strong Asset Allocation Fund II
EXHIBIT 16
----------
SCHEDULE OF COMPUTATION OF
PERFORMANCE QUOTATIONS
I. AVERAGE ANNUAL TOTAL RETURN
A. Formula
------- _____
n n
P (1 + T) =ERV or T=\ /ERV/P - 1
WHERE: P= a hypothetical initial payment of $10,000
T= average annual total return
n= number of years
ERV= ending redeemable value of a hypothetical $10,000
payment made at the beginning of the stated periods at
the end of the stated periods.
B. Calculation
-----------
_____
n
T=\ /ERV/P - 1
1. One-year period 12-31-95 through 12-31-96
_____________
1
12.94% = \ /11,294/10,000 - 1
2. Since inception 11-30-95 through 12-31-96
_____________
1.083
12.09% = \ /11,316/10,000 - 1
III. TOTAL RETURN
A. Formula
EV-IV
-----
IV = TR
Where: EV = Value at the end of the period, including reinvestment
of all dividends and capital gains distributions
IV = Initial value of a hypothetical investment at the net
asset value
TR = Total Return
B. Calculation
-----------
EV-IV
-----
IV = TR
One-year period ended December 31, 1996
11,294-10,000
-------------
10,000 = 12.94%
<PAGE> 5
Strong International Stock Fund II
EXHIBIT 16
SCHEDULE OF COMPUTATION OF
PERFORMANCE QUOTATIONS
I. AVERAGE ANNUAL TOTAL RETURN
A. Formula
-----
P(1+T)(n)=ERV or T=\n/ERV/P-1
Where: P= a hypothetical initial payment of $10,000
T= average annual total return
n= number of years
ERV= ending redeemable value of a hypothetical $10,000
payment made at the beginning of the stated periods at
the end of the stated periods.
B. Calculation
------
T=\n/ERV/P-1
1. One-year period 12-31-95 through 12-31-96
-------------
10.38% =\1/11,038/10,000-1
2. Since inception 10-20-95 through 12-31-96
-------------
10.97%=\1.20/11,327/10,000-1
III TOTAL RETURN
A. Formula
EV-IV
-----
IV = TR
Where: EV = Value at the end of the period, including reinvestment of
all dividends and capital gains distributions
IV = Initial value of a hypothetical investment at the net
asset value
TR = Total Return
B. Calculation
EV-IV
-----
IV = TR
One-year period ended December 31, 1996
11,038-10,000
-------------
10,000 = 10.38%
<PAGE> 6
Strong Government Securities Fund II
EXHIBIT 16
----------
SCHEDULE OF COMPUTATION OF
PERFORMANCE QUOTATIONS
I. CURRENT ANNUALIZED YIELD: 30 days ended December 31, 1996
A. Formula
-------
a-b (6)
YIELD = 2[(-------- +1) -1]
cd
Where: a = dividends and interests earned during the
period.
b = expenses accrued for the period (net of
reimbursements).
c = the average daily number of shares
outstanding during the period.
d = the maximum offering price per share on the
last day of the period.
B. Calculation
-----------
1,971.76 - 544.38 (6)
YIELD = 2[(--------------------- +1) -1]
20,366.132 x 9.61
YIELD = 2.72%
<PAGE> 7
II. TOTAL RETURN
A. Formula
-------
EV-IV
-----
IV = TR
Where: EV = Value at the end of the period, including
reinvestment of all dividends and capital gains
distributions
IV = Initial value of a hypothetical investment at the
net asset value
TR = Total Return
B. Calculation
-----------
EV-IV
-----
IV = TR
One-year period ended December 31, 1996
9,959 - 10,000
--------------
10,000 = -0.41%
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0000883644
<NAME> STRONG VARIABLE INSURANCE FUNDS, INC.
<SERIES>
<NUMBER> 3
<NAME> STRONG DISCOVERY FUND II
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<INVESTMENTS-AT-COST> 217681
<INVESTMENTS-AT-VALUE> 229727
<RECEIVABLES> 1144
<ASSETS-OTHER> 11
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 230882
<PAYABLE-FOR-SECURITIES> 1182
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 288
<TOTAL-LIABILITIES> 1470
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 233956
<SHARES-COMMON-STOCK> 21237
<SHARES-COMMON-PRIOR> 18233
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 0
<OVERDISTRIBUTION-GAINS> (16588)
<ACCUM-APPREC-OR-DEPREC> 12044
<NET-ASSETS> 229412
<DIVIDEND-INCOME> 966
<INTEREST-INCOME> 1167
<OTHER-INCOME> 0
<EXPENSES-NET> (2779)
<NET-INVESTMENT-INCOME> (646)
<REALIZED-GAINS-CURRENT> 1977
<APPREC-INCREASE-CURRENT> (456)
<NET-CHANGE-FROM-OPS> 875
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (20605)
<DISTRIBUTIONS-OF-GAINS> (27076)
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 8623
<NUMBER-OF-SHARES-REDEEMED> (10035)
<SHARES-REINVESTED> 4416
<NET-CHANGE-IN-ASSETS> (15635)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 28125
<OVERDISTRIB-NII-PRIOR> (234)
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 2295
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 2779
<AVERAGE-NET-ASSETS> 229870
<PER-SHARE-NAV-BEGIN> 13.44
<PER-SHARE-NII> (0.05)
<PER-SHARE-GAIN-APPREC> 0.04
<PER-SHARE-DIVIDEND> (1.05)
<PER-SHARE-DISTRIBUTIONS> (1.58)
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 10.8
<EXPENSE-RATIO> 1.2
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0000883644
<NAME> STRONG VARIABLE INSURANCE FUNDS, INC.
<SERIES>
<NUMBER> 4
<NAME> STRONG INTERNATIONAL STOCK FUND II
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<INVESTMENTS-AT-COST> 75688
<INVESTMENTS-AT-VALUE> 74752
<RECEIVABLES> 602
<ASSETS-OTHER> 1
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 75355
<PAYABLE-FOR-SECURITIES> 4
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 200
<TOTAL-LIABILITIES> 204
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 73781
<SHARES-COMMON-STOCK> 6689
<SHARES-COMMON-PRIOR> 177
<ACCUMULATED-NII-CURRENT> 103
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 2062
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> (795)
<NET-ASSETS> 75151
<DIVIDEND-INCOME> 660
<INTEREST-INCOME> 437
<OTHER-INCOME> 0
<EXPENSES-NET> (908)
<NET-INVESTMENT-INCOME> 189
<REALIZED-GAINS-CURRENT> 2280
<APPREC-INCREASE-CURRENT> (829)
<NET-CHANGE-FROM-OPS> 1640
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (189)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> (111)
<NUMBER-OF-SHARES-SOLD> 10737
<NUMBER-OF-SHARES-REDEEMED> (4251)
<SHARES-REINVESTED> 27
<NET-CHANGE-IN-ASSETS> 73346
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> (1)
<OVERDIST-NET-GAINS-PRIOR> (2)
<GROSS-ADVISORY-FEES> 476
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 908
<AVERAGE-NET-ASSETS> 47763
<PER-SHARE-NAV-BEGIN> 10.22
<PER-SHARE-NII> 0.03
<PER-SHARE-GAIN-APPREC> 1.03
<PER-SHARE-DIVIDEND> (0.05)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 11.23
<EXPENSE-RATIO> 1.9
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0000883644
<NAME> STRONG VARIABLE INSURANCE FUNDS, INC.
<SERIES>
<NUMBER> 1
<NAME> STRONG ADVANTAGE FUND II
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<INVESTMENTS-AT-COST> 581512
<INVESTMENTS-AT-VALUE> 583868
<RECEIVABLES> 6451
<ASSETS-OTHER> 97
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 590416
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 2801
<TOTAL-LIABILITIES> 2801
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 585351
<SHARES-COMMON-STOCK> 58559
<SHARES-COMMON-PRIOR> 50000
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 0
<OVERDISTRIBUTION-GAINS> (92)
<ACCUM-APPREC-OR-DEPREC> 2356
<NET-ASSETS> 587615
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 37547
<OTHER-INCOME> 0
<EXPENSES-NET> (11851)
<NET-INVESTMENT-INCOME> 25696
<REALIZED-GAINS-CURRENT> 2188
<APPREC-INCREASE-CURRENT> 1097
<NET-CHANGE-FROM-OPS> 28981
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (25696)
<DISTRIBUTIONS-OF-GAINS> (2188)
<DISTRIBUTIONS-OTHER> (92)
<NUMBER-OF-SHARES-SOLD> 137197
<NUMBER-OF-SHARES-REDEEMED> (129295)
<SHARES-REINVESTED> 657
<NET-CHANGE-IN-ASSETS> 86358
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 3429
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 16977
<AVERAGE-NET-ASSETS> 596530
<PER-SHARE-NAV-BEGIN> 10.03
<PER-SHARE-NII> 0.44
<PER-SHARE-GAIN-APPREC> 0.04
<PER-SHARE-DIVIDEND> (0.44)
<PER-SHARE-DISTRIBUTIONS> (0.04)
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 10.03
<EXPENSE-RATIO> 2.0<F1>
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
<FN>
<F1>
EXPENSE RATIO WITHOUT WAIVERS AND ABSORPTIONS IS 2.8
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0000883644
<NAME> STRONG VARIABLE INSURANCE FUNDS, INC.
<SERIES>
<NUMBER> 2
<NAME> STRONG ASSET ALLOCATION FUND II
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<INVESTMENTS-AT-COST> 595196
<INVESTMENTS-AT-VALUE> 592890
<RECEIVABLES> 1065
<ASSETS-OTHER> 0
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 593955
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 27868
<TOTAL-LIABILITIES> 27868
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 552212
<SHARES-COMMON-STOCK> 54892
<SHARES-COMMON-PRIOR> 50000
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> (30)
<ACCUMULATED-NET-GAINS> 26855
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> (12950)
<NET-ASSETS> 566087
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 26659
<OTHER-INCOME> 0
<EXPENSES-NET> (10542)
<NET-INVESTMENT-INCOME> 16117
<REALIZED-GAINS-CURRENT> 60631
<APPREC-INCREASE-CURRENT> (11885)
<NET-CHANGE-FROM-OPS> 64863
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (16070)
<DISTRIBUTIONS-OF-GAINS> (33839)
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 32643
<NUMBER-OF-SHARES-REDEEMED> (29639)
<SHARES-REINVESTED> 1888
<NET-CHANGE-IN-ASSETS> 67166
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 63
<OVERDISTRIB-NII-PRIOR> (77)
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 4481
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 22606
<AVERAGE-NET-ASSETS> 527468
<PER-SHARE-NAV-BEGIN> 9.98
<PER-SHARE-NII> 0.31
<PER-SHARE-GAIN-APPREC> 0.97
<PER-SHARE-DIVIDEND> 0.31
<PER-SHARE-DISTRIBUTIONS> 0.64
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 10.31
<EXPENSE-RATIO> 2.0<F1>
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
<FN>
<F1> Expense ratio without waivers and absorptions is 4.3.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0000883644
<NAME> STRONG VARIABLE INSURANCE FUNDS, INC.
<SERIES>
<NUMBER> 5
<NAME> STRONG GOVERNMENT SECURITIES FUND II
<S> <C>
<PERIOD-TYPE> 11-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-31-1996
<PERIOD-END> DEC-31-1996
<INVESTMENTS-AT-COST> 195375
<INVESTMENTS-AT-VALUE> 196248
<RECEIVABLES> 3659
<ASSETS-OTHER> 73
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 199980
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 652
<TOTAL-LIABILITIES> 652
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 207912
<SHARES-COMMON-STOCK> 20747
<SHARES-COMMON-PRIOR> 0
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 0
<OVERDISTRIBUTION-GAINS> (9457)
<ACCUM-APPREC-OR-DEPREC> 873
<NET-ASSETS> 199328
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 13918
<OTHER-INCOME> 0
<EXPENSES-NET> (4287)
<NET-INVESTMENT-INCOME> 9631
<REALIZED-GAINS-CURRENT> (9457)
<APPREC-INCREASE-CURRENT> 873
<NET-CHANGE-FROM-OPS> 1047
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (9631)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 106320
<NUMBER-OF-SHARES-REDEEMED> (85791)
<SHARES-REINVESTED> 218
<NET-CHANGE-IN-ASSETS> 199328
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 1416
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 9715
<AVERAGE-NET-ASSETS> 268195
<PER-SHARE-NAV-BEGIN> 10
<PER-SHARE-NII> 0.34
<PER-SHARE-GAIN-APPREC> (0.39)
<PER-SHARE-DIVIDEND> (0.34)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 9.61
<EXPENSE-RATIO> 1.7<F1>
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
<FN>
<F1>
EXPENSE RATIO WITHOUT WAIVERS AND ABSORPTIONS IS 3.9.
</FN>
</TABLE>
<PAGE> 1
Exhibit 19
STRONG VARIABLE INSURANCE FUNDS, INC.
(Registrant)
POWER OF ATTORNEY
Each person whose signature appears below, constitutes and appoints John
Dragisic, Thomas P. Lemke, Lawrence A. Totsky, Stephen J. Shenkenberg, and
John S. Weitzer, and each of them, his true and lawful attorney-in-fact and
agent with full power of substitution and resubstitution, for him and in his
name, place and stead, in any and all capacities, to sign this Registration
Statement on Form N-1A, and any and all amendments thereto, and to file the
same, with all exhibits, and any other documents in connection therewith, with
the Securities and Exchange Commission and any other regulatory body granting
unto said attorney-in-fact and agent, full power and authority to do and
perform each and every act and thing requisite and necessary to be done, as
fully to all intents and purposes, as he might or could do in person, hereby
ratifying and confirming all that said attorney-in-fact and agent, or his
substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
<TABLE>
<CAPTION>
Name Title Date
---- ----- ----
<S> <C> <C>
President of the Board
(Principal Executive
Officer and acting
Principal Financial and
/s/John Dragisic Accounting Officer) and a Director April 24, 1997
- -------------------------
John Dragisic
/s/Richard S. Strong Chairman of the Board and a Director April 24, 1997
- -------------------------
Richard S. Strong
/s/Marvin E. Nevins Director April 24, 1997
- -------------------------
Marvin E. Nevins
/s/Willie D. Davis Director April 24, 1997
- -------------------------
Willie D. Davis
/s/William F. Vogt Director April 24, 1997
- -------------------------
William F. Vogt
/s/Stanley Kritzik Director April 24, 1997
- -------------------------
Stanley Kritzik
</TABLE>
<PAGE> 1
EXHIBIT 99.B20
[GODFREY & KAHN, S.C. LETTERHEAD]
April 23, 1997
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: Strong Variable Insurance Funds, Inc.
Gentlemen:
We represent Strong Variable Insurance Funds, Inc. (the "Company"), in
connection with its filing of Post-Effective Amendment No. 14 (the
"Post-Effective Amendment") to the Company's Registration Statement
(Registration Nos. 33-45321; 811-6553) on Form N-1A under the Securities Act of
1933 (the "Securities Act") and the Investment Company Act of 1940. The
Post-Effective Amendment is being filed pursuant to Rule 485(b) under the
Securities Act.
We have reviewed the Post-Effective Amendment and, in accordance with Rule
485(b)(4) under the Securities Act, hereby represent that the Post-Effective
Amendment does not contain disclosures which would render it ineligible to
become effective pursuant to Rule 485(b).
Very truly yours,
GODFREY & KAHN, S.C.
/s/ Pamela M. Krill
Pamela M. Krill
<PAGE> 1
EXHIBIT 99.B21.1
CODE OF ETHICS
FOR ACCESS PERSONS OF
THE STRONG FAMILY OF MUTUAL FUNDS,
STRONG CAPITAL MANAGEMENT, INC.,
AND STRONG FUNDS DISTRIBUTORS, INC.
[STRONG FUNDS LOGO]
STRONG CAPITAL MANAGEMENT, INC.
October 18, 1996
<PAGE> 2
CODE OF ETHICS
For Access Persons of
The Strong Family of Mutual Funds,
Strong Capital Management, Inc.,
and Strong Funds Distributors, Inc.
Dated October 18, 1996
Table of Contents
I. INTRODUCTION ..............................................................1
A. Fiduciary Duty ............................................................1
1. Place the interests of Advisory Clients first .............................1
2. Avoid taking inappropriate advantage of their position ....................1
3. Conduct all Personal Securities Transactions in full compliance with
this Code including both the preclearance and reporting requirements ......1
B. Appendices to the Code ....................................................2
1. Definitions ...............................................................2
2. Contact Persons ...........................................................2
3. Disclosure of Personal Holdings in Securities .............................2
4. Acknowledgment of Receipt of Code of Ethics and Limited Power of Attorney..2
5. Preclearance Request for Access Persons ...................................2
6. Annual Code of Ethics Questionnaire .......................................2
7. List of Broad-Based Indices ...............................................2
8. Form Letter to Broker or Bank .............................................2
9. Gift Policy ...............................................................2
C. Application of the Code to Independent Fund Directors .....................2
D. Application of the Code to Funds Subadvised by SCM ........................2
II. PERSONAL SECURITIES TRANSACTIONS ..........................................2
A. Annual Disclosure of Personal Holdings by Access Persons ..................2
B. Preclearance Requirements for Access Persons ..............................3
1. General Requirement .......................................................3
2. Transactions Exempt from Preclearance Requirements ........................3
a. Mutual Funds ..............................................................3
b. No Knowledge ..............................................................3
c. Certain Corporate Actions .................................................3
d. Rights ....................................................................3
e. Miscellaneous .............................................................3
3. Application to Commodities, Futures, Options on Futures and Options
on Broad-Based Indices ....................................................4
C. Preclearance Requests .....................................................4
1. Trade Authorization Request Forms .........................................4
2. Review of Form ............................................................4
3. Access Person Designees ...................................................4
D. Prohibited Transactions ...................................................5
1. Prohibited Securities Transactions ........................................5
i
<PAGE> 3
a. Initial Public Offerings ..................................................5
b. Pending Buy or Sell Orders ................................................5
c. Seven Day Blackout ........................................................5
d. Intention to Buy or Sell for Advisory Client ..............................5
e. 60-Day Blackout ...........................................................6
2. Always Prohibited Securities Transactions .................................6
a. Inside Information ........................................................6
b. Market Manipulation .......................................................6
c. Large Positions in Non-Strong Funds .......................................6
d. Others ....................................................................6
3. Private Placements ........................................................6
4. No Explanation Required for Refusals ......................................6
E. Execution of Personal Securities Transactions .............................7
F. Length of Trade Authorization Approval ....................................7
G. Trade Reporting Requirements ..............................................7
1. Reporting Requirement .....................................................7
2. Disclaimers ...............................................................8
3. Quarterly Review ..........................................................8
4. Availability of Reports ...................................................8
5. Record Retention ..........................................................8
III. FIDUCIARY DUTIES ........................................................9
A. Confidentiality ...........................................................9
B. Gifts .....................................................................9
1. Accepting Gifts ...........................................................9
2. Solicitation of Gifts .....................................................9
3. Giving Gifts ..............................................................9
C. Payments to Advisory Clients ..............................................9
D. Corporate Opportunities ...................................................9
E. Undue Influence ...........................................................9
F. Service as a Director ....................................................10
G. Involvement in Criminal Matters or Investment-Related Civil Proceedings ..10
IV. COMPLIANCE WITH THIS CODE OF ETHICS .....................................10
A. Code of Ethics Review Committee ..........................................10
1. Membership, Voting, and Quorum ...........................................10
2. Investigating Violations of the Code .....................................10
3. Annual Reports ...........................................................11
B. Remedies .................................................................11
1. Sanctions ................................................................11
2. Sole Authority ...........................................................11
3. Review ...................................................................11
C. Exceptions to the Code ...................................................12
D. Compliance Certification .................................................12
E. Inquiries Regarding the Code .............................................12
ii
<PAGE> 4
CODE OF ETHICS
For Access Persons of
The Strong Family of Mutual Funds,
Strong Capital Management, Inc.,
and Strong Funds Distributors, Inc.
Dated October 18, 1996
Table of Appendices
Appendix 1 (Definitions) ....................................................13
Appendix 2 (Contact Persons) ................................................16
Appendix 3 (Disclosure of Personal Holdings in Securities)...................17
Appendix 4 (Acknowledgment of Receipt of Code of Ethics and
Limited Power of Attorney) .................................................18
Appendix 5 (Preclearance Request for Access Persons) ........................19
Appendix 6 (Annual Code of Ethics Questionnaire) ............................20
Appendix 7 (List of Broad-Based Indices) ....................................23
Appendix 8 (Form Letter to Broker or Bank) ..................................24
Appendix 9 (Gift Policy) ....................................................25
iii
<PAGE> 5
CODE OF ETHICS
For Access Persons of
The Strong Family of Mutual Funds,
Strong Capital Management, Inc.,
and Strong Funds Distributors, Inc.
Dated October 18, 1996
I. INTRODUCTION
A. Fiduciary Duty. This Code of Ethics is based upon the principle that
directors, officers, and employees of Strong Capital Management, Inc. ("SCM"),
Strong Funds Distributors, Inc. ("the Distributor"), and the Strong Family of
Mutual Funds ("the Strong Funds") have a fiduciary duty to place the interests
of clients ahead of their own. The Code applies to all Access Persons and
focuses principally on preclearance and reporting of personal transactions in
securities. Capitalized words are defined in Appendix 1. Access Persons must
avoid activities, interests, and relationships that might interfere with making
decisions in the best interests of the Advisory Clients of SCM.
As fiduciaries, Access Persons must at all times:
1. Place the interests of Advisory Clients first. Access Persons
must scrupulously avoid serving their own personal interests ahead of the
interests of the Advisory Clients of SCM. An Access Person may not
induce or cause an Advisory Client to take action, or not to take action,
for personal benefit, rather than for the benefit of the Advisory Client.
For example, an Access Person would violate this Code by causing an
Advisory Client to purchase a Security he or she owned for the purpose of
increasing the price of that Security.
2. Avoid taking inappropriate advantage of their position. The
receipt of investment opportunities, perquisites, or gifts from persons
seeking business with the Strong Funds, SCM, the Distributor, or their
clients could call into question the exercise of an Access Person's
independent judgment. Access persons may not, for example, use their
knowledge of portfolio transactions to profit by the market effect of
such transactions.
3. Conduct all Personal Securities Transactions in full compliance
with this Code including both the preclearance and reporting
requirements.
Doubtful situations should be resolved in favor of Advisory Clients.
Technical compliance with the Code's procedures will not automatically insulate
from scrutiny any trades that indicate an abuse of fiduciary duties.
1
<PAGE> 6
B. Appendices to the Code. The appendices to this Code are attached
hereto and are a part of the Code, and include the following:
1. Definitions--capitalized words as defined in the Code--(Appendix
1),
2. Contact Persons, including the Preclearance Officer designees,
and the Code of Ethics Review Committee (Appendix 2),
3. Disclosure of Personal Holdings in Securities (Appendix 3),
4. Acknowledgment of Receipt of Code of Ethics and Limited Power of
Attorney (Appendix 4),
5. Preclearance Request for Access Persons (Appendix 5),
6. Annual Code of Ethics Questionnaire (Appendix 6),
7. List of Broad-Based Indices (Appendix 7),
8. Form Letter to Broker or Bank (Appendix 8), and
9. Gift Policy (Appendix 9).
C. Application of the Code to Independent Fund Directors. This Code
applies to Independent Fund Directors, and requires Independent Fund Directors
and their Immediate Families to report Securities Transactions to the
Compliance Department in accordance with Section II.G. However, provisions of
the Code requiring the disclosure of personal holdings (Section II.A.),
preclearance of trades (Section II.B.), prohibited transactions (II.D.1.),
private placements (Section II.D.3.), restrictions on serving as a director of
a publicly-traded company (Section III.F.), and receipt of gifts (Section
III.B.) do not apply to Independent Fund Directors.
D. Application of the Code to Funds Subadvised by SCM. This Code does
not apply to the directors, officers, and general partners of Funds for which
SCM serves as a subadviser.
II. PERSONAL SECURITIES TRANSACTIONS
A. Annual Disclosure of Personal Holdings by Access Persons. Upon
designation as an Access Person, and thereafter on an annual basis, all Access
Persons must disclose on the Disclosure of Personal Holdings In Securities Form
(Appendix 3) (or a substantially similar form) all Securities in which they
have a Beneficial Interest and all Securities in non-client accounts for which
they make investment decisions (previously reported holdings need not be
reported). This provision does not apply to Independent Fund Directors.
2
<PAGE> 7
B. Preclearance Requirements for Access Persons.
1. General Requirement. Except for the transactions set forth in
Section II.B.2., all Securities Transactions in which an Access Person or
a member of his or her Immediate Family has a Beneficial Interest must be
precleared with the Preclearance Officer or his designee. This provision
does not apply to transactions of Independent Fund Directors and their
Immediate Families.
2. Transactions Exempt from Preclearance Requirements. The
following Securities Transactions are exempt from the preclearance
requirements set forth in Section II.B.1. of this Code:
a. Mutual Funds. Securities issued by any registered open-end
investment companies (including but not limited to the Strong
Funds);
b. No Knowledge. Securities Transactions where neither SCM,
the Access Person nor an Immediate Family member knows of the
transaction before it is completed (for example, Securities
Transactions effected for an Access Person by a trustee of a blind
trust or discretionary trades involving an investment partnership
or investment club in which the Access Person is neither consulted
nor advised of the trade before it is executed);
c. Certain Corporate Actions. Any acquisition of Securities
through stock dividends, dividend reinvestments, stock splits,
reverse stock splits, mergers, consolidations, spin-offs, or other
similar corporate reorganizations or distributions generally
applicable to all holders of the same class of Securities;
d. Rights. Any acquisition of Securities through the exercise
of rights issued by an issuer pro rata to all holders of a class of
its Securities, to the extent the rights were acquired in the
issue; and
e. Miscellaneous. Any transaction in the following: (1)
bankers acceptances, (2) bank certificates of deposit ("CDs"), (3)
commercial paper, (4) repurchase agreements, (5) Securities that
are direct obligations of the U.S. government, (6) equity
securities held in dividend reinvestment plans ("DRIPs"), (7)
Securities of the employer of a member of the Access Person's
Immediate Family if such securities are beneficially owned through
participation by the Immediate Family member in a Profit Sharing
plan, 401(k) plan, ESOP, or other similar plan, and (8) other
Securities as may from time to time be designated in writing by the
Code of Ethics Review Committee on the grounds that the risk of
abuse is minimal or non-existent.
THE SECURITIES TRANSACTIONS LISTED ABOVE ARE NOT EXEMPT FROM THE
REPORTING REQUIREMENTS SET FORTH IN SECTION II.G.
3
<PAGE> 8
3. Application to Commodities, Futures, Options on Futures and
Options on Broad-Based Indices. Commodities, futures (including currency
futures and futures on securities comprising part of a broad-based,
publicly traded market based index of stocks), options on futures,
options on currencies, and options on certain indices designated by the
Compliance Department as broad-based are not subject to the preclearance,
seven day black out, 60-day profit disgorgement, and prohibited
transaction provisions of Section II.D.I of the Code, but are subject to
transaction reporting. The options on indices designated by the
Compliance Department as broad-based may be changed from time to time and
are listed in Appendix 7. The options on indices that are not designated
as broad-based are subject to the preclearance, seven-day blackout,
60-day profit disgorgement, prohibited transaction, and reporting
provisions of the Code.
C. Preclearance Requests.
1. Trade Authorization Request Forms. Prior to entering an order
for a Securities Transaction that requires preclearance, the Access
Person must complete, IN WRITING, a Preclearance Request For Access
Persons Form as set forth in Appendix 5 and submit the completed form to
the Preclearance Officer (or his designee). The Preclearance Request For
Access Persons Form requires Access Persons to provide certain
information and to make certain representations. Proposed Securities
Transactions of the Preclearance Officer that require preclearance must
be submitted to his designee.
2. Review of Form. After receiving the completed Preclearance
Request For Access Persons Form, the Preclearance Officer (or his
designee) will (a) review the information set forth in the form, (b)
independently confirm whether the Securities are held by any Funds or
other accounts managed by SCM and whether there are any unexecuted orders
to purchase or sell the Securities by any Fund or accounts managed by
SCM, and (c) as soon as reasonably practicable, determine whether to
clear the proposed Securities Transaction. The authorization, date, and
time of the authorization must be reflected on the Preclearance Request
For Access Persons Form. The Preclearance Officer (or his designee) will
keep one copy of the completed form for the Compliance Department, send
one copy to the Access Person seeking authorization, and send the third
copy to the Trading Department, which will cause the transaction to be
executed.
No order for a securities transaction for which preclearance
authorization is sought may be placed prior to the receipt of written
authorization of the transaction by the preclearance officer (or his
designee). Verbal approvals are not permitted.
3. Access Person Designees. If an Access Person is away from SCM's
principal office and desires to effect a personal Securities Transaction
prior to his or her return, such Access Person may designate an
individual at SCM to complete and submit
4
<PAGE> 9
for preclearance on his or her behalf a Preclearance Request for Access
Persons Form provided the following requirements are satisfied:
a. The Access Person communicates the details of the trade and
affirms the accuracy of the representations and warranties
contained on the Form directly to such designated person; and
b. The designated person completes the Preclearance Request
For Access Persons Form on behalf of the Access Person in
accordance with the requirements of the Code and then executes the
Access Person Designee Certification contained in the Form. The
Access Person does not need to sign the Form so long as the
foregoing certification is provided.
D. Prohibited Transactions.
1. Prohibited Securities Transactions. The following Securities
Transactions for accounts in which an Access Person or a member of his or
her Immediate Family have a Beneficial Interest, to the extent they
require preclearance under Section II.B. above, are prohibited and will
not be authorized by the Preclearance Officer (or his designee) absent
exceptional circumstances:
a. Initial Public Offerings. Any purchase of Securities in an
initial public offering (other than a new offering of a registered
open-end investment company);
b. Pending Buy or Sell Orders. Any purchase or sale of
Securities on any day during which any Advisory Client has a
pending "buy" or "sell" order in the same Security (or Equivalent
Security) until that order is executed or withdrawn;
c. Seven Day Blackout. Purchases or sales of Securities by a
Portfolio Manager within seven calendar days of a purchase or sale
of the same Securities (or Equivalent Securities) by an Advisory
Client managed by that Portfolio Manager, unless the purchase or
sale is a Program Trade. For example, if a Fund trades in a
Security on day one, day eight is the first day the Portfolio
Manager may trade that Security for an account in which he or she
has a beneficial interest;
d. Intention to Buy or Sell for Advisory Client. Purchases or
sales of Securities at a time when that Access Person intends, or
knows of another's intention, to purchase or sell that Security (or
an Equivalent Security) on behalf of an Advisory Client. This
prohibition applies whether the Securities Transaction is in the
same (e.g., two purchases) or the opposite (a purchase and sale)
direction of the transaction of the Advisory Client; and
5
<PAGE> 10
e. 60-Day Blackout. (1) Purchases of a Security in which an
Access Person acquires a Beneficial Interest within 60 days of the
sale of the Security (or an Equivalent Security) in which the same
Access Person had a Beneficial Interest, and (2) sales of a
Security in which an Access Person had a Beneficial Interest within
60 days of the purchase of the Security (or an Equivalent Security)
in which the same Access Person has a Beneficial Interest, unless,
in each case, the Access Person agrees to give up all profits on
the transaction to a charitable organization specified in
accordance with Section IV.B.1.
2. Always Prohibited Securities Transactions. The following
Securities Transactions are prohibited and will not be authorized under
any circumstances:
a. Inside Information. Any transaction in a Security while in
possession of material nonpublic information regarding the Security
or the issuer of the Security;
b. Market Manipulation. Transactions intended to raise,
lower, or maintain the price of any Security or to create a false
appearance of active trading;
c. Large Positions in Non-Strong Funds. Transactions in a
registered investment company (other than the Strong Funds) which
result in the Access Person owning five percent or more of any
class of securities in such investment company; and
d. Others. Any other transactions deemed by the Preclearance
Officer (or his designee) to involve a conflict of interest,
possible diversion of corporate opportunity, or an appearance of
impropriety.
3. Private Placements. Acquisitions of Beneficial Interests in
Securities in a private placement by an Access Person is strongly
discouraged. The Preclearance Officer (or his designee) will give
permission only after considering, among other facts, whether the
investment opportunity should be reserved for Advisory Clients and
whether the opportunity is being offered to an Access Person by virtue of
his or her position as an Access Person. Access Persons who have been
authorized to acquire and have acquired securities in a private placement
are required to disclose that investment to the Compliance Department
when they play a part in any subsequent consideration of an investment in
the issuer by an Advisory Client and the decision to purchase securities
of the issuer by an Advisory Client must be independently authorized by a
Portfolio Manager with no personal interest in the issuer. This
provision does not apply to Independent Fund Directors.
4. No Explanation Required for Refusals. In some cases, the
Preclearance Officer (or his designee) may refuse to authorize a
Securities Transaction for a reason that
6
<PAGE> 11
is confidential. The Preclearance Officer is not required to give an
explanation for refusing to authorize any Securities Transaction.
E. Execution of Personal Securities Transactions. Unless an exception
is provided in writing by the Compliance Department, all transactions in
Securities subject to the preclearance requirements for which an Access Person
or a member of his or her Immediate Family has a Beneficial Interest shall be
executed by the Trading Department. IN ALL INSTANCES, THE TRADING DEPARTMENT
MUST GIVE PRIORITY TO CLIENT TRADES OVER ACCESS PERSON TRADES.
F. Length of Trade Authorization Approval. The authorization provided
by the Preclearance Officer (or his designee) is effective until the earlier of
(1) its revocation, (2) the close of business on the second trading day after
the authorization is granted (for example, if authorization is provided on a
Monday, it is effective until the close of business on Wednesday), or (3) the
Access Person learns that the information in the Trade Authorization Request
Form is not accurate. If the order for the Securities Transaction is not
placed within that period, a new advance authorization must be obtained before
the Securities Transaction is placed. If the Securities Transaction is placed
but has not been executed within two trading days after the day the
authorization is granted (as, for example, in the case of a limit order or a
not held order), no new authorization is necessary unless the person placing
the original order for the Securities Transaction amends it in any way.
G. Trade Reporting Requirements.
1. Reporting Requirement. EVERY ACCESS PERSON AND MEMBERS OF HIS OR
HER IMMEDIATE FAMILY (INCLUDING INDEPENDENT FUND DIRECTORS AND THEIR
IMMEDIATE FAMILIES) MUST ARRANGE FOR THE COMPLIANCE DEPARTMENT TO RECEIVE
DIRECTLY FROM ANY BROKER, DEALER, OR BANK THAT EFFECTS ANY SECURITIES
TRANSACTION, DUPLICATE COPIES OF EACH CONFIRMATION FOR EACH SUCH
TRANSACTION AND PERIODIC STATEMENTS FOR EACH BROKERAGE ACCOUNT IN WHICH
SUCH ACCESS PERSON HAS A BENEFICIAL INTEREST. Attached hereto as
Appendix 8 is a form letter that may be used to request such documents
from such entities. An Access Person must arrange to have duplicate
confirmations and periodic statements sent within 30 days of the sooner
of (1) designation as an Access Person, or (2) the establishment of the
account at the broker, dealer or bank. If the Access Person is unable to
arrange for the above, the Access Person must immediately notify the
Compliance Department. THE FOREGOING DOES NOT APPLY TO TRANSACTIONS AND
HOLDINGS IN (1) OPEN-END INVESTMENT COMPANIES INCLUDING BUT NOT LIMITED
TO THE STRONG FUNDS, (2) BANK CERTIFICATES OF DEPOSIT ("CDS"), (3)
EQUITY SECURITIES HELD IN DIVIDEND REINVESTMENT PLANS ("DRIPS"), OR (4)
SECURITIES OF THE EMPLOYER OF A MEMBER OF THE ACCESS PERSON'S IMMEDIATE
FAMILY IF SUCH SECURITIES ARE BENEFICIALLY OWNED THROUGH PARTICIPATION BY
THE IMMEDIATE FAMILY MEMBER IN A PROFIT SHARING PLAN, 401(K) PLAN, ESOP,
OR OTHER SIMILAR PLAN.
7
<PAGE> 12
2. Disclaimers. Any report of a Securities Transaction for the
benefit of a person other than the individual in whose account the
transaction is placed may contain a statement that the report should not
be construed as an admission by the person making the report that he or
she has any direct or indirect beneficial ownership in the Security to
which the report relates.
3. Quarterly Review. At least quarterly, for Securities
Transactions requiring preclearance under this Code, the Preclearance
Officer (or his designee) shall compare the confirmations and periodic
statements provided pursuant to Section II.G.1. above, to the approved
Trade Authorization Request Forms. Such review shall include:
a. Whether the Securities Transaction complied with this Code;
b. Whether the Securities Transaction was authorized in
advance of its placement;
c. Whether the Securities Transaction was executed within two
full trading days of when it was authorized;
d. Whether any Fund or accounts managed by SCM owned the
Securities at the time of the Securities Transaction, and;
e. Whether any Fund or separate accounts managed by SCM
purchased or sold the Securities in the Securities Transaction
within at least 10 days of the Securities Transaction.
4. Availability of Reports. All information supplied pursuant to
this Code will be available for inspection by the Boards of Directors of
SCM and SFDI, the Board of Directors of each Strong Fund, the Code of
Ethics Review Committee, the Compliance Department, the Access Person's
department manager (or designee), any party to which any investigation is
referred by any of the foregoing, the SEC, any self-regulatory
organization of which the Strong Funds, SCM or the Distributor is a
member, and any state securities commission, as well as any attorney or
agent of the foregoing, the Strong Funds, SCM, or the Distributor.
5. Record Retention. SCM shall keep and maintain for at least six
years records of the procedures it follows in connection with the
preclearance and reporting requirements of this Code and, for each
Securities Transaction, the information relied on by the Preclearance
Officer (or his designee) in authorizing the Securities Transaction and
making the post-Securities Transaction determination of Section II.G.3.
8
<PAGE> 13
III. FIDUCIARY DUTIES
A. Confidentiality. Access Persons are prohibited from revealing
information relating to the investment intentions, activities or portfolios of
Advisory Clients except to persons whose responsibilities require knowledge of
the information.
B. Gifts. The following provisions on gifts apply only to employees of
SCM and the Distributor.
1. Accepting Gifts. On occasion, because of their position with
SCM, the Distributor, or the Strong Funds, employees may be offered, or
may receive without notice, gifts from clients, brokers, vendors, or
other persons not affiliated with such entities. Acceptance of
extraordinary or extravagant gifts is not permissible. Any such gifts
must be declined or returned in order to protect the reputation and
integrity of SCM, the Distributor, and the Strong Funds. Gifts of a
nominal value (i.e., gifts whose reasonable value is no more than $100 a
year), and customary business meals, entertainment (e.g., sporting
events), and promotional items (e.g., pens, mugs, T-shirts) may be
accepted. Please see the Gift Policy Reminder memorandum dated December
1, 1994 (Appendix 9) for additional information.
If an employee receives any gift that might be prohibited under this
Code, the employee must inform the Compliance Department.
2. Solicitation of Gifts. Employees of SCM or the Distributor may
not solicit gifts or gratuities.
3. Giving Gifts. Employees of SCM or the Distributor may not give
any gift with a value in excess of $100 per year to persons associated
with securities or financial organizations, including exchanges, other
member organizations, commodity firms, news media, or clients of the
firm. Please see the Gift Policy Reminder memorandum dated December 1,
1994 (Appendix 9) for additional information.
C. Payments to Advisory Clients. Access Persons may not make any payments
to Advisory Clients in order to resolve any type of Advisory Client complaint.
All such matters must be handled by the Legal Department.
D. Corporate Opportunities. Access Persons may not take personal
advantage of any opportunity properly belonging to any Advisory Client, SCM, or
the Distributor. This includes, but is not limited to, acquiring Securities
for one's own account that would otherwise be acquired for an Advisory Client.
E. Undue Influence. Access Persons may not cause or attempt to cause any
Advisory Client to purchase, sell, or hold any Security in a manner calculated
to create any personal benefit to the Access Person. If an Access Person or
Immediate Family Member stands
9
<PAGE> 14
to materially benefit from an investment decision for an Advisory
Client that the Access Person is recommending or participating in, the Access
Person must disclose to those persons with authority to make investment
decisions for the Advisory Client (or to the Compliance Department if the
Access Person in question is a person with authority to make investment
decisions for the Advisory Client), any Beneficial Interest that the Access
Person (or Immediate Family) has in that Security or an Equivalent Security, or
in the issuer thereof, where the decision could create a material benefit to
the Access Person (or Immediate Family) or the appearance of impropriety. The
person to whom the Access Person reports the interest, in consultation with the
Compliance Department, must determine whether the Access Person will be
restricted in making investment decisions.
F. Service as a Director. No Access Person, other than an Independent
Fund Director, may serve on the board of directors of a publicly-held company
not affiliated with SCM, the Distributor, or the Strong Funds absent prior
written authorization by the Code of Ethics Review Committee. This
authorization will rarely, if ever, be granted and, if granted, will normally
require that the affected Access Person be isolated, through "Chinese Wall" or
other procedures, from those making investment decisions related to the issuer
on whose board the Access Person sits.
G. Involvement in Criminal Matters or Investment-Related Civil
Proceedings. Each Access Person must notify the Compliance Department, as soon
as reasonably practical, if arrested, arraigned, indicted, or pleads no contest
to, any criminal offense (other than minor traffic violations), or if named as
a defendant in any Investment-Related civil proceedings, or any administrative
or disciplinary action.
IV. COMPLIANCE WITH THIS CODE OF ETHICS
A. Code of Ethics Review Committee.
1. Membership, Voting, and Quorum. The Code of Ethics Review
Committee shall initially consist of the General Counsel, President, and
Chief Financial Officer of SCM. The Committee shall vote by majority
vote with two members serving as a quorum. Vacancies may be filled and,
in the case of extended absences or periods of unavailability, alternates
may be selected, by the majority vote of the remaining members of the
Committee; provided, however, in the event that the General Counsel is
unavailable, at least one member of the Committee shall also be a member
of the Compliance Department.
2. Investigating Violations of the Code. The General Counsel or his
or her designee is responsible for investigating any suspected violation
of the Code and shall report the results of each investigation to the
Code of Ethics Review Committee. The Code of Ethics Review Committee is
responsible for reviewing the results of any investigation of any
reported or suspected violation of the Code. Any material violation of
10
<PAGE> 15
the Code by an employee of SCM or the Distributor for which significant
remedial action was taken will be reported to the Boards of Directors of
the Strong Funds not later than the next regularly scheduled quarterly
Board meeting.
3. Annual Reports. The Code of Ethics Review Committee will review
the Code at least once a year, in light of legal and business
developments and experience in implementing the Code, and will prepare an
annual report to the Boards of Directors of SCM, the Distributor, and
each Strong Fund that:
a. Summarizes existing procedures concerning personal
investing and any changes in the procedures made during the past
year;
b. Identifies any violation requiring significant remedial
action during the past year, and
c. Identifies any recommended changes in existing restrictions
or procedures based on its experience under the Code, evolving
industry practices, or developments in applicable laws or
regulations.
B. Remedies.
1. Sanctions. If the Code of Ethics Review Committee determines
that an Access Person has committed a violation of the Code, the
Committee may impose sanctions and take other actions as it deems
appropriate, including a letter of caution or warning, suspension of
personal trading rights, suspension of employment (with or without
compensation), fine, civil referral to the SEC, criminal referral, and
termination of the employment of the violator for cause. The Code of
Ethics Review Committee may also require the Access Person to reverse the
trade(s) in question and forfeit any profit or absorb any loss derived
therefrom. The amount of profit shall be calculated by the Code of
Ethics Review Committee and shall be forwarded to a charitable
organization. No member of the Code of Ethics Review Committee may review
his or her own transaction.
2. Sole Authority. The Code of Ethics Review Committee has sole
authority, subject to the review set forth in Section IV.B.3. below, to
determine the remedy for any violation of the Code, including appropriate
disposition of any moneys forfeited pursuant to this provision. Failure
to promptly abide by a directive to reverse a trade or forfeit profits
may result in the imposition of additional sanctions.
3. Review. Whenever the Code of Ethics Review Committee determines
that an Access Person has committed a violation of this Code that merits
significant remedial action, it will report promptly to the Boards of
Directors of SCM and/or the Distributor (as appropriate), and no less
frequently than the quarterly meeting to the Boards of Directors of the
applicable Strong Funds, information relating to the investigation of the
violation, including any sanctions imposed. The Boards of Directors of
SCM, the
11
<PAGE> 16
Distributor, and the Strong Funds may modify such sanctions as they deem
appropriate. Such Boards shall have access to all information considered
by the Code of Ethics Review Committee in relation to the case. The Code
of Ethics Review Committee may determine whether to delay the imposition
of any sanctions pending review by the applicable Boards of Directors.
C. Exceptions to the Code. Although exceptions to the Code will rarely,
if ever, be granted, the General Counsel of SCM may grant exceptions to the
requirements of the Code on a case by case basis if he finds that the proposed
conduct involves negligible opportunity for abuse. All material exceptions
must be in writing and must be reported as soon as practicable to the Code of
Ethics Review Committee and to the Boards of Directors of the SCM Funds at
their next regularly scheduled meeting after the exception is granted.
D. Compliance Certification. At least annually, all Access Persons will
be required to certify on the Annual Code of Ethics Questionnaire set forth in
Appendix 6 or on a document substantially in the form of Appendix 6 that they
have complied with the Code in all respects.
E. Inquiries Regarding the Code. The Compliance Department will answer
any questions about this Code or any other compliance-related matters.
October 18, 1996
12
<PAGE> 17
Appendix 1
DEFINITIONS
"Access Person" means (1) every director, officer, and general partner of
SCM, the Distributor and the Strong Funds; (2) every employee of SCM and the
Distributor who, in connection with his or her regular functions, makes,
participates in, or obtains information regarding the purchase or sale of a
security by an Advisory Client's account; (3) every employee of SCM and the
Distributor who is involved in making purchase or sale recommendations for an
Advisory Client's account; (4) every employee of SCM and the Distributor who
obtains information concerning such recommendations prior to their
dissemination, and (5) such agents of SCM, the Distributor, or the Funds as the
Compliance Department shall designate who may be deemed an Access Person if
they were an employee of the foregoing. Any uncertainty as to whether an
individual is an Access Person should be brought to the attention of the
Compliance Department. Such questions will be resolved in accordance with, and
this definition shall be subject to, the definition of "Access Person" found in
Rule 17j-1(e)(1) promulgated under the Investment Company Act of 1940.
"Advisory Client" means any client (including both investment companies
and managed accounts) for which SCM serves as an investment adviser or
subadviser, renders investment advice, or makes investment decisions.
"Beneficial Interest" means the opportunity, directly or indirectly,
through any contract, arrangement, understanding, relationship, or otherwise,
to profit, or share in any profit derived from, a transaction in the subject
Securities. An Access Person is deemed to have a Beneficial Interest in
Securities owned by members of his or her Immediate Family. Common examples of
Beneficial Interest include joint accounts, spousal accounts, UTMA accounts,
partnerships, trusts, and controlling interests in corporations. Any
uncertainty as to whether an Access Person has a Beneficial Interest in a
Security should be brought to the attention of the Compliance Department. Such
questions will be resolved by reference to the principles set forth in the
definition of "beneficial owner" found in Rules 16a-1(a)(2) and (5) promulgated
under the Securities Exchange Act of 1934.
"Code" means this Code of Ethics.
"Compliance Department" means the designated persons in the SCM Legal
Department listed on Appendix 2, as such Appendix shall be amended from time to
time.
"The Distributor" means Strong Funds Distributors, Inc.
"Equivalent Security" means any Security issued by the same entity as the
issuer of a subject Security that is convertible into the equity Security of
the issuer. Examples include options, rights, stock appreciation rights,
warrants, and convertible bonds.
13
<PAGE> 18
"Fund" means an investment company registered under the Investment Company
Act of 1940 (or a portfolio or series thereof, as the case may be) for which
SCM serves as an adviser or subadviser.
"Immediate Family" of an Access Person means any of the following persons
who reside in the same household as the Access Person:
child grandparent son-in-law
stepchild spouse daughter-in-law
grandchild sibling brother-in-law
parent mother-in-law sister-in-law
stepparent father-in-law
Immediate Family includes adoptive relationships and any other relationship
(whether or not recognized by law) which the General Counsel determines could
lead to the possible conflicts of interest, diversions of corporate
opportunity, or appearances of impropriety which this Code is intended to
prevent.
"Independent Fund Director" means an independent director of an investment
company for which SCM serves as the advisor.
"Legal Department" means the SCM Legal Department.
"Portfolio Manager" means a person who has or shares principal day-to-day
responsibility for managing the portfolio of an Advisory Client.
"Preclearance Officer" means the person designated as the Preclearance
Officer in Appendix 2 hereof.
"Program Trade" means where a Portfolio Manager directs a trader to do
trades in, at a minimum, 25-30% of the Securities in an account. Program
Trades, generally, arise in three situations: (1) cash or other assets are
being added to an account and the Portfolio Manager instructs the trader that
new securities are to be bought in a manner that maintains the account's
existing allocations; (2) cash is being withdrawn from an account and the
Portfolio Manager instructs the trader that securities are to be sold in a
manner that maintains the account's current securities allocations; and (3) a
new account is established and the Portfolio Manager instructs the trader to
buy specific securities in the same allocation percentages as are held by other
client accounts.
"SEC" means the Securities and Exchange Commission.
"Security" includes stock, notes, bonds, debentures, and other evidences
of indebtedness (including loan participations and assignments), limited
partnership interests, investment contracts, and all derivative instruments of
the foregoing, such as options and warrants. Security
14
<PAGE> 19
does not include futures, options on futures, or options on currencies, but the
purchase and sale of such instruments are nevertheless subject to the reporting
requirements of the Code.
"Securities Transaction" means a purchase or sale of Securities in which
an Access Person or a members of his or her Immediate Family has or acquires a
Beneficial Interest.
"SCM" means Strong Capital Management, Inc.
"Strong Funds" means the investment companies comprising the Strong Family
of Mutual Funds.
15
<PAGE> 20
Appendix 2
CONTACT PERSONS
PRECLEARANCE OFFICER
1. Thomas P. Lemke, General Counsel of SCM
DESIGNEES OF PRECLEARANCE OFFICER
1. Jeffrey C. Nellessen
2. Stephen J. Shenkenberg
COMPLIANCE DEPARTMENT
1. Thomas P. Lemke
2. Jeffrey C. Nellessen
3. Stephen J. Shenkenberg
4. Jeffery A. Arnson
5. Donna J. Lelinski
CODE OF ETHICS REVIEW COMMITTEE
1. John Dragisic, President of SCM
2. Chief Financial Officer of SCM
3. Thomas P. Lemke, General Counsel of SCM
16
<PAGE> 21
Appendix 3
PERSONAL HOLDINGS IN SECURITIES
In accordance with Section II.A. of the Code of Ethics, please provide a
list of all Securities (other than open-end investment companies) in which each
Access Person has a Beneficial Interest, including those in accounts of the
Immediate Family of the Access Person and all Securities in non-client accounts
for which the Access Person makes investment decisions.
(1) Name of Access Person: _________________________
(2) If different than (1), name of the person
in whose name the account is held: _________________________
(3) Relationship of (2) to (1): _________________________
(4) Broker at which Account is maintained: _________________________
(5) Account Number: _________________________
(6) Contact person at Broker and phone number _________________________
(7) For each account, attach the most recent account statement listing
Securities in that account. If the Access Person owns Beneficial
Interests in Securities that are not listed in an attached account
statement, list them below:
Name of Security Quantity Value Custodian
---------------- -------- ----- ---------
1. ____________________________________________________________________________
2. ____________________________________________________________________________
3. ____________________________________________________________________________
4. ____________________________________________________________________________
5. ____________________________________________________________________________
6. ____________________________________________________________________________
(ATTACH SEPARATE SHEET IF NECESSARY.)
I certify that this form and the attached statements (if any) constitute
all of the Securities in which I have a Beneficial Interest, including those
held in accounts of my Immediate Family.
________________________
Access Person Signature
Dated: _____________ ________________________
Print Name
17
<PAGE> 22
Appendix 4
ACKNOWLEDGMENT OF RECEIPT OF CODE OF ETHICS
AND LIMITED POWER OF ATTORNEY
I acknowledge that I have received the Code of Ethics dated October 18,
1996, and represent that:
1. In accordance with Section II.A. of the Code of Ethics, I
will fully disclose the Securities holdings in which I have, or a
member of my Immediate Family has, a Beneficial Interest.*
2. In accordance with Section II.B.1. of the Code of Ethics,
I will obtain prior authorization for all Securities Transactions
in which I have, or a member of my Immediate Family has, a
Beneficial Interest except for transactions exempt from
preclearance under Section II.B. 2. of the Code of Ethics.*
3. In accordance with Section II.G.1 of the Code of Ethics, I
will report all Securities Transactions in which I have, or a
member of my Immediate Family has, a Beneficial Interest, except
for transactions exempt from reporting under Section II.G.1. of
the Code of Ethics.
4. I will comply with the Code of Ethics in all other
respects.
5. I agree to disgorge and forfeit any profits on prohibited
transactions in accordance with the requirements of the Code.*
I hereby appoint Strong Capital Management, Inc. as my attorney-in-fact
for the purpose of placing orders for and on my behalf to buy, sell, tender,
exchange, covert, and otherwise effectuate transactions in any and all stocks,
bonds, options, and other securities. I agree that Strong Capital Management,
Inc. shall not be liable for the consequences of any errors made by the
executing brokers in connection with such transactions.*
__________________________
Access Person Signature
__________________________
Print Name
Dated: __________
* Representations (1), (2) and (5) and the Limited Power of Attorney do
not apply to Independent Fund Directors.
18
<PAGE> 23
Ctrl. No:_________________________ Appendix 5
STRONG CAPITAL MANAGEMENT, INC.
PRECLEARANCE REQUEST FOR ACCESS PERSONS
1. Name of Access Person (and trading entity, if different): __________________
2. Name and symbol of Security: _______________________________________________
3. Maximum quantity to be purchased or sold: __________________________________
4. Name and phone number of broker to effect transaction: _____________________
<TABLE>
<S> <C> <C> <C>
5. Check if applicable: Purchase ____ Market Order ____
Sale ____ Limit Order ____ (Limit Order Price: ___________)
Not Held Order ____
</TABLE>
6. In connection with the foregoing transaction, I hereby make the foregoing
representations and warranties:
(a) I do not possess any material nonpublic information regarding the
Security or the issuer of the Security.
(b) To my knowledge:
(1) The Securities or "equivalent" securities (i.e., securities
issued by the same issuer) [ ARE / ARE NOT ] (circle one) held by
any investment companies or other accounts managed by SCM;
(2) There are no outstanding purchase or sell orders for this
Security (or any equivalent security) by any investment companies or
other accounts managed by SCM; and
(3) None of the Securities (or equivalent securities) are actively
being considered for purchase or sale by any investment companies or
other accounts managed by SCM.
(c) The Securities are not being acquired in an initial public offering.
(d) The Securities are not being acquired in a private placement or, if
they are, I have reviewed Section II.D.3. of the Code and have attached
hereto a written explanation of such transaction.
(e) If I am a Portfolio Manager, none of the accounts I manage purchased
or sold these Securities (or equivalent securities) within the past
seven calendar days and I do not expect any such client accounts to
purchase or sell these Securities (or equivalent securities) within
seven calendar days of my purchase or sale.
(f) If I am purchasing these Securities, I have not directly or
indirectly (through any member of my Immediate Family, any account in
which I have a Beneficial Interest or otherwise) sold these Securities
(or equivalent securities) in the prior 60 days.
(g) If I am selling these Securities, I have not directly or indirectly
(through any member of my Immediate Family, any account in which I have
a beneficial Interest or otherwise) purchased these Securities (or
equivalent securities) in the prior 60 days.
(h) I have read the SCM Code of Ethics within the prior 12 months and
believe that the proposed trade fully complies with the requirements of
the Code.
______________________________ ______________________________
Access Person Print Name
CERTIFICATION OF ACCESS PERSON DESIGNEE
The undersigned hereby certifies that the above Access Person (a) directly
instructed me to complete this Form on his or her behalf, (b) to the best of my
knowledge, was out of the office at the time of such instruction and has not
returned, and (c) confirmed to me that the representations and warranties
contained in this form are accurate.
________________________________ ______________________________
Access Person Designee Print Name
AUTHORIZATION
Authorized By: _____________________ Date: _____________ Time: _____________
PLACEMENT
Trader:____________________ Date:___________ Time:_____________ Qty:_________
EXECUTION
Trader:____________________ Date:___________ Time:_____________
Qty:____________ Price:________________________
(Original to Compliance Department, Yellow copy to Trading
Department, Pink copy to Access Person)
19
<PAGE> 24
Confidential Appendix 6
ANNUAL CODE OF ETHICS QUESTIONNAIRE (1)
For ACCESS PERSONS of
The Strong Family of Mutual Funds,
Strong Capital Management, Inc.,
and Strong Funds Distributors, Inc.
September 18, 1996
Associate: ____________________________
I. Introduction
Access Persons (2) are required to answer all of the questions below for the
year September 1, 1995, through August 31, 1996, and then sign and return the
questionnaire by FRIDAY, SEPTEMBER 27 to Jeff Nellessen in the Legal
Department. ANSWERS OF "NO" TO ANY OF THE QUESTIONS MUST BE EXPLAINED ON THE
"ATTACHMENT" ON PAGE 3. All information provided is kept confidential to the
maximum extent possible. If you have any questions, please contact Jeff
Nellessen at extension 3514.
II. Annual certification of compliance with the Code of Ethics
A. Have you, in accordance with Section II.B.1. of the Code of Ethics,
obtained preclearance for all Securities (3) Transactions in which you
have, or a member of your Immediate Family has, a Beneficial Interest,
except for transactions exempt from preclearance under Section II.B.2.
of the Code of Ethics? (If there have been no Securities Transactions,
circle "Yes".)
YES NO (CIRCLE ONE)
B. Have you, in accordance with Section II.G.1. of the Code of Ethics,
reported all Securities Transactions in which you have, or a member of
your Immediate Family has, a Beneficial Interest, except for
transactions exempt from reporting under Section II.G.1. of the Code of
Ethics? In particular, have you arranged for the Legal Department to
receive directly from your broker duplicate transaction confirmations
and duplicate periodic statements for each brokerage account in which
you have, or a member of your Immediate Family has, a Beneficial
Interest? (4) (If there are no brokerage accounts, circle "Yes".)
YES NO (CIRCLE ONE)
- -------------------------
1 All definitions used in this questionnaire have the same meaning as those in
the Code of Ethics.
2 Independent Fund Directors of the Strong Funds must complete a separate
questionnaire.
3 Security, as defined, does NOT include open-end investment companies,
including the Strong Funds.
4 Please contact Jeff Nellessen (extension 3514) if you are uncertain as to
what confirmations and statements you have arranged for the Legal Department to
receive.
20
<PAGE> 25
C. Have you complied with the Code of Ethics in all other respects,
including the gift policy (Section III.B.)?
YES NO (CIRCLE ONE)
LIST ON THE ATTACHMENT ALL REPORTABLE5 GIFTS6 GIVEN OR RECEIVED FOR THE
YEAR SEPTEMBER 1, 1995, THROUGH AUGUST 31, 1996, NOTING THE MONTH,
"COUNTERPARTY," GIFT DESCRIPTION, AND ESTIMATED VALUE. IF NONE, SO STATE.
III. Annual certification of compliance with Insider Trading Policy
Have you complied in all respects with the Insider Trading Policy (dated
October 20, 1995)?
YES NO (CIRCLE ONE)
IV. Disclosure of directorships statement
A. I am not, nor is any member of my Immediate Family, a director and/or
an officer of any for-profit, privately held companies.7 (If you are
NOT, answer YES.)
YES NO (CIRCLE ONE)
If "NO", please list on the Attachment each company for which you are, or
a member of your Immediate Family is, a director.
B. If the response to A. is "NO", is there a reasonable expectation that
any of the companies for which you are, or a member of your Immediate
Family is, a director and/or an officer, will go public or be acquired
within the next 12 months?
YES NO (CIRCLE ONE)
(If the answer is "YES", please be prepared to discuss this matter with a
member of the Legal Department in the near future.)
ANSWERS OF "NO" TO ANY OF THE ABOVE QUESTIONS MUST BE EXPLAINED ON THE
"ATTACHMENT" ON PAGE 3.
I hereby represent that, to the best of my knowledge, the foregoing responses
are true and complete. I understand that any untrue or incomplete response may
be subject to disciplinary action by the firm.
___________________________________
Access Person Signature
Dated: _________________________
Print Name ________________________
____________________________
5 Associates are NOT required to report the following: (i) usual and customary
promotional items given to or received from vendors, (ii) items donated to
charity (through Mary Beitzel in Legal), or (iii) food items consumed on the
premises.
6 Entertainment -- i.e., a meal or activity with the vendor present -- does not
have to be reported.
7 Per Section III.F. of the Code of Ethics, no Access Person, other than an
Independent Fund Director, may serve on the board of directors of a publicly
held company.
21
<PAGE> 26
ATTACHMENT TO
ANNUAL CODE OF ETHICS QUESTIONNAIRE
(to explain all "NO" answers and to list reportable(8) gifts(9) )
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
GIFTS(8),(9) for the year September 1, 1995, through August 31, 1996.
(If NONE, so state):
Month Gift Giver / Receiver Gift Description Estimated Value
----- --------------------- ---------------- ---------------
1. _____________________________________________________________________________
2. _____________________________________________________________________________
3. _____________________________________________________________________________
4. _____________________________________________________________________________
5. _____________________________________________________________________________
6. _____________________________________________________________________________
7. _____________________________________________________________________________
8. _____________________________________________________________________________
9. _____________________________________________________________________________
10._____________________________________________________________________________
(CONTINUE ON AN ADDITIONAL SHEET IF NECESSARY.)
__________________
8 Associates are NOT required to report the following: (i) usual and customary
promotional items given to or received from vendors, (ii) items donated to
charity (through Mary Beitzel in Legal), or (iii) food items consumed on the
premises.
9 Entertainment -- i.e., a meal or activity with the vendor present -- does not
have to be reported.
22
<PAGE> 27
Appendix 7
LIST OF BROAD-BASED INDICES
Listed below are the broad-based indices as designated by the Compliance
Department. See Section II.B.3. for additional information.
- -------------------------------------------------
DESCRIPTION OF OPTION SYMBOL EXCHANGE
- -------------------------------------------------
Computer Technology XCI AMEX
- -------------------------------------------------
Eurotop 100 ERT AMEX
- -------------------------------------------------
Hong Kong Option Index HKO AMEX
- -------------------------------------------------
Inter@ctive Wk. Internet Index INX CBOE
- -------------------------------------------------
Japan Index JPN AMEX
- -------------------------------------------------
Major Market Index * XMI AMEX
- -------------------------------------------------
Morgan Stanley High Tech Index MSH AMEX
- -------------------------------------------------
NASDAQ-100 NDX CBOE
- -------------------------------------------------
Pacific High Tech Index XPI PSE
- -------------------------------------------------
Russell 2000 * RUT CBOE
- -------------------------------------------------
Semiconductor Sector SOX PHLX
- -------------------------------------------------
S & P 100 * OEX CBOE
- -------------------------------------------------
S & P 500 * SPX CBOE
- -------------------------------------------------
Technology Index TXX CBOE
- -------------------------------------------------
Value Line Index * VLE PHLX
- -------------------------------------------------
Wilshire Small Cap Index WSX PSE
- -------------------------------------------------
- -------------------------------------------------
* Includes LEAPS.
- -------------------------------------------------
23
<PAGE> 28
Appendix 8
FORM LETTER TO BROKER OR BANK
[DATE]
<Broker Name>
<Broker Address>
<Broker City, State and Zip>
Subject: Account Number_____________________
Account Registration_______________
Dear ____________:
Strong Capital Management, Inc. ("SCM"), my employer, is a registered
investment adviser as well as the indirect parent of an NASD member firm. The
Code of Ethics of SCM requires that I have certain personal securities
transactions placed on my behalf by the trading desk of SCM. Accordingly,
please send me the necessary forms or instructions that you will require in
order to enable the securities traders of SCM to place orders on my behalf.
In addition, you are requested to send duplicate confirmations of individual
transactions as well as duplicate periodic statements for the referenced
account to SCM. Please address the confirmations and statements directly to:
Confidential
Chief Compliance Officer
Strong Capital Management, Inc.
100 Heritage Reserve
Menomonee Falls, Wisconsin 53051
Your cooperation is most appreciated. If you have any questions regarding these
requests, please contact me or Mr. Jeffrey C. Nellessen of Strong at (414)
359-3400.
Sincerely,
<Name of Access Person>
Copy: Mr. Jeffrey C. Nellessen
24
<PAGE> 29
Appendix 9
GIFT POLICY
MEMORANDUM
TO: All Associates
FROM: Thomas P. Lemke
DATE: December 1, 1994
SUBJECT: Gift Policy Reminder
With the Holiday season upon us, I wanted to remind you of our firm's gift
policy, which covers both GIVING GIFTS TO and ACCEPTING GIFTS FROM clients,
brokers, persons with whom we do business, or others (collectively, "vendors").
It is based on the applicable requirements of the Rules of Fair Practice of
the National Association of Securities Dealers, Inc. ("NASD") and is included
as part of the firm's Codes of Ethics.
Under our policy, associates may not give gifts to or accept gifts from
vendors with a value in excess of $100 per person per year and must report to
the firm annually if they accept certain types of gifts. The NASD defines a
"gift" to include any kind of gratuity. Since giving or receiving any gifts in
a business setting may give rise to an appearance of impropriety or may raise a
potential conflict of interest, we are relying on your professional attitude
and good judgment to ensure that our policy is observed to the fullest extent
possible. The discussion below is designed to assist you in this regard.
If you have any questions about the appropriateness of any gift, contact
Legal.
1. GIFTS GIVEN BY ASSOCIATES
Under applicable NASD rules, an associate may not give any gift with a
value in excess of $100 per year to any person associated with a securities or
financial organization, including exchanges, broker-dealers, commodity firms,
the news media, or clients of the firm. Please note, however, that the firm
may not take a tax deduction for any gift with a value exceeding $25.
This memorandum is not intended to authorize any associate to give a gift
to a vendor -- appropriate supervisory approval must be obtained before giving
any gifts.
2. GIFTS ACCEPTED BY ASSOCIATES
On occasion, because of their position within the firm, associates may
be offered, or may receive without notice, gifts from vendors. Associates may
not accept any gift or form of entertainment from vendors (e.g., tickets to the
theater or a sporting event where the vendor does not
25
<PAGE> 30
accompany the associate) other than gifts of NOMINAL VALUE, which the
NASD defines as under $100 in total from any vendor in any year (managers may,
if they deem it appropriate for their department, adopt a lower dollar
ceiling). Any gift accepted by an associate must be reported to the firm,
subject to certain exceptions (see heading 4 below). In addition, note that
our gift policy does not apply to normal and customary business entertainment
or to personal gifts (see heading 3 below).
Associates may not accept a gift of cash or a cash equivalent (e.g., gift
certificates) in ANY amount, and under no circumstances may an associate
solicit a gift from a vendor.
Associates may wish to have gifts from vendors donated to charity,
particularly where it might be awkward or impolite for an associate to decline
a gift not permitted by our policy. In such case, the gift should be forwarded
to Mary Beitzel in Legal, who will arrange for it to be donated to charity.
Similarly, associates may wish to suggest to vendors that, in lieu of an annual
gift, the vendors make a donation to charity. In either situation discussed
in this paragraph, an associate would not need to report the gift to the firm
(see heading 4 below).
3. EXCLUSION FOR BUSINESS ENTERTAINMENT/PERSONAL GIFTS
Our gift policy does not apply to normal and customary business meals and
entertainment with vendors. For example, if an associate has a business meal
and attends a sporting event or show with a vendor, that activity would not be
subject to our gift policy, provided the vendor is present. If, on the other
hand, a vendor gives an associate tickets to a sporting event and the associate
attends the event without the vendor also being present, the tickets would be
subject to the dollar limitation and reporting requirements of our gift policy.
Under no circumstances may associates accept business entertainment that is
extraordinary or extravagant in nature.
In addition, our gift policy does not apply to usual and customary gifts
given to or received from vendors based on a personal relationship (e.g., gifts
between an associate and a vendor where the vendor is a family member or
personal friend).
4. REPORTING
The NASD requires gifts to be reported to the firm. Except as noted
below, associates must report annually all gifts given to or accepted from
vendors (Legal will distribute the appropriate reporting form to associates).
Associates are NOT required to report the following: (i) usual and
customary promotional items given to or received from vendors (e.g., hats,
pens, T-shirts, and similar items marked with a firm's logo), (ii) items
donated to charity through Mary Beitzel in Legal, or (iii) food items consumed
on the firm's premises (e.g., candy, popcorn, etc.).
26
<PAGE> 1
EXHIBIT 99.B21.2
CODE OF ETHICS
FOR NON-ACCESS PERSONS OF
STRONG CAPITAL MANAGEMENT, INC.,
STRONG FUNDS DISTRIBUTORS, INC., AND
HERITAGE RESERVE DEVELOPMENT
CORPORATION, INC.
[STRONG FUNDS LOGO]
STRONG CAPITAL MANAGEMENT, INC.
October 18, 1996
<PAGE> 2
CODE OF ETHICS
For Non-Access Persons of
Strong Capital Management, Inc.,
Strong Funds Distributors, Inc., and
Heritage Reserve Development Corporation, Inc.
Dated October 18, 1996
Table of Contents
I. INTRODUCTION .............................................................1
A. Fiduciary Duty ...........................................................1
1. Place the interests of clients first .....................................1
2. Avoid taking inappropriate advantage of their position ...................1
3. Conduct all personal Securities Transactions in full compliance with this
Code including the reporting requirements ....................................1
B. Appendices to the Code ...................................................1
1. Definitions ..............................................................1
2. Acknowledgment of Receipt of Code of Ethics ..............................2
3. Annual Code of Ethics Questionnaire ......................................2
4. Form Letter to Broker or Bank ............................................2
5. Gift Policy ..............................................................2
II. TRADE REPORTING REQUIREMENTS .............................................2
A. Reporting Requirement ....................................................2
B. Disclaimers ..............................................................2
C. Availability of Reports ..................................................2
D. Record Retention .........................................................2
III. FIDUCIARY DUTIES .......................................................3
A. Confidentiality ..........................................................3
B. Gifts To or From Employees ...............................................3
1. Accepting Gifts ..........................................................3
2. Solicatation of Gifts ....................................................3
3. Giving Gifts .............................................................3
C. Payments to Advisory Clients or Shareholders .............................3
D. Corporate Opportunities ..................................................3
E. Service as a Director ....................................................3
F. Involvement in Criminal Matters or Investment-Related Civil Proceedings ..4
IV. COMPLIANCE WITH THIS CODE OF ETHICS .....................................4
A. Code of Ethics Review Committee ..........................................4
1. Membership, Voting, and Quorum ...........................................4
2. Investigating Violations of the Code .....................................4
B. Remedies .................................................................4
C. Compliance Certification .................................................4
D. Inquiries Regarding the Code .............................................4
i
<PAGE> 3
CODE OF ETHICS
For Non-Access Persons of
Strong Capital Management, Inc.,
Strong Funds Distributors, Inc., and
Heritage Reserve Development Corporation, Inc.
Dated October 18, 1996
Table of Appendices
Appendix 1 (Definitions).................................................... 5
Appendix 2 (Acknowledgment of Receipt of Code of Ethics) ................... 7
Appendix 3 (Annual Code of Ethics Questionnaire) ........................... 8
Appendix 4 (Form Letter to Broker or Bank) .................................11
Appendix 5 (Gift Policy)....................................................12
ii
<PAGE> 4
CODE OF ETHICS
For Non-Access Persons of
Strong Capital Management, Inc.,
Strong Funds Distributors, Inc., and
Heritage Reserve Development Corporation, Inc.
Dated October 18, 1996
I. INTRODUCTION
A. Fiduciary Duty. This Code of Ethics is based upon the principle that
employees of Strong Capital Management, Inc. ("SCM"), Strong Funds
Distributors, Inc. ("the Distributor"), Heritage Reserve Development
Corporation, Inc. ("HRDC"), and such other affiliated entities of the foregoing
that may from time to time adopt this Code (each of which is individually
referred to herein as a "Company") have a fiduciary duty to place the interests
of clients ahead of their own. Employees must avoid activities, interests, and
relationships that might interfere with making decisions in the best interests
of each Company and its clients.
As fiduciaries, employees must at all times:
1. Place the interests of clients first. Employees must
scrupulously avoid serving their own personal interests ahead of the
interests of the clients of each Company. An employee may not induce or
cause a client to take action, or not to take action, for personal
benefit, rather than for the benefit of the client.
2. Avoid taking inappropriate advantage of their position. The
receipt of investment opportunities, perquisites, or gifts from persons
seeking business with the Strong Funds, any of the Companies, or their
clients could call into question the exercise of an employee's
independent judgment. Employees may not, for example, use their
knowledge of portfolio transactions to profit by the market effect of
such transactions.
3. Conduct all personal Securities Transactions in full compliance
with this Code including the reporting requirements.
Doubtful situations should be resolved in favor of clients and each
Company. Technical compliance with the Code's procedures will not
automatically insulate from scrutiny any personal Securities Transactions that
indicate an abuse of fiduciary duties.
B. Appendices to the Code. The appendices to this Code, including the
definitions set forth in Appendix 1, are attached to and are a part of the
Code. The appendices include the following:
1. Definitions (capitalized terms in the Code are defined in
Appendix 1),
1
<PAGE> 5
2. Acknowledgment of Receipt of Code of Ethics (Appendix 2),
3. Annual Code of Ethics Questionnaire (Appendix 3),
4. Form Letter to Broker or Bank (Appendix 4), and
5. Gift Policy (Appendix 5)
II. TRADE REPORTING REQUIREMENTS
A. Reporting Requirement. EVERY EMPLOYEE AND MEMBERS OF HIS OR HER
IMMEDIATE FAMILY MUST ARRANGE FOR THE COMPLIANCE DEPARTMENT TO RECEIVE DIRECTLY
FROM ANY BROKER, DEALER, OR BANK THAT EFFECTS ANY SECURITIES TRANSACTION, A
DUPLICATE COPY OF EACH CONFIRMATION FOR EACH SUCH TRANSACTION AND PERIODIC
STATEMENTS FOR EACH BROKERAGE ACCOUNT IN WHICH SUCH EMPLOYEE HAS A BENEFICIAL
INTEREST. Attached hereto as Appendix 4 is a form letter that may be used to
request such documents from such entities. An employee must arrange to have
duplicate confirmations and periodic statements sent within 30 days. If unable
to make such arrangements, the employee must immediately notify the Compliance
Department. THE FOREGOING DOES NOT APPLY TO TRANSACTIONS AND HOLDINGS IN (1)
MUTUAL FUNDS (INCLUDING BUT NOT LIMITED TO THE STRONG FUNDS), (2) BANK
CERTIFICATES OF DEPOSIT ("CDS"), (3) EQUITY SECURITIES HELD IN DIVIDEND
REINVESTMENT PLANS ("DRIPS"), OR (4) SECURITIES OF THE EMPLOYER OF A MEMBER OF
THE EMPLOYEE'S IMMEDIATE FAMILY IF SUCH SECURITIES ARE BENEFICIALLY OWNED
THROUGH PARTICIPATION BY THE IMMEDIATE FAMILY MEMBER IN A PROFIT SHARING PLAN,
401(K) PLAN, ESOP, OR OTHER SIMILAR PLAN.
B. Disclaimers. Any employee who files a report of a Securities
Transaction for the benefit of a person other than the employee may include in
such report a statement that the report should not be construed as an admission
by the employee making the report that he or she has any direct or indirect
beneficial ownership in the Security to which the report relates.
C. Availability of Reports. All information supplied pursuant to this
Code will be available for inspection by the Boards of Directors of SCM and
SFDI, the Board of Directors of each Strong Fund, the Code of Ethics Review
Committee, the Compliance Department, the employees department manager (or
designee), any party to which any investigation is referred by any of the
foregoing, the SEC, any self-regulatory organization of which the Strong Funds,
SCM, or the Distributor is a member, any state securities commission, as well
as any attorney or agent of the foregoing, the Strong Funds, SCM, or the
Distributor.
D. Record Retention. The Company shall keep and maintain for at least six
years records of the procedures it follows in connection with the reporting
requirements of this Code.
2
<PAGE> 6
III. FIDUCIARY DUTIES
A. Confidentiality. Employees are prohibited from revealing information
relating to the investment intentions, activities, or portfolios of Advisory
Clients except to persons whose responsibilities require knowledge of the
information.
B. Gifts To or From Employees.
1. Accepting Gifts. On occasion, because of their relationship with
the Company and its affiliates, employees thereof may be offered, or may
receive without notice, gifts from clients, brokers, vendors, or other
persons not affiliated with the Company. Acceptance of extraordinary or
extravagant gifts is not permissible. Any such gifts must be declined or
returned in order to protect the reputation and integrity of the Company.
Gifts of a nominal value (i.e., gifts whose reasonable value is no more
than $100 a year), and customary business meals, entertainment (e.g.,
sporting events), and promotional items (e.g., pens, mugs, T-shirts) may
be accepted. Please see the Gift Policy Reminder memorandum dated
December 1, 1994 (Appendix 5) for additional information.
If an employee receives any gift that might be prohibited under this
Code, the employee must inform the Compliance Department immediately.
2. Solicitation of Gifts. Employees may not solicit gifts or
gratuities from clients, brokers, vendors, or other persons with which
the Company has a relationship.
3. Giving Gifts. Employees may not give any gift with a value in
excess of $100 per year to persons associated with securities or
financial organizations, including exchanges, other member organizations,
commodity firms, news media, or clients of the Company. Please see the
Gift Policy Reminder memorandum dated December 1, 1994 (Appendix 5) for
additional information.
C. Payments to Advisory Clients or Shareholders. Employees may not make
any payments to Advisory Clients or Shareholders in order to resolve any type
of Advisory Client or Shareholder complaint. All such matters must be handled
by the Legal Department.
D. Corporate Opportunities. Employees may not take personal advantage of
any opportunity properly belonging to any client or Company.
E. Service as a Director. No employee may serve on the board of directors
of a publicly-held company not affiliated with a Company or the Strong Funds
absent prior written authorization by the Code of Ethics Review Committee.
This authorization will rarely, if ever, be granted and, if granted, will
normally require that the affected employee be isolated, through "Chinese Wall"
or other procedures, from those making investment decisions related to the
issuer on whose board the employee sits.
3
<PAGE> 7
F. Involvement in Criminal Matters or Investment-Related Civil
Proceedings. Each Non-Access Person must notify the Compliance Department, as
soon as reasonably practical, if arrested, arraigned, indicted, or pleads no
contest to, any criminal offense (other than minor traffic violations), or if
named as a defendant in any Investment-Related civil proceedings, or any
administrative or disciplinary action.
IV. COMPLIANCE WITH THIS CODE OF ETHICS
A. Code of Ethics Review Committee.
1. Membership, Voting, and Quorum. The Code of Ethics Review
Committee shall initially consist of the General Counsel, President, and
Chief Financial Officer of SCM. The Committee shall vote by majority
vote with two members serving as a quorum. Vacancies may be filled and,
in the case of extended absences or periods of unavailability, alternates
may be selected, by the majority vote of the remaining members of the
Committee; provided, however, in the event that the General Counsel is
unavailable, at least one member of the Committee shall also be a member
of the Compliance Department.
2. Investigating Violations of the Code. The General Counsel or his
or her designee is responsible for investigating any suspected violation
of the Code and shall report the results of each investigation to the
Code of Ethics Review Committee. The Code of Ethics Review Committee is
responsible for reviewing the results of any investigation of any
reported or suspected violation of the Code.
B. Remedies. If the Code of Ethics Review Committee determines that an
employee has committed a violation of the Code, the Committee may impose
sanctions and take other actions as it deems appropriate, including, but not
limited to, suspension of employment (with or without compensation) and
termination of the employment of the violator for cause. The Code of Ethics
Review Committee may also require the employee to reverse the trade(s) in
question and forfeit any profit or absorb any loss derived therefrom. Any
profit shall be forwarded to a charitable organization.
C. Compliance Certification. At least annually, all employees will be
required to certify on the Annual Code of Ethics Questionnaire set forth in
Appendix 2 or on a document substantially in the form of Appendix 2 that they
have complied with the Code in all respects.
D. Inquiries Regarding the Code. The Compliance Department will answer
any questions about this Code or any other compliance-related matters.
October 18, 1996
4
<PAGE> 8
Appendix 1
DEFINITIONS
"Advisory Client" means any client (including both investment companies
and managed accounts) for which SCM serves as an investment adviser or
subadviser, renders investment advice, or makes investment decisions.
"Beneficial Interest" means the opportunity, directly or indirectly,
through any contract, arrangement, understanding, relationship, or otherwise,
to profit, or share in any profit derived from, a transaction in the subject
Securities. An employee is deemed to have a Beneficial Interest in Securities
owned by members of his or her Immediate Family. Common examples of Beneficial
Interest include joint accounts, spousal accounts, UTMA accounts, partnerships,
trusts, and controlling interests in corporations. Any uncertainty as to
whether an employee has a Beneficial Interest in a Security should be brought
to the attention of the Compliance Department. Such questions will be resolved
in accordance with, and this definition shall be subject to, the definition of
"beneficial owner" found in Rules 16a-1(a)(2) and (5) promulgated under the
Securities Exchange Act of 1934.
"Company" means "SCM", "the Distributor", "HRDC", and such other
affiliated entities of the foregoing that may from time to time adopt this
Code.
"Code" means this Code of Ethics.
"Compliance Department" means the designated persons in the Strong Legal
Department.
"Distributor" means Strong Funds Distributors, Inc.
"HRDC" means Heritage Reserve Development Corporation, Inc.
"Immediate Family" of an employee means any of the following persons who
reside in the same household as the employee:
child grandparent son-in-law
stepchild spouse daughter-in-law
grandchild sibling brother-in-law
parent mother-in-law sister-in-law
stepparent father-in-law
Immediate Family includes adoptive relationships and any other relationship
(whether or not recognized by law) which the General Counsel determines could
lead to the possible conflicts of interest, diversions of corporate
opportunity, or appearances of impropriety which this Code is intended to
prevent.
"Legal Department" means the SCM Legal Department.
5
<PAGE> 9
"SEC" means the Securities and Exchange Commission.
"Security" includes stock, notes, bonds, debentures, and other evidences
of indebtedness (including loan participations and assignments), limited
partnership interests, investment contracts, and all derivative instruments of
the foregoing, such as options and warrants. Security does not include
futures, options on futures, or options on currencies, but the purchase and
sale of such instruments are nevertheless subject to the reporting requirements
of the Code.
"Securities Transaction" means a purchase or sale of Securities in which
an employee or a members of his or her Immediate Family has or acquires a
Beneficial Interest.
"Shareholder" means a shareholder in any of the Strong Funds.
"SCM" means Strong Capital Management, Inc.
"Strong Funds" means the investment companies comprising the Strong Family
of Mutual Funds.
6
<PAGE> 10
Appendix 2
ACKNOWLEDGMENT OF RECEIPT OF CODE OF ETHICS
I acknowledge that I have received and read the Code of Ethics dated
October 18, 1996, and represent that:
1. I will report all Securities Transactions in which I have, or a
member of my Immediate Family has, a Beneficial Interest, except for
transactions and holdings in (1) mutual funds (including but not limited
to the Strong Funds), (2) bank certificates of deposit ("CDs"), (3)
equity securities held in dividend reinvestment plans ("DRIPs"), or (4)
securities of the employer of a member of the employee's Immediate Family
if such securities are beneficially owned through participation by the
Immediate Family member in a Profit Sharing plan, 401(k) plan, ESOP, or
other similar plan.
2. I will comply with the Code of Ethics in all other respects.
_________________________________
Employee Signature
_________________________________
Print Name
Dated: ________________________________
7
<PAGE> 11
Confidential Appendix 3
ANNUAL CODE OF ETHICS QUESTIONNAIRE (1)
For NON-ACCESS PERSONS (2) of
Strong Capital Management, Inc.,
Strong Funds Distributors, Inc.,
and Heritage Reserve Development Corporation.
September 18, 1996
Associate: ____________________________
I. Introduction
Non-Access Persons are required to answer all of the questions below for the
year September 1, 1995, through August 31, 1996, sign the questionnaire and
return it to the Legal Department (an intra-office mail slip is copied on the
back of the last page) by FRIDAY, SEPTEMBER 27. ANSWERS OF "NO" TO ANY OF
THE QUESTIONS MUST BE EXPLAINED ON THE "ATTACHMENT" ON PAGE 3. If you have
any questions, please contact Jeffery Arnson (x3590) or Donna Lelinski
(x3362) in the Legal Department.
II. Annual certification of compliance with the Code of Ethics
A. Have you, in accordance with Section II.A. of the Code of Ethics,
reported all Securities Transactions in which you have, or a member of
your Immediate Family has, a Beneficial Interest, except for
transactions in mutual funds (including the Strong Funds), dividend
reinvestment plans ("DRIPs"), and certificates of deposit (CDs"). (If
there are no brokerage accounts, circle "Yes".)
YES NO (CIRCLE ONE)
B. Have you complied with the Code of Ethics in all other respects,
including the gift policy (Section III.B.)?
YES NO (CIRCLE ONE)
LIST ON THE ATTACHMENT ALL REPORTABLE (3) GIFTS (4) GIVEN OR RECEIVED FOR
THE YEAR SEPTEMBER 1, 1995, THROUGH AUGUST 31, 1996, NOTING THE MONTH,
"COUNTERPARTY," GIFT DESCRIPTION, AND ESTIMATED VALUE. IF NONE, SO STATE.
________________________
1 All definitions used in this questionnaire have the same meaning as those in
the Code of Ethics.
2 Access Persons must complete a separate questionnaire.
3 Associates are NOT required to report the following: (i) usual and customary
promotional items given to or received from vendors, (ii) items donated to
charity (through Mary Beitzel in Legal), or (iii) food items consumed on the
premises.
4 Entertainment -- i.e., a meal or activity with the vendor present -- does not
have to be reported.
8
<PAGE> 12
III. Annual certification of compliance with Insider Trading Policy
Have you complied in all respects with the Insider Trading Policy (dated
October 20, 1995)?
YES NO (CIRCLE ONE)
IV. Disclosure of directorships statement
A. I am not, nor is any member of my Immediate Family, a director and/or
an officer of any for-profit, privately held companies.(5) (If you are
NOT, answer YES.)
YES NO (CIRCLE ONE)
If "NO", please list on the Attachment each company for which you are,
or a member of your Immediate Family is, a director.
B. If the response to A. is "NO", is there a reasonable expectation that
any of the companies for which you are, or a member of your Immediate
Family is, a director and/or an officer, will go public or be acquired
within the next 12 months?
YES NO (CIRCLE ONE)
(If the answer is "YES", please be prepared to discuss this matter
with a member of the Legal Department in the near future.)
**********************
ANSWERS OF "NO" TO ANY OF THE ABOVE QUESTIONS MUST BE
EXPLAINED ON THE "ATTACHMENT" ON PAGE 3.
**********************
I hereby represent that, to the best of my knowledge, the foregoing responses
are true and complete. I understand that any untrue or incomplete response may
be subject to disciplinary action by the firm.
_____________________________
Non-Access Person Signature
Dated: ________________ _____________________________
Print Name
_________________________
(5) Per Section III.E. of the Code of Ethics, no associate may serve on the
board of directors of a publicly held company.
9
<PAGE> 13
ATTACHMENT TO
ANNUAL CODE OF ETHICS QUESTIONNAIRE
(to explain all "NO" answers and to list reportable(6) gifts(7) )
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
______________GIFTS(6),(7) for the year September 1, 1995, through August 31,
1996. (If NONE, so state):
Month Gift Giver / Receiver Gift Description Estimated Value
----- --------------------- ---------------- ---------------
1. _____________________________________________________________________________
2. _____________________________________________________________________________
3. _____________________________________________________________________________
4. _____________________________________________________________________________
5. _____________________________________________________________________________
6. _____________________________________________________________________________
7. _____________________________________________________________________________
8. _____________________________________________________________________________
9. _____________________________________________________________________________
10._____________________________________________________________________________
(CONTINUE ON AN ADDITIONAL SHEET IF NECESSARY.)
___________________________
(6) Associates are NOT required to report the following: (i) usual and customary
promotional items given to or received from vendors, (ii) items donated to
charity (through Mary Beitzel in Legal), or (iii) food items consumed on the
premises.
(7) Entertainment -- i.e., a meal or activity with the vendor present -- does
not have to be reported.
10
<PAGE> 14
Appendix 4
FORM LETTER TO BROKER OR BANK
[DATE]
<Broker Name>
<Broker Address>
<Broker City, State and Zip>
Subject: Account Number____________________
Account Registration______________
Dear ____________:
Please send duplicate confirmations of individual transactions as well as
duplicate periodic statements for the referenced account to:
Confidential
------------
Chief Compliance Officer
Strong Capital Management, Inc.
100 Heritage Reserve
Menomonee Falls, Wisconsin 53051
Your cooperation is most appreciated. If you have any questions regarding this
request, please contact me or the Compliance Department of Strong Capital
Management at (414) 359-3400.
Sincerely,
<Name of Employee>
copy: Chief Compliance Officer
Strong Capital Management, Inc.
11
<PAGE> 15
Appendix 5
GIFT POLICY
MEMORANDUM
----------
TO: All Associates
FROM: Thomas P. Lemke
DATE: December 1, 1994
SUBJECT: Gift Policy Reminder
With the Holiday season upon us, I wanted to remind you of our firm's gift
policy, which covers both GIVING GIFTS TO and ACCEPTING GIFTS FROM clients,
brokers, persons with whom we do business, or others (collectively, "vendors").
It is based on the applicable requirements of the Rules of Fair Practice of
the National Association of Securities Dealers, Inc. ("NASD") and is included
as part of the firm's Codes of Ethics.
Under our policy, associates may not give gifts to or accept gifts from
vendors with a value in excess of $100 per person per year and must report to
the firm annually if they accept certain types of gifts. The NASD defines a
"gift" to include any kind of gratuity. Since giving or receiving any gifts in
a business setting may give rise to an appearance of impropriety or may raise a
potential conflict of interest, we are relying on your professional attitude
and good judgment to ensure that our policy is observed to the fullest extent
possible. The discussion below is designed to assist you in this regard.
If you have any questions about the appropriateness of any gift, contact
Legal.
1. GIFTS GIVEN BY ASSOCIATES
Under applicable NASD rules, an associate may not give any gift with a
value in excess of $100 per year to any person associated with a securities or
financial organization, including exchanges, broker-dealers, commodity firms,
the news media, or clients of the firm. Please note, however, that the firm
may not take a tax deduction for any gift with a value exceeding $25.
This memorandum is not intended to authorize any associate to give a gift
to a vendor -- appropriate supervisory approval must be obtained before giving
any gifts.
2. GIFTS ACCEPTED BY ASSOCIATES
12
<PAGE> 16
On occasion, because of their position within the firm, associates may
be offered, or may receive without notice, gifts from vendors. Associates may
not accept any gift or form of entertainment from vendors (e.g., tickets to the
theater or a sporting event where the vendor does not accompany the associate)
other than gifts of NOMINAL VALUE, which the NASD defines as under $100 in
total from any vendor in any year (managers may, if they deem it appropriate
for their department, adopt a lower dollar ceiling). Any gift accepted by an
associate must be reported to the firm, subject to certain exceptions (see
heading 4 below). In addition, note that our gift policy does not apply to
normal and customary business entertainment or to personal gifts (see heading 3
below).
Associates may not accept a gift of cash or a cash equivalent (e.g., gift
certificates) in ANY amount, and under no circumstances may an associate
solicit a gift from a vendor.
Associates may wish to have gifts from vendors donated to charity,
particularly where it might be awkward or impolite for an associate to decline
a gift not permitted by our policy. In such case, the gift should be forwarded
to Mary Beitzel in Legal, who will arrange for it to be donated to charity.
Similarly, associates may wish to suggest to vendors that, in lieu of an annual
gift, the vendors make a donation to charity. In either situation discussed
in this paragraph, an associate would not need to report the gift to the firm
(see heading 4 below).
3. EXCLUSION FOR BUSINESS ENTERTAINMENT/PERSONAL GIFTS
Our gift policy does not apply to normal and customary business meals and
entertainment with vendors. For example, if an associate has a business meal
and attends a sporting event or show with a vendor, that activity would not be
subject to our gift policy, provided the vendor is present. If, on the other
hand, a vendor gives an associate tickets to a sporting event and the associate
attends the event without the vendor also being present, the tickets would be
subject to the dollar limitation and reporting requirements of our gift policy.
Under no circumstances may associates accept business entertainment that is
extraordinary or extravagant in nature.
In addition, our gift policy does not apply to usual and customary gifts
given to or received from vendors based on a personal relationship (e.g., gifts
between an associate and a vendor where the vendor is a family member or
personal friend).
4. REPORTING
The NASD requires gifts to be reported to the firm. Except as noted
below, associates must report annually all gifts given to or accepted from
vendors (Legal will distribute the appropriate reporting form to associates).
Associates are NOT required to report the following: (i) usual and
customary promotional items given to or received from vendors (e.g., hats,
pens, T-shirts, and similar items marked with a firm's logo), (ii) items
donated to charity through Mary Beitzel in Legal, or (iii) food items consumed
on the firm's premises (e.g., candy, popcorn, etc.).
13
